When it comes to retirement savings, finance professionals have the same answer about when to start: ASAP.
And for good measure, Angela Bender at AMJ Financial Management in Leesburg says people need to start “well before anybody thinks they do.”
Bender is not alone among the Northern Virginia finance professionals surveyed on retirement savings who urge teenagers still in high school to put the money they earn mowing lawns or babysitting into a retirement account.
“Even if it’s just $500, put it into a Roth IRA,” says Stan Corey at United Capital Financial Management in Great Falls.
A Roth IRA differs from the traditional Individual Retirement Account, which allows a saver to put pretax earnings into a special account and then taxes withdrawals in retirement, in some important ways. For one thing, the money put into a Roth IRA is taxed, but then the withdrawals are tax-free. This is ideal for high school or college students who won’t earn enough money to pay taxes anyway.
The other big difference is that the money can be withdrawn virtually at any time without any penalty, subject to certain conditions. “The Roth is so good because it’s not just about retirement savings,” Corey says.
This ability to withdraw the money for other expenses, such as a down payment on a home, allays the reservations young people might have about tying up money for retirement, financial advisers say. A Roth IRA, Bender emphasizes, “is extraordinarily flexible.”
But perhaps the most important benefit, advisers say, is that young people develop a habit of saving. “It teaches [them] to get into something systematic,” says Kelly Campbell at Campbell Wealth Management in Alexandria. “You develop habits for life.” He adds that he has clients in their 60s, approaching or already in retirement, who still save 10 percent of their income, so ingrained is the habit of saving.
Parents or grandparents can help jump-start the process by adding their contributions or matching those of the young person. “It’s a great gift in high school or college to contribute to a Roth IRA,” says Jason Williams at Sullivan, Bruyette, Speros & Blayney in McLean.
For most people, however, the earliest they will think about retirement savings is when they get their first full-time job and can get enrolled in a 401(k) plan, the primary tax-deferred plan for retirement savings. This, according to a broad consensus among advisers, is the critical moment for maximizing the potential benefit for retirement because it gives employees the longest period to have their savings compound tax-free, that is, all the return on investment will be invested as capital and then will earn further returns.
“Compounding is the eighth wonder of the world,” says Corey. Whether in a Roth IRA, traditional IRA or a 401(k), it is what enables even modest contributions to grow into a substantial asset over decades.
The important thing is to get started, even with a small percentage of the initial gross income. “It’s like a snowman,” explains Paula Friedman at McLean Asset Management Corp. in McLean. “It seems like a little bit of snow won’t make much difference, but you keep rolling it up until you have a snowman.”
Friedman tells clients that if they start saving $320 a month at age 25 and keep it up until age 65, it will result in a retirement account worth a million dollars, even at a conservative return of just 7 percent a year. If they wait until age 35 to start saving, it will take contributions of $820 a month to reach that amount.
“If they wait until they’re 40,” she adds, “it’s almost impossible.”
And that’s the point of starting early. “You can’t make it up if you’re behind,” says Lauren O’Brien at Lara, May & Associates in Falls Church.
“Time is our most precious commodity,” Bender says, emphasizing the need to start early even if with small amounts. “People think it’s some grand plan, but it’s a game of inches.”
Young people, of course, have many competing claims on what may be a modest starting salary. Student debt is becoming a huge drag as the cost of college increases and graduates have a sizable debt to pay off when they start working.
Nonetheless, financial advisers say, it is important to start making contributions to a retirement plan even as the debt is paid off.
“The important thing is to start participating, at least take advantage of the employer match,” says Jeff Eveland of The Eveland Group at Merrill Lynch in Leesburg, referring to the benefit offered by many employers of matching employee contributions up to 3 percent or more. “We’re very much in favor of free money.”
Friedman suggests to clients that they invest the amount needed to get the full employer match, which can go up to 6 percent of income, and then double that so their contribution is as much as 12 percent.
That is ambitious, but advisers say the target should be to save 15 percent of gross income for retirement. “Ideally the amount grows from 5 percent to 15 percent,” Corey says, “though 2 percent to 10 percent is probably more realistic.”
The important thing, advisers agree, is to come up with a plan and stick to it. “You need to automate savings,” Williams says. “Take the need for attention out of it.”
