Saving for Retirement

Revive Your Retirement

You may have to save a little more and work a little longer. But you can still get there in good shape.

By Mary Beth Franklin, Senior Editor

From Kiplinger's Personal Finance magazine, February 2009

The Incredible Shrinking Nest Egg sounds like the title of a cheesy Hollywood horror movie. But it might as well be reality TV for millions of American investors in or near retirement. Many of them have watched their house values plummet along with their 401(k)s, jeopardizing backup plans to tap home equity should their retirement savings come up short.

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But younger workers, with decades to go before they retire, may look back on the Panic of 2008 as one of the best things that ever happened to their finances. By continuing to contribute to their retirement plans, they can scoop up mutual fund shares at bargain prices. And thanks to a precipitous decline in home prices, many of them may finally be able to afford a house that was previously out of reach.

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But if you are age 50 or older, your picture is not so rosy. You may have to work a few years longer than you had planned, particularly if you're not covered by a traditional pension (most baby-boomers aren't). That will give you time to stockpile or replenish your retirement savings, delay claiming Social Security benefits until they are worth more at an older age, and give your current investments a chance to recover from the biggest market rout since the Great Depression.

If you are already retired, take a hard look at your finances. A popular rule of thumb suggests that to ensure you don't outlive your savings, you should limit your withdrawals to 4% of your portfolio in the first year and increase subsequent withdrawals by 3% a year to keep pace with inflation. Christine Fahlund, a senior financial planner for T. Rowe Price in Baltimore, says although that rule works in 90% of stock-market simulations, "there is another 10% scenario to talk about -- and we've just lived through it."

Fahlund recommends that retirees concerned about running out of money reduce withdrawals from their portfolios, if possible, or at least skip the annual inflation adjustment until the market rebounds. And if you've suffered substantial losses, you may want to reset your withdrawals altogether, using your new, lower portfolio balance as the basis for your 4% distribution. The biggest threat to your savings now is withdrawing too much from a declining balance because you may not have enough left to benefit from rising stock prices when the market finally turns around.

In the meantime, you have to play the hand you've been dealt. No amount of anger or frustration is going to restore your investment losses. But moving forward with a concrete plan will help you get back on the right track, no matter your age or where you are on the road to retirement.

Younger workers benefit

Wendy and Rodney Dunn are prime examples of young investors well positioned to profit from the market meltdown. Their portfolio lost nearly 40% in 2008, about as much as Standard & Poor's 500-stock index lost. But they have decided to stick with their long-term plan. Says Wendy emphatically: "Given our age, we're staying the course."

The couple have the time to be patient. A former portfolio manager for North Carolina's state pension plan, Wendy, 33, is now a stay-at-home mom in Benson and chief financial officer of her family's finances. "We are reevaluating our asset allocation and making sure that we are still in quality funds," she says.

Rodney, 36, plans to contribute the maximum $16,500 to his 401(k) this year. Lynne Ford, head of the Retail Retirement Group at Wachovia, which merged with Wells Fargo at the end of December, says that's what workers of all ages need to do: Keep contributing as much as you can to your retirement savings. "This is the era of YOYO retirement," she says, "which stands for 'You're on your own.'"

Tax-free future

The Dunns also plan to add $5,000 each to a nondeductible IRA and then convert the two accounts to Roth IRAs in 2010, when the current $100,000 income-eligibility limit on conversions disappears. At that point, they will owe taxes only on the earnings, not the after-tax money they contributed to their traditional IRA accounts. (This strategy works best if you have only nondeductible contributions in your IRA. If your account holds a mix of deductible and nondeductible contributions, only a portion of any amount you convert to a Roth IRA will be tax-free.)

A Roth IRA is an excellent way to diversify the tax status of your future retirement income. Although you can't take a tax deduction for contributions -- as you can with a 401(k) or similar employer-based retirement fund -- all withdrawals are tax-free in retirement. And you can even withdraw your contributions (but not earnings) tax-free and penalty-free at any time. Roth IRAs are particularly attractive to anyone who believes that tax rates will be higher in the future -- a plausible scenario given the nation's record budget deficit. Single tax filers can make a full contribution of $5,000 to a Roth IRA if they earn less than $105,000, and married filers can contribute the maximum if they make less than $166,000.

Oyuki Lopez has contributed to a Roth IRA since she began working as a flight attendant nearly ten years ago. The 31-year-old recalls that once during a five-hour transcontinental flight a first-class passenger lectured her about the magic of compounding and the allure of tax-free income in retirement. She's been a crusader for saving for retirement ever since, helping her friends become more savvy about money and later bribing her husband by offering him $500 to participate in his company's 401(k) plan.

It's been a rough year for Lopez. She got divorced, quit her job and relocated to San Francisco, where she landed a position with start-up airline Virgin America. Despite the temporary setbacks, she's still keeping her eye on the future, funding her Roth IRA each month until she is eligible to participate in her new employer's 401(k) plan. She expects to contribute 15% of her salary.

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