5 Biggest Retirement Myths
It was a simple enough proposition. Michael and Margie Gershtenson had always heard that the Southwest, land of cacti, affordable housing and low taxes, was a great retiree haven. And they knew they needed to set aside a certain amount for life's next chapter—as those big-broker ads ask, "What's your number?" So they set up a foolproof plan: Build a nest egg of at least $3 million, and get out of town. Which is exactly what they did, hitting that threshold five years ago and closing down their dental practice in Colorado—Michael had been the dentist, Margie the hygienist. Off they went, to senior-rich Sedona, Ariz., to live out their golden years.
Fact: Like it or not, most retirees will need stocks.
Historically, bonds have returned about 5 percent a year, while stocks have returned nearly twice that. So while people with a huge nest egg may be able to retire on bonds alone, those whose savings shrank in the crash may need growth from stocks to avoid running out of money.
But like millions of others, the Gershtensons ran into trouble—and not just because of the crash of 2008. Arizona may have low taxes, but the couple spent several thousand dollars more than expected each year on out-of-state travel, to visit their former home and escape the state's miserable summer heat. They faced high insurance costs—about $450 a month—to fill in gaps in their Medicare coverage. And most damaging of all, they've seen the income they were counting on from their portfolio slashed by record-low interest rates. The result? The Gershtensons now live on about 20 percent less than they originally planned to. "The golden ages aren't always golden," sighs Michael.
These days a lot of silver-haired folks are sharing the same sigh, along with a collective uneasiness that comes from reading those still-shrunken numbers on their financial statements. Indeed, whether they are in, near or just daydreaming about retirement, Americans are discovering that the rules they've followed for a decade didn't make much sense—and still don't. It all started, of course, with the 2008 crash, when faith in the reliability of buying and holding stocks came tumbling down. Today investors' faith remains shaken, but the messages many are getting—from retirement planners, brokerage firms and an adviser community the size of a small city—are still bewilderingly upbeat, not to mention out of touch. Worried about stocks? Ride bonds to the top. Wondering how much money you'll need? Just type a few numbers into a calculator and get your magic number. Nest egg too small? Just move somewhere cheaper—and warmer! "Financial pros have to be confident," says Punam Keller, a professor of marketing at Dartmouth University's Tuck School of Business. "But now when people hear these things, they're much more skeptical."
Nowhere is the collision of happy illusion and difficult reality more vivid than in the 401(k) world. Late last year retirement giant Vanguard reported that 71 percent of the investors in its 401(k) network had more money in their accounts than they did before the crash. The nonprofit Employee Benefit Research Institute released similar figures for older investors in general. But while some pundits popped the corks on their prosecco, both institutions also highlighted a big caveat: Their numbers included all the investors' contributions and their company matches to boot—not investing gains, but shovelfuls of new money. So boomers who feel like they haven't caught up are, in essence, dead right. "Being back to even is great in theory," says Alan Glickstein, who works with 401(k) plans as a senior consultant at human-resources firm Towers Watson. "But most retirement accounts should have been far further ahead by now—we've lost three years."
To be sure, the unsatisfying state of affairs isn't just the fault of wrongheaded advice from the finance industry. We investors love to create our own realities—just ask the average boomer how much help he expects to get from Medicare. But comforting stories—myths, if you will—about retirement are hard to dislodge. Here's our look at five of the biggest, with a few alternatives for the reality-driven investor.
1. $1 Million Will Be Enough
When Rod and Jeanne Koleno sat down several years ago to figure out how much they needed to save for retirement, the process felt downright scientific. Their adviser asked them how much money they thought they'd spend each year; he even factored in the possibility that they'd live to be 95. The adviser punched the data into an Excel spreadsheet, and the result was the Kolenos' magic number: $1.4 million—not only attainable but reassuringly specific for the Kolenos, who eventually left Eugene, Ore., and settled in Sun Valley, Idaho. The only problem? As of today, the Kolenos say, to make the math work—to make sure they don't run out of money when they're in their 90s—they're living on 25 percent less income than the plan called for.
