Saturday, January 27, 2007

Saving for Retirement

The article copied at the bottom caught my attention.

I've questioned the economic advice of those that have pumped retirement savings at peril of debt repayment and lifestyle much of my adult life.

Housing: A big priority.

My view is somewhat different in that I have always considered that the first priority was to secure a home, so that when you retire you no longer have mortgage or rent costs, and once you've secured your home, you put the money you would have paid towards the mortgage to retirement savings, and once you retire, your income needs decline by the rate of savings, and the costs of going to a job. They increase by the cost of what you do to fill all that extra time.

Currently with the high cost of housing, I do not think entering the housing market is a good idea, but certainly saving for a better entry point is still a wise money management decision.

If you are not living the lifestyle you would like to live in your retirement, then you will need to save more.

I have also always looked at down sizing the home as a part of retirement planning. In Canada there simply isn't any capital gains taxes for your home.

So, my retirement plan has included buying double the home I need and RRSPs. It holds protection against currency devaluation. I down size at around retirement and I have a nice nest egg to live off. When it comes time to look for some kind of support living arrangement, I sell off the rest of my home and that finances that extra cost.

As the home is the biggest investment, it is extremely important to pick a good entry point into the market. When it seems like housing prices are going up, and up and up and if you don't get in now you will never get it, well, that is the worst time to buy. A decision to buy in these conditions will compromise lifestyle and ability to save for retirement for life. Choose to buy in these conditions is choosing to ensure that your economic future is much harder than it needs to be.

I know the economy where I live, and from 1986 to 1992/3 we had a bull run on our housing market. People that got in around 1986 to 1988 won the quarter million dollar, or better, housing lottery. Their economic future was secured by triple or quadrupile, or even more, increases in the price of homes. Add in the leverage that a down payment could have been as low as 10%, well, that is as much as a 5000% return on investment. People that got in around 1989-1990 have done ok, they also secured homes that appreciated far in excess of what they paid, and are better off for buying when they did, and still had lifestyle preserved.

Those that bought in 1991-1995 paid peak prices and many saw their homes worth less than they paid for them, or relatively flat in valuation for the next 5-8 years. Mortgage payments were such that it ate up the ability to save or have lifestyle, and wage increases have been poor through that time line as well, so there has also not been the increase in income to provide more disposible income. My home was selling for 10% less in 1998 then it was in 1995. I know many people who sold homes they bought in the 1993-1996 years for less than they paid for them in the 1996-1999 years.

Prices were relatively flat and in some cases declining until about 1996-1998. Somewhere around here was again good entry years. From 1998 to around 2000 were very good entry years again and 2001-2003 have also been reasonable entry years. Prices are up from 2004, but prices were also grossly crippling to lifesyle, and they may decline back to 2004 levels.

So, with respect to housing, the market is high, be patient, save your money, and if you plan to enter or upgrade, look to do it around 2010-2014. It is probably still a good time to downsize. Check out the housing market prices and trends in your area over the past 30 years and look at that and take it into serious consideration about when to buy. In general, about 4-7 years after a peak is a better time to buy. An investment into a home is so enormous, it is worth doing this kind of analysis, and to be patient.

Savings: How much to save and when depends on interest rates.

When I got into the housing market interest rates were around 10% for 5 year mortgages. In Canada mortgage rates are renewed at the end of a choosen term, which can be as short as 6 months. Five years is considered a long term. I saw many lose their homes when interest rates increase dramatically in the early 80s. New homeowners lack equity in their homes and it is wise for them to secure longer term financing, even if they end up paying more. It is especially wise with today's low interest rates as if you consider the past, interest rates have been as high as 20% or more.

The low interest rates do suggest that there is opportunity to gain a better rate of return on savings with careful investment. All investments that earn a better rate of return than a mortgage have downside risk, so it is very risky for a new home owner without much equity in their home. Paying down mortgage guarantees a rate of return equal to the mortgage rate. After taxes, investments need to bring in at least double the mortgage rate to be worth the risk. I believe it is better to wait and pay down the mortgage until you can afford your mortgage should interest rates again increase to the 10% range. But then, I have the experience of seeing many people lose their homes because of increasing interest rates and I am cautious that way.

How much do you need?

