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Monday, December 27, 2010

Doomsday Retirement Scenarios

If you're older than 30 or ever attended a 401(k) educational seminar you've heard it. How we're not ready for retirement. How we haven't saved enough and how you need some astronomical amount of money you can't possibly save in order to afford retirement.

While few people are saving enough, period, there are problems with the doomsday scenario. It is based upon an unrealistic retirement age established in 1935, manual labor, and the idea of employer pensions, now mostly a thing of the past. With no pension and a traditional retirement age, how do you possibly retire?

Traditional retirement savings ideas are based upon the "three-legged stool" notion; your retirement is financed by your own personal savings, your private retirement benefits (pension or 401(k)), and Social Security. The doomsday Sayers project that without a pension your 401(k) and Social Security are all you'll have, and you'll be short.

Well, if you perform manual labor and have no alternative career, and you plan to retire at age 65, they're probably right. Here's why that won't happen.

The retirement age of 65 was established in 1935 with the original Social Security Act. At that time the average life expectancy in the U.S. was 69. The typical job performed by most workers was manual. See a problem already?

According to the CDC, the average life expectancy is now 78 years. Moreover, the forces at work causing increased life expectancy (improvements in nutrition, health care, etc...) are still at work. Since the Social Security Act we've added, on-average, 44 days (.12% of a year) of life expectancy each year. That means if you're 40 right now you could expect to live not just to 78 (by 2049), but to 83 (by 2054).

Were you to retire at age 65, in 2036, Social Security would be subsidizing your idle retirement for 18 years, not the 4 originally intended in 1935. This is why Social Security solvency is an issue, and why governments including our own are pushing for older retirement ages.

But you won't retire at 65 now will you? No, you might retire officially and cash out your 401(k), but after that you'll most likely continue to work as long as your mind is sound. Why? Because most of you don't perform manual labor any more.

What about personal savings other than 401(k)? You'll have that in the form of home equity and, if you're smart, investments. Most people approaching retirement either have the opportunity to or actually do buy-down to a smaller, more manageable home.

Don't let the doomsayers tell you that your home won't be worth as much due to the recession. That sells headlines but just isn't true. In our area home values increased by 7-8%/year for a couple of decades, then lost about 15% in the recession. Do the math. A $40,000 home I looked at in the Vanderbilt area in 1992 sold in 2007 for over $400,000.

In the coming years you'll pay off your home and, in retirement, most likely need a smaller less expensive one. That becomes one leg of your stool.

So how much do you need for retirement? Here's a new "calculator". Calculate your estimated life expectancy (78 - your age) x 1.12 + your age. Subtract that by 5 years to calculate a reasonable retirement date. Take that date and plug it into the retirement benefit calculator of your 401(k) provider and get a real estimate of what you'll need to retire.

Chances are you may still be short. But you won't be "throw up your hands and pretend its not a problem" short. You'll be "some" short and can put together a plan for a secure, albeit briefer, retirement.

Don't want to work that long? That means you don't love what you're doing and should consider a second career. That's another story for another post.