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Saturday, 4 April 2009

Five strategies to rescue your retirement

By Janice Revell, Money Magazine senior writer

Will I ever be able to retire now? That's a question you're likely asking yourself these days. After a year in which your 401(k) has been hammered by the biggest stock losses since the Great Depression, your home equity has been whacked by the collapse of the real estate market and the specter of being laid off looms larger every day, no one can blame you for being skeptical.

In fact, more than two-thirds of the respondents in a recent poll CNNMoney.com poll said they'll have to postpone their retirement as a result of the current financial crisis; more than a third worried that they'll be chained to their desks for life.

Now for the good news: You've got more weapons at your disposal to win the battle against a hostile economy than you may imagine. Read on for specific strategies to help you position your portfolio for a rebound, take advantage of other financial assets in your arsenal and make the most of the time you have left in the work force.

Sure, the task would be a lot easier if you had 25 years or more before quitting time. But while the challenges are great, so are the opportunities for a comeback.

Need convincing - and inspiration? Check out these profiles of people who lived through similar crises in the past - portfolios down by half in market crashes and recession-fueled layoffs - took smart action and ended up in better financial shape than they were before.

One thing's for sure, though: The task before you won't get any easier if you delay. Here's how to get started on your retirement rescue mission.

1. Know where you stand

Assuming that you will not be able to retire when and how you planned is vastly different from knowing it for a fact. If you haven't taken count of how much money you have and how much you'll need to retire comfortably, you may be in the dire straits that you fear - or you could be in far better shape. Either way, to figure out a plan for where to go from here, you first need to know where you are right now.

Assess the Damage. This is no time to be squeamish. Dig up your latest 401(k) statement, along with the most recent statements from your bank and brokerage accounts, and add up what you've got. The extent of your losses may depress you - a typical 401(k) invested 60% to 70% in stocks and the rest in bonds is likely to be down 20% to 30%, and a more stock-heavy portfolio will have even steeper drops. But knowing the current value of your portfolio will help you determine how much you have to save going forward.

You'll also need to make an educated assumption about how much you will earn on those investments in the future. Coming out of past long-term slumps (the carnage is not just over the past year; this is, in fact, one of the worst 10-year periods on record), stocks have returned no less than 7.2% annually over the following decade and as much as 15.6%, according to the Leuthold Group.

In estimating future returns, err on the conservative side. "If you've got at least a 10-year time horizon and a balanced portfolio, a 7% rate of return is reasonable," says Chris Cordaro, a financial adviser in Morristown, N.J. While that may not sound like much, remember that you won't have to count on your investments alone to fund a comfortable retirement.

Tally other sources of income. Social Security will likely make up at least 20% of your retirement income. The longer you wait to collect (you're eligible at 62), the more money you'll get. Every year you delay up to age 70 adds about 8% to your payout. If you're retiring this year and you qualify for the maximum benefit, that would mean the difference between about $21,000 a year (in today's dollars) at 62 and $38,000 if you wait until 70.

You may have a pension to fall back on as well. Despite widespread reports of the demise of the traditional pension plan, roughly 70% of employees at large companies and 95% of people who work in state and local government still have access to one. (Federal employees and workers at small businesses aren't likely to be as fortunate.) If you're eligible for a pension, ask your HR department for an estimate of your projected payout at retirement. Even a seemingly piddly pension can make a major difference. An annual payout of $20,000, for example - one you might expect to collect if you earn $100,000 a year and have been with the company for 15 years - is the equivalent of saving an extra $300,000 in your retirement account, according to Steve Vernon, an actuary in Oxnard, Calif.

Rerun the numbers. Once you have all the facts, head to an online calculator like the Retirement Planner, to get an estimate of how much you'll need to save to meet your goal. The answer isn't likely to be a huge surprise - yes, repairing your beaten-up portfolio will likely involve serious saving on your part, as the chart on the right illustrates. But as the next steps show, saving more is only one of the tools at your disposal.

2. Pump up your portfolio

Having the right blend of investments is key. And yes, we do mean blend, even though you may feel that diversification let you down last year, failing to provide a cushion against losses. Instead, everything went down; some assets just dropped less than others. But diversification is a long-term strategy that pays off over a period of decades, not months or even a few years. Then too, imagine how much steeper the drop in your portfolio might have been if you hadn't had your money spread among several kinds of investments.

Stick with a mix. Still, the losses were painful enough, and the urge to get out of stocks entirely is understandable. So, at the other extreme, is the impulse to "swing for the fences" by aggressively moving into beaten-down stocks to recoup your losses by the time you retire. Both are bad moves.

Consider the all-bond strategy. It may sound safe, but a new study by T. Rowe Price shows that switching completely into fixed-income investments after a market crash would give you only a 31% chance of your nest egg lasting through retirement. "With a 100%-bond portfolio, you simply can't keep up with inflation and your own longevity," says Christine Fahlund, senior financial planner at T. Rowe Price.