This entirely depends on pension income. If you have a pension worth 60+% of working income, that along with government pension, extra tax breaks and savings from work related expenses means that income level will remain relatively constant going into retirement without any savings, or downsizing.

Those without a work-place pension need to provide about 50-60% of their working income to maintain lifestyle. Saving for retirement stops at retirement, as do work related expenses.

Down sizing can give a good boost to retirement income. Every $100,000 dollars in savings can provide about $6,000 of income per year, using 6% per year. Say you want $50-60,000 per year from retirement savings, well, that's $800,000-1,000,000 in retirement savings.

This, with government pension, taking off 10% for savings, would give you a lifestyle comparable to if you earned $75,000 per year while working.

I put these numbers into a financial planner on

The results were that if I made $75,000 now, and had about that in savings, I would have to save $29,000 per year to have about $1.9 million for retirement. Notice that I'd be living on $46,000 per year if I saved at that rate? Obviously, along with my government pension, my lifestyle would more than double at retirement following their advice, and like the article below suggested, I'd have no lifestyle.

What do I calculate?

Assume the starting point is age 45, retirement savings so far is $75,000, you invest wisely and earn 10% return, and you can afford $7,500 savings per year, and you save in a tax sheltered RRSP. At age 65 you would have $934,000.

This example does not take into account inflation. With 20 years of 2% inflation, you'd need about 1.25 million for an income of about $75,000 per year, rather than $50,000. To compensate for inflation you'd have to save about $11,000 per year and increase savings by 2% per year.

But neither of these examples uses any home equity. With inflation, down sizing would provide for increased income needs due to inflation.

So, I calculate saving at a rate of $7,500 per year for 30 years and investing wisely would provide enough for someone without a pension. But you do have to be proactive about investments to make 10% per year.

A Contrarian View: Save Less, Retire With Enough

Could it be possible that you are saving too much for your retirement?

Such an idea would fly in the face of almost every exhortation to a nation of spendthrifts that saving more is an imperative. After all, even as people are living longer, corporate pension plans and Social Security can no longer be relied on to ease most Americans through their retirement years. Fidelity, the nation’s largest provider of workplace retirement savings plans, says the average 401(k) account balance is only $62,000.

Beyond that, the national savings rate — the difference between after-tax income and expenditures — is actually negative, government statistics show.

Nevertheless, a small band of economists from universities, research institutions and the government are clearly expressing the blasphemy that many Americans could be saving less than they are being told to by the financial services industry — and spending more — while they are younger. The negative savings rate, they say, is wildly distorted.

According to them, the financial industry, with its ostensibly objective online calculators, overstates how much money someone will need in retirement. Some, in fact, contend that financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.

The more realistic amount could be as little as half the typical recommendation made by Fidelity, Vanguard or any number of other financial institutions.

For a middle-income couple, that could mean trading $400,000 in retirement money for about $3,000 a year more during prime working years to spend on education or home improvement. “For a middle-class household, that’s a lot of money,” said Laurence J. Kotlikoff, a Boston University economics professor, who is on the forefront of this research into spending and savings, and is selling his own retirement calculator.

Andrew Behla is a case in point of someone who is not saving enough. Mr. Behla, a Los Angeles graphic designer and consultant, is at age 38 just starting to think about retirement. He and his wife, Michele Krolik, a payroll manager, together have just $70,000 squirreled away for their old age.

“I think we will have to save a lot more,” he said, a point on which the economists and the financial planning industry would agree. Even so, the couple recently bought a house and put extra money they had into improving it, figuring that over their lifetimes it will add handily to their net worth.

But other people like Beverly Alexander, 49, an energy consultant in Marin County, Calif., might be able to slow down. Her financial planner has her retirement finances mapped out to age 105 (her parents are still alive in their 90s), a plan that gives Ms. Alexander, a former utility executive, the freedom to quit her corporate job and live on her consulting income.

“One reason I could retire,” she said, “was that I saved and I always lived below my means.”

The findings of the economists are being met as most challenges to orthodoxy are: with stony silence or extreme umbrage.

“I count myself as deeply skeptical,” said Christopher Jones, the chief investment officer at Financial Engines, a financial planning software company.

The big financial services companies refused to comment on the research but they did say that their use of simple rules of thumb keeps the process of retirement planning less complicated, and thus, less daunting.