Employees should take advantage of a 401(k) plan if it is offered, but if that is not available or if an individual wants to diversify plans, a traditional IRA is an option that also defers tax on contributions and returns until withdrawals are made in retirement.
20s & 30s
Financial planners have a number of suggestions for those in their 20s and 30s to support this saving. One is to create an emergency fund of cash reserves that can cover at least three months of basic costs in the case of job loss or other emergency. This can at least delay the temptation to cash out the retirement account to cope with an emergency.
Another is to avoid credit card debt and systematically pay down existing credit card debt, starting with the balance that carries the highest interest rate.
Instead of putting a big vacation on the credit card, save up for it two or three years ahead of time. Alternatively, take part of a bonus for a special trip rather than banking all of it.
Take advantage of other ways to save, like buying a home with an FHA loan, a government mortgage insurance program that keeps down payments and interest rates low, or making use of a health savings account, especially if contract or part-time work does not include health care benefits, because money can be put aside tax-free to cover high deductibles and other out-of-pocket expenses.
Not surprisingly, one suggestion is to engage the services of a finance professional. While some firms specialized in wealth management aren’t interested in anyone who doesn’t have half a million or a million in investable assets, there are financial planners who will help a client draw up a budget for an hourly fee or a flat rate.
“You don’t need an asset manager; you need a financial planner,” Bender says. A recent engineering graduate from Virginia Tech just starting a new job, for instance, came to her for a budget that included paying off student debt in three years and also allocating the investments in his 401(k) plan.
Some firms offer multigenerational planning, making advice available to the children of clients just starting to work. Alternatively, there are do-it-yourself tools online to set retirement goals and devise a savings plan for them.
“Put a number on paper,” Campbell recommends. “It’s your financial GPS. That’s the piece that tells you what you need to save.”
The point of having a plan is to impose a discipline on spending and saving. “Traditionally people think they will spend and then save what’s left over,” Corey notes. “I like to reverse that and say you should save your target amount and then spend what’s left over.”
Expert help can reinforce the discipline needed to enforce savings targets and spending limits, Corey adds. “It’s hard to be objective when it’s your own money.”
While no one is recommending making a career choice based on retirement benefits, it is a fact that the government is one of the few employers still offering a pension, and that is a ready option in the greater Washington area.
“People who have a government job end up in a pretty good situation,” notes Campbell. If the traditional “three-legged stool” of retirement income is Social Security, pension and savings, then government employees are among the few who can count on all three. Not only are government pension plans relatively generous, but workers in civil service and other government jobs often have 401(k) plans as well.
As far as Social Security is concerned, many young people have gotten the notion it won’t be around for them. “They think it’s something you can’t count on,” agrees Friedman. “People have lost a little bit of faith in government taking care of you.”
But most advisers don’t think this core retirement benefit is going away. “Social Security will always be around,” Campbell says. Most advisers expect some tweaks—such as removing the adjustment for inflation and raising the age for full retirement to 70—but are confident it can remain a part of retirement planning.
40s & 50s
As people move into their 40s and 50s, there are new demands on income and saving, from buying a (bigger) home, raising kids and putting them through school with the sky-high costs for college or even for private schools in earlier years.
“Parents want the best for their kids and are willing to sacrifice their needs for those of their children,” Williams says.
But advisers say that retirement savings should not be one of those sacrifices. “It’s like the oxygen masks in the airplane,” says Friedman. “Take care of yourself first and then your children.”
For one thing, planning for financial independence in retirement ensures that grown children won’t be burdened with caring for their parents.
For another thing, there are loans available for education, but there are no loans for retirement. “Your retirement has to be the No. 1 priority because it is the only thing you can’t get a loan for,” O’Brien says.
Parents are better off getting loans for their children’s education or assisting them with the student loans instead of sacrificing or diminishing their own retirement savings to pay for their children’s education, advisers say. There are also grants and scholarships to help defray college costs.
Education costs have risen to the point, in fact, where some parents are starting to question the wisdom of spending that kind of money on college.
“People are asking, half a million dollars for a four-year degree, is that really smart?” says Eveland. “We haven’t seen a sea change, but there’s some pushback on how much money is spent on education. People are talking about it instead of just writing a check.”
Some parents are questioning whether a college education is right for everyone. They are exploring options like having the student spend two years in a community college before transferring to a four-year college and looking again at local colleges with in-state tuition.
