Time is on Your Side

Savers watched their investments get mauled as the stock market lost almost 40% of its value in 2008, but a new study finds it may not take them as long as they think to get back on track for retirement.

For investors within five years of retirement, adding just one or two more years on the job can put them on pace for retirement, according to a study of 401(k) and other defined-contribution plans managed by Financial Engines, a Palo Alto, Calif.-based investment advisory firm that provides services to companies who offer such plans, including advice to employees.

While most people assume that steep losses will take many years from which to recover, Financial Engines said that's not always the case, in part because retirement income from future savings and Social Security is not affected by the 2008 decline. For savers who began 2008 on track to replace 70% of their income in retirement in a few years, portfolio declines of 23% to 30% mean only a 10% to 19% decrease in projected median retirement income, according to Financial Engines.

Assuming you can hold on to your job in this economy, working one or two extra years solves the problem in some situations, according to the study, which focused on savers 50 to 60 years old, with salaries from $50,000 to $100,000. The study assumed a retirement age of 65 and did not address those whose retirement was less than five years away.

For instance, if a saver who was 50 in January 2008 and earning $50,000 a year delayed retirement until age 66.5, that person still would be able to replace 70% of income in retirement, according to the analysis, which assumes workers maintain a consistent savings rate of 9% of salary (6% by the worker, with a matching 3% contribution from the employer).

A 55-year-old earning $50,000 would need to delay retirement until 66.7 years old, instead of retiring at age 65. A 60-year-old would have to work until 66.4.

A 50-year-old earning $75,000 in January 2008 would need to delay retirement until age 67.1, while a 55-year-old earning $75,000 would need to work until age 67.2, and a 60-year-old until 66.9.

For those at the $100,000 income level in January 2008, a 50-year-old would need to delay retirement until age 67.5, a 55-year-old until 67.6 and a 60-year-old until 67.4.

The study's authors note that working longer does not mean recouping all of your losses, but simply getting to a place where retirement is possible. "It's getting back on track to retire with a projection that meets your goals on average," said Wei-Yin Hu, director of investment analysis and research at Financial Engines.

"The cost of the market decline in 2008, while severe on people's portfolios, in many cases means something more modest when you actually look at projected retirement income," he said.

That's because delaying retirement means setting aside more money, plus letting your savings grow for a longer time. Also, delaying Social Security benefits means a higher monthly payout, he said.

"There are modest, reasonable recovery strategies that can get people back on track by retiring a little bit later than they expected to or saving a modest additional amount. Ultimately, there is not a simple rule of thumb that applies to everybody, but there are reasonable actions that people should be taking to get back on track," Hu said.

The analysis assumes a 51-year-old saver invests 28% of his portfolio in bonds and 72% in equities, including 31% in U.S. large-cap stocks, 16% in U.S. mid- and small-cap stocks, and 25% in international equities. As savers age, the analysis assumes a more conservative portfolio, with the portion in bonds rising to 51% by the time the saver is 61 years old. The study assumes a median portfolio growth rate of 5.1% for the 51-year-old, dropping to 4.5% for the 61-year-old.

The news is less good for people who jumped into an all-cash portfolio. Some savers who moved their money out of stocks will need to stay on the job as much as two to four years longer than those who didn't bail out, according to the study.

Devilish Details

The analysis assumes that replacing 70% of income in retirement is sufficient. Plus, the study notes that savers who take these steps have a 50% chance of reaching their retirement goal. How far off you are will depend on market performance going forward.

Still, Hu said, "Having a 50% likelihood of meeting your goals is a pretty good starting point if you're a few years from retirement." That is, savers have some time to adjust their savings rate or reduce their expenses if the market fares poorly over the next few years. Alternatively, if the market does better than the study assumes, they may retire earlier than expected or with a higher than expected retirement income.

"If the market's really lousy, it could mean working an additional 2 1/2 years versus 1 1/2," said Jeff Maggioncalda, chief executive of Financial Engines.

Meanwhile, those worried that the government will cut Social Security benefits may question the study's assumption that delaying retirement will bring higher benefits, as is currently the case under the government program. But most savers are unlikely to be affected by benefit cuts, Maggioncalda said.

"If there are cutbacks in Social Security and there may be, it's going to be from people who are wealthy as opposed to less wealthy," he said.

Also, the study assumes salary hikes keep pace with inflation, and rather than make assumptions about life expectancy, the study assumes savers will use their retirement savings to purchase an immediate lifetime annuity indexed to inflation. "We're not recommending that people do that," Hu said, "but it's a way of saying this is how much a portfolio could produce in lifetime purchasing power."