Retirement Myths and Realities

Henry "Bud" K. Hebeler says that if we expect to reach our financial retirement goals, we're going to have to put the kibosh on extraneous spending and make savings a priority in our lives.

It seems simple enough, but for many Americans, giving up flat-screen TVs, luxury vehicles and the penchant for dining out is about as palatable as swallowing a spoonful of castor oil.

For those of us who have moved retirement planning to the back burner, Hebeler's back-to-basics advice is propped up by stark figures on American saving habits.

Forty-nine percent of workers report savings and investments of less than $50,000 (not including the value of a home or a traditional pension plan). And 22 percent of workers and 28 percent of retirees report no savings whatsoever, according to a recent survey by the Employee Benefit Research Institute, or EBRI.

Hebeler says all Americans should become self-educated about retirement issues, even if they have a financial planner.

The former president of Boeing Co. and ballistic missile engineer didn't pick up the financial planning bug until he was 55 and considering his own retirement future.

He says that although he adequately planned for his retirement, he became inquisitive about the nuts and bolts of financial planning and started attending seminars and taking classes.

Seventeen years later, Hebeler shares sage advice on retirement planning with Bankrate readers.

During the accumulation stage -- while people are working, say, from their 20s through their 50s -- how much should they be putting away toward retirement, expressed as a percentage of earnings? Is there a number that can work for everyone?

My father used to tell me to save 10 percent of my wages all the time for retirement. And so I did. I never looked at any retirement plan; we didn't have retirement planning tools in those days. We didn't have experts to advise us. We didn't read financial magazines and newspapers.

I just did what my father suggested. I always put away 10 percent. My father said if you have a year where you can't do that, put away your next raise, you won't know the difference.

A lot of people around me did the same thing. That was in the day when a lot of people got pensions. If you take pensions out of the picture, then you're going to have to save more. I think the number is closer to 15 (percent) to 20 percent -- that's from the time when you're a relatively young person, say, 30 years old or something like that.

It also depends on what kind of work you do. If you work with the government, it's not as much of a problem. You can probably save slightly less. That's because the government provides COLA (cost of living adjustment) pensions. So with the exception of the government employees, I'd say save 15 (percent) to 20 percent at the minimum.

What about those who are playing catch up?

Since people are starting from such a low base, they're going to have to save a lot more as they get older. Many people are going to have to save 50 percent of their income. They're going to have to clamp down on everything. They are going to have to resolve: We are not going to get a new car. We are not going to have cell phones for every person in the family. We are not going to buy that 52-inch plasma TV. We're just going to have to clamp down.

If a couple wanted to generate an income of $50,000 a year during retirement in addition to their Social Security income, and they expect to live 25 years, how much money do they need to save up?

There is no perfect answer to this question. The answer depends on your investment allocations, investment costs, future inflation, future market performance and future tax rates. But let's assume that you are already close to retirement. If you are not, you'll need to increase amounts to account for inflation until you retire.

For example, if the answer is $1 million in today's dollar values, then in 10 years you would need 1.34 times as much with 3 percent inflation per year or 1.48 times as much for 4 percent inflation. In 20 years, and until retirement, you would need 1.89 times as much at 3 percent or 2.19 times as much at 4 percent.

If you have a retirement allocation of 40 percent stocks, 50 percent bonds and 10 percent money markets along with investment costs of 1.5 percent (very common), and if future inflation will be 4 percent, you would need $1.12 million savings at retirement. You can reduce the amount you need by using index funds with costs of only 0.2 percent. Then you need $950,000, or about 15 percent less.

You also might need less with a higher allocation of stocks, but you incur significantly more risk, especially if you have a couple of bad years of stock returns earlier in retirement. That's what happened to those who retired in 1965, like my father, or those who retired near 2000, like a number of my younger friends. Unlike the poor performance following a 1965 retirement, 1948 was one of the very best years to have retired.

Those who retired in 1965 would have used up the entire $950,000 in 25 years if they only spent $15,000 a year, not $50,000. On the other hand, they could have spent $108,000 if they had retired in 1948. This difference is staggering. All of this with only 40 percent stock allocation. Also those who retired in 1965 had higher taxes than those who retired in 1948, thus delivering another crippling blow.

How much attention should we pay to inflation as we save for retirement?

It is important to understand that inflation plays a very large part in these results. Virtually all retirement planners assume that expenses will go up every year with inflation.

Most planners use a default value of 3 percent to represent the inflation results including the Great Depression. The average inflation starting right after the Great Depression is about 4 percent. Inflation in the first 20 years of a 1965 retiree was 6.3 percent. Even with retirement in 1948, the first 20 years, inflation was 4.3 percent (annualized). That's why I don't like to see people use historical returns along with 3 percent inflation.