“In Virginia, we have a number of great state institutions,” Eveland notes.
But parents increasingly face an additional problem as college graduates return home while looking for that elusive first job or even as they start work. “You want to get the kids off the payroll as you approach retirement,” Williams says.
For those in their 40s and 50s, this may coincide with added burdens they have with their own parents, whose bad health or insufficient savings make them in need of assistance.
During this phase, many will use insurance to hedge risks. While term-life insurance will protect a family against the loss of the breadwinner(s), only whole-life insurance functions as a savings vehicle, though advisers caution premiums can be expensive.
Long-term care insurance has become more popular to help defray costs for home or nursing home care, one of the retirement costs that often catches people off-guard. However, LTCI has also gotten expensive.
One of the trickiest stages for retirement saving nowadays is the 60s as people near and enter retirement. The reason is that people are living much longer, and if they keep to the traditional retirement age of 65, they are facing as much as 25 to 30 years in retirement.
“You may be spending a third or even half your life in retirement,” warns Eveland.
This poses significant new challenges. “It is difficult to save enough in 40 years to pay for 25 years and more of retirement,” says Williams. “With longevity, there may be a need to reassess retirement age.”
This is particularly true for those who started saving too late, who may have to continue working well past retirement age or face a drastically reduced standard of living.
But even those who have saved assiduously may want to continue working. “People often are willing to work a three-day week at lower pay to keep from dipping into that nest egg,” says Campbell. “Some employers would rather keep that experience and knowledge than hire someone new full time.”
For others, their identity is tied up with their work, says Campbell, whose firm specializes in advice for those nearing or in retirement. “For engineers, attorneys and others, they love what they do; it gives them a sense of identity.”
Some choose to continue work even though they are financially able to retire. “If they have options, they find it makes work more palatable,” Williams says.
Ultimately, says Campbell in recommending having a plan for activity in retirement, “you want to retire to something rather than away from something.”
Financial advisers are cautious about viewing a home as a form of retirement savings, even though it is often a family’s biggest asset and can build up considerable equity in Northern Virginia.
“I wouldn’t view a home as an investment,” Williams says. “A home is often a cost structure rather than investment and comes with significant costs: mortgage, taxes, insurance, maintenance.”
Everyone has to live some place, and even if a mortgage is paid off, saving that cost in retirement, retirees would have to be willing to sell the house to monetize the equity and then invest in another place to live.
“Some people prefer to ‘age in place,’ to stay in your own environment,” says Corey.
Increased longevity has also called into question the traditional notion that investments should become more conservative as retirement nears, with a higher proportion of bonds and less of the more volatile equities.
“You have to be careful about being too conservative because your money may not grow fast enough to stay with you,” Eveland says.
Advisers recommend “baskets” of savings, with low-volatility assets to cover the near and intermediate term and riskier assets like equities for the time beyond eight years, which allows enough time to ride out a market downturn.
“When you start retirement, you may have at least 20 years,” observes Corey. “You don’t want everything in a money market account at 0.0 percent.”
There are financial products that can take some of the worry about how long retirement income will last. Reverse mortgages and annuities are two products that have had a dubious reputation because of abuses, but new safeguards have been built in, and advisers say they may be the right solutions for some. For instance, a single premium immediate annuity—different than the deferred variable annuity, which has been subject to high costs and abuse—pays out a fixed amount each month for life after payment of the single premium at the outset. In this sense it mimics a pension, and the retiree can’t outlive it. On the other hand, the beneficiary may die before that premium is paid back, and the rest is lost.
Once again, financial advisers strongly recommend taking advantage of professional services in plotting out retirement income distribution.
“We do a lot of tax planning for retirees,” says Bender. One tactic they often recommend, for instance, is taking a distribution from a Roth IRA as at least part of income in the first years of retirement because it is tax-free and will keep a tax bracket lower even though income may still be higher to pay for vacation trips and other activities.
For some, having a legacy to leave to heirs is an important consideration. But there is also a school of thought, Corey observes, that “you should travel first class or your kids will.”
As for those who failed to save sufficiently and were not bailed out by an inheritance themselves, “those [are] cards you have to deal with and make changes in your lifestyle,” Campbell says.
From beginning to end with retirement savings, says Eveland, “There are no right or wrong answers. There’s choices.”