But an outsize bet on stocks to revive your portfolio isn't smart either. Even if after the past year's losses you still have a hefty amount socked away, you don't need to take the extra risk. And if you're way behind on your savings goals, it's a risk you can't afford, especially if you're within a decade of retirement. The probable payoff is just too slim.

T. Rowe ran the numbers for a 55-year-old with a $100,000 salary and just $150,000 in savings who ratcheted up his stock allocation from 40% to 80% to help his portfolio recover. After running 10,000 market scenarios, the researchers found that while the portfolio invested 40% in stocks replaced an average of 27% of the investor's salary in retirement, the 80%-stock allocation replaced only 28% - virtually no difference. That's because while stocks have historically delivered higher returns over very long periods, over any 10-year period you're more likely to suffer a few losing years, and there simply isn't enough time for your gains to compound.

Cut your risk of big losses. As a general rule, financial advisers recommend keeping about 80% of your savings in stocks when you're in your forties, 70% in your fifties and 50% to 60% in your sixties, with the rest in bonds and stable-value funds. With stocks now at their cheapest levels in nearly two decades, those allocations give you a good shot at regrowing your portfolio going forward.

But understand, the gut-wrenching volatility of the past year isn't going away anytime soon. If the thought of watching your portfolio swoon after the Dow drops 500 points in a day - again - keeps you awake at night, it may be worth it to dial back that commitment to stocks somewhat.

Yes, you'll sacrifice a bit of your potential gains. But you'll also dampen the magnitude of the losses you could suffer - a particularly important consideration if you're within 10 years of retirement. A portfolio invested 70% in large U.S. stocks and 30% in bonds historically has averaged gains of 8.9% a year vs. 8.2% for a fifty-fifty mix, according to Ibbotson Associates. How much safety does that seven-tenths of a percentage point buy you? The worst loss in a single year for the evenly split portfolio was 24.7% vs. 32.3% for the bigger stock portfolio.

As you get closer to retirement, also try to beef up your cash reserves. Keeping two to three years' worth of living expenses in CDs or money-market funds means you won't be forced to sell stocks or bonds when they're down.

Reduce your tax bite. One surefire way to boost the real return on your portfolio is to reduce Uncle Sam's cut. Today tax rates are at multi-decade lows, but given the projected $1 trillion federal deficit this year, most experts don't expect that to last.

You can take advantage of today's low rates by saving for retirement in a Roth IRA or the new Roth 401(k), either by funneling new contributions into these accounts or by converting an existing IRA. With a Roth, you pay taxes up front on the money you put in but no taxes on your withdrawals. With traditional IRAs and 401(k)s, you get an up-front break, but your withdrawals are taxed at your regular income tax rate. Says Ed Slott, a C.P.A. and IRA adviser in Rockville Centre, N.Y.: "The sooner you get rid of Uncle Sam as a partner in your retirement account, the better."

A married couple can invest $5,000 a year per person ($6,000 if you're over 50 years old) in a Roth IRA as long as your joint income is $166,000 or less. There are no income limits for Roth 401(k)s, but only 25% of companies currently offer them, according to Hewitt Associates. That's likely to reach 50%, though, in a couple of years' time.

3. Keep the paycheck... and have a plan B

"I'll just work a few more years." That's the common solution many boomers are counting on to make up for the downturn in their portfolios. But how much longer will you really have to work to make up for the hit that your investments have taken? And what's your fallback position in case your current job doesn't last as long as you need it to?

Work longer if you can... Keeping your full-time job for a few extra years isn't a silver bullet, but it's pretty darn close. For starters, you'll be able to postpone drawing Social Security, setting yourself up for a much larger monthly check when you eventually retire. Working longer also gives your portfolio more time to grow. At the same time, you'll be shortening your retirement span and the period over which you have to support yourself with those savings. Combine all of these factors and the results are powerful: A 62-year-old who keeps working until age 65 will experience a 25% boost in annual retirement income (see the graph on previous page).

...But you can lighten up. What if staying in your current job isn't an option? If you're in your forties or fifties now, there's a good chance you'll be with a different employer by the time you hit retirement age - or possibly well before then. In 2006, 43% of full-time workers ages 65 to 69 weren't working for the company that had employed them in their early fifties, the Urban Institute reports. About a quarter of those workers had changed jobs owing to layoffs - and that was before the current recession.

So to stay employed longer, you may have to change jobs, which could involve taking a pay cut or shifting to a part-time position - the typical worker 45 and older experiences a 12% drop in salary after a layoff. Fortunately, earning less or working fewer hours once you reach the career home stretch probably won't put a dent in your retirement rescue efforts, as long as you earn enough that you don't need to start collecting Social Security or dipping into your retirement savings.

