Thirteen Retirement Myths

7. Myth: Social Security won't be there

Social Security isn't going the way of the LP record soon. Sure, the headlines are alarming. In just 10 years the cost of Social Security benefits will outstrip the amount that workers pay into the system, according to government studies. And by 2041 the Social Security trust fund reserves will run out, unless Washington gets around to addressing the problem.

But that doesn't mean Social Security will shut down. Enough new money will continue to flow into the program from payroll taxes to fund 70% to 75% of scheduled benefits until 2081. Andwith a few reforms, Social Security could continue to pay full benefits. "Compared with theother issues we face, such as financing health care, fixing Social Security is child's play," says Alicia Munnell, head of the Center for Retirement Research at Boston College."You could raise the payroll tax by just one percentage point for both employers and employees, and you would be able to fund full benefits for the next 75 years."

So it's a good bet that you can count on something close to what retirees collect today. The real issue is how big even a full benefit will be. "Most Americans think that Social Security will replace more of their income than it really does," says Dallas Salisbury, president of EBRI.

For the average retiree, Social Security currently covers only 39% of pre-retirement income; and if you earn more than the maximum taxable amount ($97,500 this year), Social Security will replace just 26%, on average, of the income you earned on the job. And those percentages will drop over the next 20 years to 33% and 20%, respectively. That's largely because Medicare Part B premiums, which are deducted from your Social Security check, are increasing at a faster rate than your benefit's annual cost-of-living adjustments.

8. Myth: Your house can finance retirement

Treating your house as the ultimate retirement insurance is an easy trap to fall into. Even with the housing market in the doldrums, the five-year real estate bull market has likely left you feeling house-rich. According to a 2004 study by the National Economic Bureau, upper-income boomers ages 51 to 56 have a third of their net worth invested in their principal residence.

As recently as May, a survey of affluent boomers by financial adviser Bell Investments Advisors found that nearly 70% were relying on their homes as a retirement asset. Question is, will the strategy work? The answer is, not that well.

Why? Because it's hard to eat out on your home equity. You have to live somewhere. To turn your equity into cash, you can sell and then rent, move to a cheaper area or downsize. Most retirees prefer to stay put. Yes, you can do what a small but growing number of retirees are doing: Get a reverse mortgage, which is a loan against the value of your house that you don't have to pay back. (When you die or move out, the loan is paid off by the sale of the house, which means you may not be able to pass the home on to your children.)

But these loans give you much less than the value of your house. For homeowners ages 62 to 69, lenders will typically let you borrow just 49% of your home equity, says Wharton finance professor Nicholas Souleles.

The best way to look at your house is as a place to live, not a retirement account. So in the years leading up to retirement, don't overinvest in it with the idea that you can get that money out later. Keep your mortgage and other housing expenses to no more than 28% of your income, and don't prepay your mortgage instead of saving for retirement.

9. Myth: You're too old to start saving

Okay, it would have been better to start saving early, but let's face it: Most people don't. Still, there's hope for late starters (even those starting at 50). A few years of serious saving can make a huge difference to your quality of life in retirement.

"The first thing you need to do is take a reality pill," says Martha Priddy Patterson, director of employee-benefits analysis at Deloitte Touche. "Figure out what you have and how much you'll need to put away for a decent retirement."

Then launch into savings overdrive - you need to stash away as much as, or more than, someone seeking to retire early. You do have one thing going for you. Anyone over age 50 can also make catch-up contributions of as much as $5,000 to a 401(k) and an additional $1,000 to an IRA.

You might be surprised at how quickly your work can show results. Say you are a 50-year-old earning $100,000 with only $150,000 saved. Research by T. Rowe Price shows that if you put the max in your 401(k), including a catch-up contribution and a 50% match, plus invest another 5% outside the plan, you'll have $1.5 million by age 65, assuming you earn an average of 8% a year. With that, a true retirement will be no myth at all.

