Catch-Up Retirement Planning Strategies for Late Savers
Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, oneill@aesop.rutgers.edu
There are several types of late savers who are trying to make up for lost time and accumulate an adequate nest egg for retirement. Are you one of them? Below are three common later saver profiles:
• Procrastinators with little or no past and current savings. This could be for any number of reasons including high monthly living expenses, overextended credit, poor spending habits, lack of financial discipline, and negative life events, such as unemployment, bouts of illness or disability, and divorce. According to the American Savings Education Council (ASEC), there are five Retirement Personality Profiles: Deniers, Strugglers, Impulsives, Savers, and Planners (see www.asec.org/profiler.htm). Most retirement savings procrastinators probably fit into one of the first three personality profiles.
• People who are currently saving for retirement but got a late start and are trying to make up for the years they did not save. They are saving more than they ever did before and are now taking advantage of IRAs and tax-deferred employer retirement savings plans such as 401(k)s or 403(b)s. These are people who are now making a serious effort to save but need help catching up.
• People who have been investing all along but lost some of their retirement savings. Perhaps they lacked diversification by not selecting different asset classes (e.g., stocks, bonds, and cash), invested in risky securities, or tried unsuccessfully to practice market timing (i.e., trying to time investments to the highs and lows of the market). They may have also simply experienced market risk, where investment values track normal market fluctuations and the value of assets declines during market downturns.
If you’re beating yourself up about market losses or what you haven’t done to prepare for retirement, it’s time to stop. Instead, take action now to create a bright future. Today is the first day of the rest of your financial life. There is a popular saying that says it all: “If it is to be, it is up to me.”
It’s not too late to save for retirement. Remember that your investment time horizon is the rest of your life…not your retirement date. This means that, if you are 45 years old today and live to age 90, you have 45 years for your money to grow through the power of compound interest. Long time frames also reduce market volatility.
On the other hand, compound interest is not retroactive. In other words, it is impossible to earn interest on money that was never saved years before. That’s the bad news. The good news is that there are over a dozen different ways for late savers to make up for lost time. All of these methods basically fall into one of two basic strategies:
• Take action before retirement to increase retirement savings
• Take action after retirement to decrease the amount of savings required
Strategies to increase retirement savings include: saving more money (e.g., higher payroll deductions for retirement savings plans), reducing expenses to “find” money to invest, accelerating household debt repayment, “moonlighting” for additional income and retirement plans (e.g., SEPs and Keoghs) for the self-employed, investing aggressively (i.e., more stock in your portfolio) before and during retirement, automating investment deposits, maximizing tax-deferral opportunities (e.g., IRAs), and preserving lump sum distributions by rolling them over into another tax-deferred savings plan.
Strategies to reduce the amount of money needed for retirement include: trading down to a smaller home, moving to a less expensive location, delaying retirement, working after retirement, tapping home equity via a reverse mortgage or sale-leaseback arrangement, and making tax efficient retirement asset withdrawals (i.e., tapping tax-free investments and taxable accounts first).
Like many decisions in life, catch-up retirement planning requires trade-offs. For example, spending less now in order to save more in a tax-deferred plan or delaying retirement and working longer in order to earn additional retirement benefits and/or save more money. The popular phrase “there ain’t no such thing as a free lunch” is an appropriate description of the planning process for late savers because all retirement catch-up strategies have disadvantages as well as benefits.
Various retirement catch-up strategies can also be combined for greater impact. Three examples are: investing more in a 401(k) and moving to a less expensive location in retirement; moonlighting for additional income and delaying retirement; and investing more aggressively and “downsizing” to a smaller home without changing geographic location.
In the aftermath of the 2007-2009 financial crisis and bear market, several financial industry firms ran computerized simulations of various retirement recovery strategies. Their consensus was that two of the most effective catch-up strategies are working two to three years longer than planned (or working at least part time after you retire) and postponing the collection of Social Security benefits until full retirement age (e.g., age 66 for workers born between 1943 and 1954).
By working longer, there is more time for investment account balances to grow and for workers to make additional retirement savings plan contributions. Additionally, Social Security and pension benefits may increase with extra years of service. Even more importantly, by working longer, employed investors can postpone retirement asset withdrawals because they’re still earning a paycheck. Combine all these effects with a healthy dose of compound interest and it is possible to accumulate a sizable nest egg and/or recover from bear market losses without having to increase annual savings deposits or take on more investment risk.
The bottom line is that it’s never too late to implement a retirement catch up strategy. Catch-up savers have many options. A helpful resource for late savers is the Guidebook to Help Late Savers Prepare for Retirement developed by the National Endowment for Financial Education. Over a dozen catch-up strategies are explained in this publication, along with tax law savings incentives and available resources. The publication also includes personalized worksheets to help readers develop a personal retirement catch-up strategy. To obtain a copy of the Guidebook to Help Late Savers Prepare for Retirement, go to the National Endowment for Financial Education’s Smart About Money Web site at www.smartaboutmoney.org and type the words “Late Savers Guidebook” in the search box. A link for this 50-page PDF file document will appear and the publication can then be downloaded to a computer and/or printed out.