EDITOR'S NOTE: This article was originally published in the February 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.
Workers approaching retirement are focused on the finish line. They anticipate sleeping late, taking exotic trips or spending more time with family. But as they sprint toward those goals, many overlook a formidable obstacle: a yawning gap in their savings.
With the demise of defined-benefit pension plans, tumultuous markets, skyrocketing health care costs and a bleak employment landscape, the last few legs of the race to retirement have become much tougher than they used to be. Many people are running out of steam as they hit the home stretch. Nearly half of people age 57 to 63 in 2010 won't have enough retirement income to cover basic expenses, according to the Employee Benefit Research Institute.
What's more, some popular strategies for catching up on retirement savings may backfire on older workers. Many people are investing more aggressively in hopes that higher returns will close a savings gap. But that raises the risk that a market downturn will trip them up just as they enter retirement. And though baby boomers are increasingly banking on working longer, research shows that nearly half of recent retirees left the workforce earlier than anticipated. To assume that you can simply keep working if you don't have enough saved at retirement age is "extraordinarily risky," says Jack VanDerhei, research director at EBRI. "It may not be feasible."
The good news: It's still possible to close a significant savings shortfall, even if you're within a few years of your planned retirement date. While you may not be able to count on a surging stock market or steady employment, there are powerful factors within your control that can propel you into a secure retirement. These include maximizing the tax-efficiency of your portfolio, optimizing Social Security benefits, reviewing your asset allocation, and of course, saving more and spending less.
To close a savings shortfall, the key is "taking concrete steps, even if those are relatively modest steps," says Christopher Jones, chief investment officer of 401(k) advice provider Financial Engines. Here's how to ensure that your final working years will set you on course for a smooth retirement.
Mind the savings gap. If you fear you're losing the retirement-savings race, your first step is to determine the size of your savings gap. Older workers tackling this task hear a bewildering array of retirement-saving rules of thumb. Some advisers say retirees need their investments, Social Security and other income sources to generate about 75% of their preretirement income, while others say that figure is closer to 100% or more.
Instead of searching for the perfect formula, consider simply tracking your expenses for a couple of months. Separate essential outlays from discretionary expenses, bearing in mind that retirees typically want to maintain the lifestyle of their working years. If you eat out once a week and have season tickets to the symphony, plan on doing the same in retirement.
An online budgeting tool such as Mint.com can help you categorize expenses and weed out those, such as commuting costs, that won’t continue in your retirement years. To determine whether your portfolio, pension and other benefits will cover those expenses, run your nest-egg numbers through a free retirement-income calculator, such as T. Rowe Price's tool at www.troweprice.com/ric.
To be sure, there are a host of uncertainties in such back-of-the-envelope calculations. You may face massive long-term-care expenses or move to a lower-cost city. But at least the exercise will give you an early warning sign if you're facing a savings shortfall. "It would be unrealistic to think whatever budget you come up with for the next few years will be the same one you'll have 10, 15 or 20 years from now," says Christine Fahlund, senior financial planner at T. Rowe Price. "But at least you can get started."
If you have a large savings gap, remember that even those getting a very late start can build substantial nest eggs. Consider a 55-year-old who earns $80,000 a year and has no retirement savings. If she maxes out her 401(k) in each of the next ten years, including the $5,500 catch-up contribution for participants 50 or older, and receives a 3% employer match, she could have roughly $426,000 saved at age 65, assuming a 7% annual return, according to T. Rowe Price.
As with losing weight, the task of boosting savings will look a lot more achievable if you "look at it in small increments rather than the end goal," says Maria Bruno, senior investment analyst at the Vanguard Group. So instead of making an unrealistic vow to max out your 401(k) on day one, consider some budget cuts. If you have high-interest credit card debt, for example, start paying it down and putting the money you would have spent on interest into retirement savings. Also review the fees on your 401(k) investment options, which can take a big bite out of your nest egg over the long term. If your plan offers only high-cost funds, consider contributing just enough to get your employer's full matching contribution, and then put additional savings into low-fee funds in an IRA.
Those playing catch-up might also consider downsizing to a smaller home. "A bigger house means not only a bigger house payment but more maintenance bills," says Carrie Schwab-Pomerantz, senior vice-president at Charles Schwab. Downsizing, she says, is "an easy way to really reduce your expenses."