Say, for instance, that you end up switching jobs at 62, making only half as much as you did before and you keep working until 65. You'd end up with only about 5% less in annual retirement income than if you'd kept your full-time position until 65, as long as you're able to cover your living expenses. The reason: The benefit of delaying Social Security and not tapping into retirement accounts far outstrips the value of any extra savings you could accumulate between ages 62 and 65. "The income you get from working part time may seem like a pittance, but it can actually have a profound effect on your retirement lifestyle," says Fahlund.

Keep your eyes open. With the pace of layoffs expected to accelerate this year, you may need to find that new job sooner rather than later. But landing a position in the midst of recession is a lot tougher for fiftysomethings than for thirtysomethings. Start laying the groundwork now by reconnecting with some of the names in your Rolodex; the vast majority of openings are still filled by knowing people who know people who know people. Use sites like LinkedIn to expand your contacts. Join a professional networking group; attend their get-togethers; and scour their job lists, which often advertise positions before they are public knowledge.

Also be alert to new opportunities and ways to transfer your current skills to new employers or industries. Put together a list of companies where you'd like to work; then research them to find out what it would take to get in the door. If you need to beef up your credentials in a certain area, volunteer for a project at work that will help you gain the skills you need. Not possible? Think about joining a nonprofit board that will provide similar hands-on experience.

4. Tap your home equity

Housing prices have fallen 23% since 2006 and economists are forecasting another 15% drop before the market bottoms. As a result, you've probably written off your home as a source of funds in retirement. Not so fast, bub.

You can still retire on the house. Or at least, the house can help. Even if home prices slump for a few more years, the sharp rise in values over the past couple of decades means that your home equity will still likely account for a third to half of your net worth by the time you retire, the National Economic Bureau reports. That can be a significant backstop if your savings plan comes up short.

You might choose to cash out your equity by selling your home and moving to a less expensive area. Or you might opt for a reverse mortgage, which lets homeowners age 62 and older draw down their home equity without repaying it for as long as they live in the house. Last year, new federal regulations raised the limits on government-backed reverse mortgages up to $417,000 (the maximum is likely to be raised soon to $625,000 in areas of the country with high housing costs). For example, a 65-year-old with a fully paid house worth $400,000 could tap about $237,000 of that equity.

But up-front costs for a reverse mortgage can exceed 10% of the loan. So if you need to borrow only a small amount or you might be moving in a few years, an ordinary home-equity line of credit would probably be a better option. Although you would have to make monthly payments, tapping a HELOC is a useful short-term strategy for generating retirement income while the financial markets are in turmoil. "It can save you from having to sell your stocks when they're down," says Cordaro.

Aim to be mortgage-free. Of course, this strategy works only if you've got equity to tap. That's why you should aim to pay off your mortgage if possible by the time you retire. If you're already maxing out your retirement savings and you have an adequate emergency fund, consider boosting the amount you pay every month on your mortgage.

Think of it as an alternative kind of fixed-income investment, in which your return is the interest rate on the loan. Say you have a mortgage with a 6% fixed rate; if you deduct your interest payments on your taxes, you'll earn 4.3% by prepaying the loan if you're in the 28% bracket. That's a risk-free return of 4.3% - nearly 1.5 percentage points better than the recent rate on 10-year Treasuries. If your mortgage rate is higher, your effective return on the accelerated mortgage payments will be higher as well.

5. Rethink your expectations

Let's be honest: Given the magnitude of the financial collapse, you may end up falling short of your savings goal by the time you quit working no matter what you do. Luckily, small changes in the way you manage your withdrawals in the early years of retirement can go a long way toward closing any gaps that are left.

Make minor sacrifices early on. Planners generally recommend that you limit your initial withdrawal from your retirement account to about 4% of your portfolio's value. Then, in subsequent years, you would boost your withdrawals to keep up with inflation.

The problem is that if you happen to retire just as the stock market is tanking, your odds of running out of money skyrocket with this withdrawal plan. There's an easy fix: Simply forgoing the inflation adjustment in the first five years of your retirement can cut your risk of running out of money in half. These days, of course, that's hardly a huge sacrifice since inflation is barely above 0% a year. But even at the long-run average rate of about 3%, you wouldn't be giving up much - about $900 in the first year on a $750,000 portfolio and about $3,700 by year five.

Tap your nest egg wisely. By the time you stop working for good, your money will likely be spread among several different kinds of accounts, including tax-deferred plans like 401(k)s, traditional and Roth IRAs, taxable brokerage accounts and ordinary bank accounts. How much money you decide to take from each one, and when, will have a big impact on how well you live.

If your portfolio still hasn't recovered by the time you stop working, refrain from cashing in any stock for as long as possible to give those shares more time to recover. Instead, start withdrawals from your bank accounts and other cash investments. By this point, ideally you'll have at least two years' living expenses set aside in cash for this type of situation. Not so ideally situated? Then tap your taxable brokerage accounts, which will allow your 401(k) and IRAs to continue compounding tax deferred.

Add up all the moves and, despite the travails of the past year, the odds are great that you'll still be able to retire in comfort, and maybe even in style.

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