If your financial source says that you need only a fraction of that result, start asking a lot more questions.

It's often common for financial sales people to say how you can be a millionaire if you save relatively small amounts of money over long periods. They (intentionally) fail to point out that $1 million in the future will be far short of what $1 million is worth today.

In your book, you cite a half-dozen retirement planning myths. One is that Social Security is inflation-adjusted. Social Security does have a cost-of-living adjustment. Why isn't this sufficient to cover inflation?

A retiree's inflation rate is about 0.2 percent higher than the normal Consumer Price Index. When you retire, you have medical expenses that continually increase. You have more need for this service and the unit cost is increasing much faster than inflation.

So, you've got two things working to really accelerate the amount of money that you have to spend for medical expenses. That's the primary reason. The dollar amount of our checks this year is actually less than it was last year. The reason is we have a Medicare Part D premium deducted from our Social Security checks. Well, Medicare costs have been going up so fast and so high that it completely offset the increase from the standard inflation rate.

So I would say Social Security is not really adjusted. The government sends every working person a report about what you're going to get from Social Security, but it doesn't tell you that your check is going to be reduced by Medicare parts B and D.

Another retirement myth you cite is that there are safe portfolio withdrawal limits. It's widely believed that a 4 percent withdrawal rate each year is pretty safe. Is this a false assumption?

It's not a false assumption if history repeats itself. If the returns in the future have the same kinds of statistical distributions that you had in the past, then I think that's a pretty safe number.

Now, if you're going to retire at 80 years old, you could actually have a bigger number than 4 percent. If you're going to retire around 65 or so, 4 percent is not a bad number. Some people are now saying 3.5 percent instead of 4 percent. If you're going to retire at 55, you'd better spend a lot less than 4 percent because you've got another 10 years of life that you're going to have to support.

People should start thinking about retirement as being something like a quarter or up to a third of their life. They therefore have, at most, half of their life to earn the money to support the rest of it. When they start thinking about that in those kinds of terms, I think they'll start saving more money.

You advocate shifting into more conservative investments as people get older. Yet many financial experts say that people should have stock market exposure so they have growth in their portfolio. How much of one's portfolio should be devoted to fixed income versus stocks during retirement?

Again, if dealing with the future is sort of like the past, in my view, and this is what I did, subtract your age from 100. So if you're 60, you would have 40 percent in stocks probably as the minimum and you might go up higher than that to 40 (percent) to 50 percent. So what you do is use your age as a guide. So at 70 you're at 30 percent in stock, when you're 80 you might have 20 percent in stock. Plus let it go up another 10 percent.

Maybe every other year I might have had to rebalance my portfolio.

Do you find using that formula pretty effective?

Oh yes. I find as a consequence of using it, I've done better than I would have by keeping a constant percentage all the time. I balance it precisely every year or every quarter. Having that little bit extra in there at 10 percent makes a huge difference.

If someone is getting a pension from their workplace, why should they bother saving for retirement in a 401(k) or similar retirement plan?

For most people, chances are that a pension won't be enough, because what most people do is hop around from job to job.

Let's say based on the amount of time you've been working for your employer, you're going to get $1,000 a month. Now you quit and you go to work somewhere else. Well that $1,000 amount does not increase. Twenty years from now, you'll still just get that $1,000 when you actually reach retirement age. That amount of money will not be worth anywhere near what it is today.

So problems can arise if you jump around from job to job -- and most do that now. Also, there are many employers who don't provide pensions and then there are a lot of employers who've been dropping pensions and have been putting people in cash balance pension plans.

So you have to be cautious about using a pension projection that an employer gives you. You have to think very broadly about it and probably discount the value because you may not end up working there for your entire working career.

The decision about when to collect Social Security depends on many factors, but is there a rule of thumb that people should follow?

I think they should do an analysis of it and if they can't do it themselves, then go to a professional who's not selling anything. The professionals used to say take your money at 62 and that was a terrible mistake in my view, but what they wanted to do was get their hands on your money as early as they could so they had income themselves. That's my view of why they recommended that.

If you do a thorough analysis of your situation, you'll find that there's a great benefit in retiring later. If people can't do the numbers themselves, there are enough honest planners out there that could do it for you or you could use a software program to help you with that decision.

For the most part, people will do better by waiting. There are some qualifications to that. First of all, you wouldn't want to wait for a long period of time if you were in really bad health and you knew you were going to die long before the average person. Another reason is you just haven't saved enough money that you can afford to take Social Security later -- there are a lot of people in that situation. I get letters all the time.