M E R I D I A N     M A G A Z I N E

Planning to Retire
by Richard P. Halverson

You may not be able to take it with you, but you sure want to have enough while you're here.

Retirement can be thought of as an asset - an asset like a home. In fact, it may be the ultimate asset in achieving financial freedom. Like all assets, you buy it to use it. This is an asset used by senior citizens. But everyone should be interested in this asset regardless of his or her current age for two good reasons. First, everyone not already a senior citizen is a prospective senior citizen. Second, unlike most assets, retirement must be paid for in advance. It definitely cannot be used now and paid for later - like many Americans have made a habit of doing with everything else in their lives.

A good retirement is a valuable asset. It can add quality to your standard of living during an important time of your life. A poor retirement is a trap. If you run out of what you can't take with you before you are ready to leave then you may just be sitting around with your bags packed waiting for departure. Like most assets, a good retirement costs money.

Because a retirement must be paid for in advance, it is logical to decide what kind of retirement you want to have in advance. In modern America, retirements tend to range from standard government subsidized models to elaborate luxury models loaded with all the options. Naturally, the luxury models cost more. The challenge is to decide how luxurious a retirement you are willing to pay for. After all, a luxury retirement tomorrow could mean a stripped-down standard of living today.

Regardless of where you fall on the prospective senior citizen to senior citizen spectrum it is wise to do some retirement analysis and to update it periodically. The analysis itself requires two things: lots of estimates about the future and some complex calculations. Only you can make the estimates. For the calculations, fortunately, these days we can go to the Internet and find many sites that have created easy to use calculators. (If you are very good at working with spreadsheets and doing compound average projections it is smart to create your own calculator. Everyone's circumstances are different and a custom built calculator that you can save and update periodically can be helpful.)

My search on Yahoo.com for "Retirement & Calculator" produced over 1,500 hits. Nearly every financial institution selling investments or insurance has one. Some require more work to complete than others do. As with most things the better ones require the most work. I did not begin to look at them all. My favorite is on Quicken.com (which I assume is on that search somewhere.) The links to Quicken and a couple of other good ones are:

http://www.quicken.com/retirement/planner/personal/

http://www.usnews.com/usnews/nycu/money/moretcal.htm

http://www.newyorklife.com/NYL2/Display/0,1235,10651,00.html

There are two things you would like from this analysis: a snap shot of where you are headed and an idea of what you need to do to get where you want to go if you are not headed there right now. To get to these answers the calculator will ask you for, among other things, how much you want to spend when you are retired, when you plan to retire, when you plan to die, (they will word it differently) your estimate of inflation and your estimate of your investment returns. You will also need to provide information on your current investment and savings, your pension plan, and your social security assumptions.

Your responses to these questions are yours. To be helpful some calculators will propose estimates but you should have your own opinions. Here are some thoughts as you consider some of these questions.

RETIREMENT COSTS

This is the asset. How you will be able to live and what can you afford to do during your retirement. As with most assets dreams and reality are not always the same. The calculator you use may suggest something like 70% of retirement income. Rather than just accepting a national average I encourage you to spend a little time making up several budgets. I recommend you make up a "Desired Retirement Budget" and a "Minimum Acceptable Budget". Hopefully the intent of these two is obvious. For example, you may desire a retirement that includes living in an attractive condominium at your favorite resort. However, you would not consider it beneath your dignity to live in a comfortable apartment in the town you grew up in. You might feel it is unacceptable to move into your cousin's basement. This is one of those situations where there are no right or wrong answers. Only you know what your desired and minimum thresholds are. It should also be obvious that these levels need to be discussed and agreed upon with your spouse. You might think your cousin's basement is fine but your spouse may not.

In making these budgets consider all the things you consider in making up your current budget e.g. food, housing, transportation, contributions, entertainment, health, etc. (You do make up a current budget don't you? Well, if not make one of these anyway.) In these budgets you are going to try and imagine what things will be like when you retire. For example, you may not have any demands for children's education expenses but your health care needs will increase. Hint: budgeting and forecasting are very inexact sciences. Do not bog down in details and uncertainties. Odds are you won't improve the accuracy all that much. By the same token don't take wild guesses. If you have no idea what assisted living insurance costs try to get some idea. My experience is that when budgeters make wild guesses on future expenses they tend to be unreasonably optimistic.

