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Saving for Retirement: A Reality Check Can Help to Ease Some of the Concerns

July 12, 1998|SCOTT BURNS | Scott Burns writes for the Dallas Morning News

Question: I'm worried about how unprepared I am for retirement. It seems like because I didn't start saving a decade ago (by my mid-30s), I'm out of luck. Am I wrong to be depressed?

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A: Your mood is being affected by the relentless supply of surveys that you get in the mail or read about. The ones that say we don't save enough money. That we invest it the wrong way. In the future, the surveys intimate, there will be only two kinds of people in the world: those who are mindlessly rich and those who eat cat food.

If we don't save and invest more, lots more, the surveys say, we are doomed.

Well, although it's great to save, I don't think you are doomed.

First, consider the source of these surveys. Most come from well-meaning mutual fund companies, helpful insurance companies and thoughtful banks--institutions whose stock in trade is our savings. Institutions whose source of income, profits and management compensation is our savings. It's just possible they may not be getting enough of our savings to meet their goals, but we'll meet ours.

Some rude questions: How do these surveys check out with reality? How much retirement income will we need? And where will it come from?

Let's start with income.

Every three years the Center for Risk Management and Insurance Research at Georgia State University does an examination of the income required in retirement. They do this by taking pre-retirement income and subtracting savings, taxes, work-related expenses and changes in consumption in retirement. Then they recalculate taxes based on retirement consumption and come up with an income replacement percentage. They do this for different income levels and different types of households.

Using consumer expenditure surveys, project researcher Bruce Palmer found that a $50,000-a-year married worker cut spending in retirement by $2,311, had been saving 6.5% of income, and enjoyed a radical cut in income taxes upon retirement.

The worker, for instance, no longer paid $3,825 in employment taxes and saw his federal income tax bill cut from $5,670 to $156. As a result, the couple needed to replace only about 69% of their pre-retirement income to maintain their standard of living.

About 90% of all workers earn less than the Social Security wage-base maximum ($68,400 for 1998). So for about 90% of all workers, the real replacement income gap ranges from a low of 22% to a high of 36%. (Whether Social Security will deliver is subject to debate, but that's an entirely different issue.)

Query: How do private pensions and personal savings measure up to filling that gap?

* Private pensions. For the minority of workers covered by a traditional corporate pension plan, the retirement income gap can be filled simply by having a stable job history. With a typical pension providing about 1.25% of final salary per year of service, 18 years will fill the 22% gap for the $20,000 worker, and 29 years will fill the gap for the $70,000 worker.

That's a lot of years, to be sure, but millions of workers do it, and any period of work long enough to vest will contribute retirement income. A worker who starts his last job at age 50 and works to age 66, for instance, will replace 20% of income from a typical corporate pension. Public employees, of course, tend to do even better.

* Personal savings. The most common savings vehicle in use today is the tax-deferred 401(k) plan. In a typical plan, the employer will match your savings 50 cents on the dollar up to about 6% of payroll. In other words, if you save 6%, your effective savings rate is 9%. Invested at the long-term return on common stocks, you'll have enough to replace 36% of income in about 25 years. You'll have enough to make the 22% gap in 20 years.

To be sure, 20 or 25 years is a long time, but it also means that a person who never saved a dime before age 40 could fulfill a savings goal for age 65 and beyond.

Note that I've made no mention of other obvious, money-saving options--like moving to a lower-cost area, trading down in houses or just plain spending less.

Does all this mean you should pay no attention to the endless exhortations to save?

Not at all. It needs to be done.

But next time you see one of those surveys, salt it well.

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Q: I was thinking that it might be prudent to borrow against our house and invest. Let's say we could borrow $100,000 and assume a 10-year mortgage at 7%. We're conservative investors, so say we invested the money in a Vanguard or T. Rowe Price couch potato fund or a balanced fund for the 10 years.

My only concern is whether there would be enough of a difference, or spread, between the mortgage and the investment. It seems that many analysts put the return on these types of funds around 9% or 10% maximum. If that is the case, then I don't know that 2% or 3% over 10 years is worth it. What are your thoughts?

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