John Rother, policy director with AARP, says the economists are “not doing anyone a service because of the tremendous amount of effort it takes to get people to save.”

Nevertheless, the loose confederation of well-regarded economists, who have not been working in concert, say their research points to the startling conclusion that many Americans are saving too much, not too little. Indeed, their studies of the savings and spending habits of the generation born between 1931 and 1941 revealed that at least 80 percent had accumulated more than enough wealth for retirement. While they have not studied the baby boom generation as closely, they believe that the greater wealth of that generation should also leave those retirees secure.

A study last October by another group of economists, including two working for the Federal Reserve Board, found 88 percent of retirees age 51 and older had adequate wealth.

“Even the most casual reading of the popular press will have you convinced that Americans are heading like lemmings over a cliff,” said John Karl Scholz, an economics professor at the University of Wisconsin at Madison. “Going into this, I had no idea that we’d find any results anything like this.”

The argument between the sides is similar to the classic debate between the hardworking ants and lazy grasshoppers of Aesop’s fable. The financial planning industry says saving, even too much, provides a safety net and peace of mind, and possibly a gift to heirs at the end.

The economists answer that people would get more out of their money by using it when they are younger. “There is risk in saving too much,” Mr. Kotlikoff said. “You could end up squandering your youth rather than your money.”

Mr. Scholz said he and his co-authors of a study, “Are Americans Saving ‘Optimally’ for Retirement?” found oversaving across all economic and education levels and most ethnic or racial groups as well. (It found that Hispanics tended to save less.) Those who were not saving enough were usually missing their target by only a small amount.

The one exception to this optimism involves people who enter retirement single, either because their spouse died early, they divorced, or they never married. The studies found this group did not save enough.

“If they are worried about end-of-life medical expenses or they don’t mind leaving money to their heirs,” Mr. Scholz said, “then oversaving is fine.” The dispute revolves around how financial planners determine how much a person should save. That amount will vary depending on age, income and assets. To simplify the calculations, computer programs resort to rules of thumb.

The starting point for most retirement plans is the so-called replacement rate. It says an American needs an annual income in retirement equal to 75 percent to 86 percent of what he or she earned in the final year of employment. Someone making $100,000 would typically plan for about $85,000 a year in retirement.

Coupling that with a second industry rule of thumb that says retirees should spend no more than about 4 percent of their assets each year to make them last, a typical couple with that level of income should enter retirement with at least $2.1 million in assets, including 401(k)s, I.R.A.’s, stocks and bonds, real estate, cash value life insurance, pensions and Social Security benefits.

Not so, says Mr. Kotlikoff. It may be simple, but he argues it is more important to look at how people spend their income while working to determine how much they will need when retired.

Mr. Kotlikoff’s calculations showed that Fidelity’s online calculators typically set the target of assets needed to cover spending in retirement 36.4 percent too high. Vanguard’s was 53.1 percent too high. A calculator offered by TIAA-CREF, one of the largest managers of retirement savings, was 78 higher than his calculation.

Fidelity’s Retirement Quick Check calculator says that a 50-year-old person making $100,000 a year with $700,000 stashed in retirement accounts, saving $15,000 a year, would still fall short of the $2.8 million goal that would provide the necessary monthly retirement income of $7,408 that it sets. Its calculations do not include Social Security payments.

Fidelity actually recommends saving about $1,000 a month more. It also encourages this person to save more even when more than enough has been saved. It recommends putting away up to $9,749 a month on top of the $15,000 a year already being saved, an impossibility since that would more than consume the person’s entire gross income.

Mr. Kotlikoff’s ESPlanner software, taking real estate holdings and life insurance into account, says the person could cut back on savings by $10,000 a year and still have enough for a monthly income of $6,000 at retirement, the amount his calculations deems adequate to live on given prior consumption patterns.

Mr. Kotlikoff is trying to sell his software, called ESPlanner, to large employers as well as to the financial services industry. He has made no major sales so far. It is also available to individuals at for $150.

The financial planning industry prefers to characterize itself as cautious. William Ebsworth, chief investment officer of Fidelity Investments’ Strategic Advisers division, which runs retirement programs, said, “We take a very conservative approach,” preferring to err on the side of having money left over at death rather than risk running out before then.

“We believe in the research we’ve done and that others have done that Americans aren’t saving enough,” he said.

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