Make these budgets up using today's costs even though retirement may be years away. The calculator will adjust for your estimate of inflation. It is likely the difference between your desired level and your minimum acceptable retirement assets will be substantial. As you play with these numbers in the calculator you will probably be astonished how much you need to save today to reach your desired retirement asset. In fact, most people are astonished how much they need to save just to reach the minimum retirement asset.

RETIREMENT AGE

This is personal. I am finding today, however, that many people who have always assumed they would retire at 65 are being offered packages at work to retire early. This can come as an exciting surprise. Some of these packages are very attractive. But exercise serious care when making the decision. What may be a comfortable retirement income today may be very inadequate in a few years with inflation. Be sure you have planned for the long haul.

LIFE EXPECTANCY

Life expectancy has a direct bearing on how many years you are going to be retired. And that has a big effect on how much money you will need to live on. If you plan to die in a timely fashion you won't need to save as much. Talk about making guesses. How many of us know how long we will live? And few people I know are hoping for a shortened retirement.

Some retirement calculators will propose an age from standard actuarial tables. I suggest you think about several factors and adjust the expected age accordingly.

First, Statistics suggest one of the best guidelines to our own longevity is that of our parents.

Second, current actuarial tables may not be adequately adjusting for medical advances that are helping people live longer. I believe that life expectancies will rise much more rapidly in the next thirty years than in the past thirty years. Medical technology is making amazing strides. Like most areas of technology it is improving at an exponential rate. I believe that one of the great shocks to retirement planners and to public policy makers will be a rapid increase in life expectancy. Policy makers who are worried about social security and Medicare budgets now are going to have real problems if people don't die on time. In fact, a lot of those senior citizens may be shocked to out live their own resources.

Third, you should probably add a little to your life expectancy estimate for being Mormon. If you are a faithful member of the Church the odds are good you will outlive the national actuarial estimates.

INVESTMENT RETURNS

One of the key estimates in working with any retirement calculator is your estimate of what your investments are going to earn, both before and after retirement. The fact is most lay investors have no idea. The fact is very few professional investors have any idea - but we don't dare admit it.

When working with a retirement calculator you will find you can get dramatically different answers with relatively small changes in the estimated return rate. Here is something to be careful of. It is easy to work through the calculator and discover that at your current rate of savings you will be living in the stake center dumpster by the time you are 69. Then you will discover that if you just increase your estimate of how much your investments will earn you can live in a palace with a view of the Hawaiian Temple until you are translated. It is really easy to make an apparent savings problem go away if you just increase your estimate of how much your savings are going to earn every year. And if you can in-fact earn more it really does work. For example, $1,000 invested every year for 30 years and earning 10% a year is worth about $181,000. The same $1,000 annual investment at 15% will be worth $532,000 in 30 years. Simply double the original 10% estimated investment rate to 20% and the investment increases 7.8 times to $1,418,000. Compounding is a beautiful thing.

However, before you double your earnings estimates here are some thoughts. Returns in the past two decades have convinced many people that equity returns of 20% to 25% are almost an inalienable right. They are not. Long-term returns for equities are closer to 10% to 12% with plenty of long stretches below 5%. Exceptionally good periods are often followed by long periods of lower returns.

There will always be some investors who will achieve amazing returns in any market. If you are one of these talented investors you probably already know it. If you are an ordinary human and you still want to use a very high estimate ask yourself exactly how you are going to achieve it? If you don't know for sure use more conservative estimates. If you under save and under invest until you retire, it is then too late to correct the problem.

INFLATION

This is another area where seemingly small changes in the estimate can have a huge effect on your estimated needs. For example, assume you plan to retire in 30 years and you currently believe you need $60,000 a year in today's dollars to live comfortably. If inflation is 3.0% in the next 3 decades the amount you will need the first year of your retirement will have risen to $145,600 due to inflation. However, if inflation is 4.0%, only 1 percentage point higher, you will need $194,600. That would represent a $49,000 shortfall and that is just in the first year of your retirement. The problem will grow every year after that if inflation continues high.