10. Myth: Short-term market swings don't matter

It's comforting to look at historical returns. Despite the occasional setback, the market continues to rise over the long run. In any 10-year period since 1926, you'd have made money in stocks 97% of the time; over 20 years you'd be ahead 100% of the time.

As long as you're patient and keep investing, you'll do well, right?

Not necessarily. When you're far from retirement, you can tough out even devastating bear markets, buying low while you do. Once you near your quit date, the rules change. Say you were within a few years of retirement in January 2000, on the eve of the March 2000 to October 2002 meltdown, when stocks plunged 44%.

If you were solely in stocks, it would have taken you 41/2 years just to break even. But if you'd had 60% of your portfolio in stocks, 30% in bonds and 10% in cash, you'd have had far milder losses of 21%. Once you start cashing out, a bear market of that magnitude can seriously jeopardize your standard of living. If youwere a retiree with that same all-stock portfolio in the 2000-02 bear market, those losses would mean you'd have only a 43% chance of seeing your money last until age 85 vs. 80% if you had a more conservative allocation.

11. Myth: Top priority is the kids' college

Unless you expect your children to support you in retirement, stop thinking like an all-nurturing parent. When you have kids, it's only natural to believe that college needs are more pressing than your far more distant retirement. A recent survey by the College Savings Foundation found that 53% of parents consider college savings their top priority, ahead of retirement or a house.

Problem is, this kind of thinking can lead you to pass up a big weapon: the power of compounding over time.

Save $100 a month from age 25 to 35, then stop and let the money grow. You'll have $182,000 in 30 years. Wait until you turn 45 to start saving and you'll have to put away $315 a month for 20 years to end up with the same amount.

Then too, if you come up short when it's time to pay for college, you (and your kids) can get help, from loans to outright grants. You can't apply for a retirement scholarship at age 65. That doesn't mean you should give up entirely on saving for college or other goals. Just make putting away money for retirement your top priority.

As for college, don't assume you have to save enough to pay the full price tag - for most families, a reasonable goal is to save for a third of the costs and make up the rest through financial aid, loans and your income when classes start and the bills roll in.

12. Myth: Decent savings plan = early retirement

Wouldn't it be great to call it a career in your fifties and spend the second half of your life doing whatever you want - with no money worries to get in the way? For many Americans that's the dream. Yet when you consider how much you have to overcome to retire early, that dream looks more like wishful thinking. You need a portfolio big enough to support you for some 30 or 40 years. You won't qualify for Medicare until age 65, and full Social Security benefits don't kick in until at least age 66. The only way to pull off this feat is through prodigious saving - at least a third of your take-home pay.

Still, this isn't a bad myth to strive to make true. With four out of 10 workers forced to leave their jobs sooner than planned because of layoffs or health problems or to care for an ailing relative, according to a McKinsey survey, it's hard to go wrong by saving and investing for the goal of an early exit date. If you choose to work longer, you'll have that much more secure an eventual retirement.

13. Myth: You're bound to mess up your 401(k)

It's true that if you set out to make a colossal mess of your 401(k), no one is going to stop you. You can cash out when you quit or borrow once too often. And now there's no longer a pension sponsor taking responsibility for paying you a certain benefit no matter what; all the investment risk falls to you.

But you're about to get a lot more help if you want it. Last year's Pension Protection Act gave employers the green light to take more responsibility for their workers' retirement savings. Now an increasing number of plans will give you investment advice or even account management. And when you start a job, your plan sponsor may automatically enroll you in the 401(k), raise your contribution level each year and direct your money into diversified investments, such as life-cycle or target-date funds, unless you opt out.

All of which means that even if you never make an independent investing decision, you can nevertheless wind up with a decent portfolio.

Still, you can probably do better with just a little effort. Forstarters, you should try to save the max ($15,500 this year) rather than the 6% or so of salary that many plans set as a default level. And while target funds work well, it's not hard to design a customized mix that suits your goals and risk tolerance.

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