Retirement Planning and Magical Thinking

by HTG Investment Advisors

In 2005, Joan Didion topped the bestseller list with her book titled The Year of Magical Thinking. The book describes the sudden death of her husband and soul mate, and the ensuing year during which she fails to accept the reality of his death.

Magical thinking is not limited to widows. By many accounts, millions of Americans engage in magical thinking when it comes to retirement. Consider the results of the 2006 Retirement Confidence Survey in which 44% of workers who have not saved for retirement felt confident they will have a comfortable retirement!

Without a doubt, there is a “disconnect” between the reality of pre-retirees’ financial situations and their perception of what it takes to retire. Let’s look at some examples of "Magical Retirement Thinking.”

 

• “I’ll tap my home equity to pay for retirement” While your home’s appreciation may strengthen your retirement picture, there are several cautions to keep in mind. First, gains on your home are taxable if they rise above the $250,000/person threshold. Second, you have to live somewhere; meaning you can only tap part of your equity. Third, you need to be able to be flexible about when you sell, as real estate markets do not always increase in value.
  

• I can save later, when the kids are out of college.” Time is not on your side, unless you are relatively young. If you wait until you are 50 to start saving for retirement, you will have to save at five times the rate of a person who starts at 30.
  

• “I’ve saved some, but I’m a smart investor and my returns will save me.” Better take a good look at how high the returns need to be. If you wait to age 50 to start saving, your return will have to be 25% a year as compared to 7% a year if you started 20 years earlier.

• “I’ll die young, so I don’t need to plan for 30 years in retirement.” If you are married, it is very likely that one of you will live beyond 85. What if you are wrong and live beyond your money?

• “I can downsize when I need to. I/We can live on less.” This is another very popular idea. While it may be true for 80+ year olds, the new retiree is likely to spend more in early retirement (age 65 to 75) than when he/she was working.

 

Working Longer: A Solution?

A recent article in Financial Planning asserts that working longer may be a solution to a shortage of savings. Working longer means more earnings, more retirement contributions, more investment income, no drawdown of assets and greater Social Security. But, there can be landmines to avoid. Health issues, corporate downsizing, loss of interest in work, and family demands may hamper working beyond 65.

Therefore, when thinking about whether working longer will “work” for you, consider your “work expectancy” as well as your “life expectancy”. To help answer the question of how much a prolonged career can add, we offer an example below.

Let’s consider a 62-year-old single person, earning $100,000 a year. She saves $12,500 annually and has already accumulated $500,000. She needs $80,000 per year in retirement income to age 85. The following chart shows the impact if she were to retire at age 62, 65 and 70. In making this projection, we have assumed a 4% rate of return, net of inflation.

A glance at the table below shows that through the combination of a higher social security, more savings, and more growth on her savings, her retirement future goes from being under-funded by $473,000 at age 62 to over-funded by $188,000 in 8 years!

If you can find a desirable job that can follow you into your sunset years, you may be "golden.”

 

Retirement Age	62	65	70
Total Annual Retirement Income =	$80,000	$80,000	$80,000
Social Security +	$17,000	$22,000	$27,000
Income from Portfolio	$63,000	$58,000	$53,000
Accumulated Savings	$500,000	$601,000	$800,000
Savings needed to fund Retirement Income to 85	$973,000	$819,000	$612,000
(Shortfall)/ Excess	$(473,000)	$(218,000)	$188,000

 

HTG Investment Advisors Inc
50 Locust Avenue
New Canaan, CT 06840
203-972-8262
203-966-4740(fax)