This is a problem. There is nothing you can personally do about inflation. The best you can do is use a conservative estimate (higher rate) when making your calculation. You can also use investments in your retirement savings that offer some hedge against inflation. Finally, redo your retirement calculation on a periodic basis and update your inflation estimate as you go along.

Incidentally, there are some excellent economists who believe the rate of inflation will remain low for many years.

SOCIAL SECURITY, MEDICARE

Unless you go out of your way to avoid the news you know there are huge debates raging in Congress about what to do with these programs. Here is one simple fact - both programs are fundamentally broken. Unlike some national issues there can be no question that something is wrong. Oh, you can get different estimates of when the programs will go bankrupt depending on your estimates of inflation and growth. It works about the way our illustrations above do. But the fundamental facts are we know how many people have been born. Demographers can tell you exactly how old they are and exactly when they will turn 65. We know there was a huge baby boom after World War II. We know that was followed by a protracted decline in births. This means baby boomers represent a disproportionately large part of the population and they are followed by a relative small group.

Another fact is that Social Security is a pay as you go program. This is a fact that many, maybe a majority, of people do not understand. The Social Security tax deducted from your paycheck today is used to pay a social security benefit to somebody today. It is not put away and invested for your future retirement. Social Security is different than your company pension. The government requires employers to put pension donations into a trust fund for the benefit of the employees. There are very strict laws that prevent the employer from using the money for company purposes. Wouldn't it be wonderful if Congress had imposed these same laws on the Government when they created Social Security?

Well they didn't. Now because of the demographics, because people are living longer, and because benefits are rising with inflation it is certain that there will be too few workers supporting too many retirees and Social Security as we know it will collapse. This won't happen for about 25 to 35 years and that may seem like a long time -- but it isn't. Politically, a Social Security collapse is unacceptable, so something will get done. Hopefully, it will get done soon. Just like your retirement planning every year is important. Just what will be done is the subject of today's political debate. Both political sides are trying to scare you silly for their own political gain, I suppose. I encourage everyone, regardless of age, to get fully informed. An informed electorate is the only hope of coming up a viable solution.

In the mean time what assumption do you build into your calculator? I have no better recommendation than to use the Social Security Administration estimate of what you will receive. You can get that information and more from their well-done web site at http://www.sss.gov.

Having waded through all the assumptions of a good calculator the prospective senior citizen finally gets an answer. You may be pleasantly surprised. But in the majority of cases the surprise is more sobering than pleasant. For those in the latter category emotions ranging from: its hopeless I'll give up; to I'll think about it later; to I'll kiss the family good bye and get two part time jobs. None of these are right. A good plan, doing as much as you can and starting as soon as possible is best approach.

Oh and one final thought. One of the least expensive places to be during retirement can be a mission for the Church. It is a lot cheaper than taking cruises and playing golf every day. Why not plan financially and spiritually to spend a lot of your retirement years serving the Lord? What better way to stretch what you have while you're here and build something you really can take with you once your retirement is over.

About the Author
Richard P. Halverson is a founding partner of the investment company Great Northern Capital. He received his Bachelor of Science degree in Banking and Finance from the University of Utah and a Master of Business Administration degree from Harvard University where he was named a Baker Scholar. He served on the following committees for the Association of Investment Management and Research (AIMR): as a member of The Standards and Practices Committee, 1981-1990; as a member and chairman of the Professional Conduct Committee, 1982-1993; as chairman of the Ethics Awareness and Education Committee, 1993-1996. In 1994, he received the Daniel J. Forrestall III Leadership Award from The Association for Investment Management and Research (AIMR) for his work in the area of ethics in the investment profession.

He first became interested in personal finance while serving as a Bishop. During the day he worked in the world of billion dollar finance, but during the evenings he found himself immersed in the more difficult world of family finance. This led him to write the book Financial Freedom. He is also a contributing author to the McGraw Hill Real Estate Handbook and Smart Money Magazine. He claims to be proof that you can be in the investment business and still not get rich! He resides in Minnesota and is the father of seven children.

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