What went wrong? Retirees who use calculators often run into problems like this. To come up with a number, calculators essentially take one figure that retirees seldom predict accurately (how much they'll spend every year) and multiply it by another (how long they'll live). Advisers and planners say the most effective calculators use dozens of variables and ask for frequent updates. But even then, anything unexpected can derail a boomer's plans. In the Kolenos' case, they wound up spending quite a bit to support their aging parents and help their kids—expenses they hadn't factored in. Rod says that if he'd known about the true cost of being retired, he "might have worked another couple of years." The Kolenos' adviser, Neal Van Zutphen, of Mesa, Ariz., says it's difficult to anticipate every expense, so he encourages clients to think of their number as a baseline, not an absolute.
2. You'll Spend Less When You're Older
Boomers approaching retirement are likely to run into a rule of thumb like this, from one brokerage's online calculator: "You need about 70 percent to 80 percent of your annual preretirement household income during retirement." That figure seems to reflect reality: The federal Bureau of Labor Statistics reports that in 2009 the average person in the 65-to-74 age range spent about $43,000, while the average person age 55 to 64 spent more than $52,000. Over time, the idea that spending falls in retirement has become a mantra of financial planning. No more commutes, no more kids to feed—and no more business attire. (Flip-flops for everyone!)
Fact: Older people spend more of their income.
While Americans 65 and over spend less than their younger peers, they also spend a bigger share of their income—almost 95 percent, compared with 78 percent for the average person. Some advisers say that's a sign that many retirees are on uncomfortably tight budgets.
The question, of course, is whether retirees spend less by choice—or because they don't have a better choice, financially. A deeper dive into the federal statistics shows some interesting wrinkles. The spending categories that drop the most after age 65 include education (presumably, the kids have grown) and pensions (no more paychecks means no more payouts for 401(k)s or Social Security), but most other categories drop only slightly. And for younger, more active retirees eager to celebrate their freedom, spending on entertainment and travel often skyrockets. The result: Many retirees find themselves abruptly changing course. For Denver-area retiree John Hansell, hitting constraints after three years of spending meant being forced to choose recently between a trip to Antarctica and a donation to a grandchild's college-savings plan. "The reality becomes more stark," says Hansell. (The college fund won.) To prepare for that kind of realism, some planners recommend that clients do a test-drive year, during which they live for 12 months on a reduced, retirement-level budget.
3. Older people need more bonds
Even a cursory look at the headlines shows it's a shaky time for bonds, with inflation fears rising and government finances in bad shape. But while some Main Street investors are finally pulling money out of bond funds, the industry is still pumping out new products in response to the bond boom of two years ago: Last year the number of bond exchange-traded funds—products that track bond indexes but trade like stocks—rose by 51 percent, to 137, according to research site ETFdb. And many companies have been redesigning their 401(k)s to funnel investors into target-date funds, which automatically steer older investors into— you guessed it—bonds.
Of course, there's a reason older investors need bonds—historically, they've been safer and less plunge-prone than stocks. Hence the old "own your age" theory: If you're 65, then 65 percent of your portfolio should be in bonds, and so on. But with their prices near record highs, "bonds have no place to go" right now, says Diahann Lassus, whose New Jersey wealth-management firm Lassus Wherley manages $320 million. She recommends that boomers keep anywhere from 50 to 65 percent of their portfolio in stocks—including high-dividend stocks that can replace some of the income that retirees get from bonds. And she and other planners say that to get the safety they've associated with bonds, investors can buy commodities and other alternative investments that tend to rise when stocks fall.
4. Your Money Lasts Longer if You Move
For boomers in expensive coastal cities, the idea of leaving town has become a linchpin of retirement strategy. Who wouldn't want to trade Boston's dreary winters for the Gulf beaches of Texas — where there's no income tax and housing costs only a third as much as in Beantown? Planners and advisers say that even the sluggish housing market hasn't dulled their clients' ardor for cheaper, low-tax states: "We're telling people about places in the center of the country, with wonderful lakes," says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards. (Others are seeking less expensive living overseas; see "Golden Years Gone Global," page 64.)
Still, a lower housing price tag doesn't guarantee low overall expenses. Couples like the Gershtensons have learned that giving in to the desire to go home can get awfully expensive—and staying put can also cost you. In retiree havens like Texas, Florida and South Carolina, income taxes may be nonexistent, but sales taxes are high, and many communities are considering property-tax hikes to meet budget shortfalls. Dory Kilburn left high-tax Canada for Boynton Beach, Fla., in 2005, only to see her property taxes triple, to $7,500 annually, after a reassessment and local tax hike. Compared with Florida, she says, these days "the snow is looking good!" With so much in flux, savvier boomers are looking at these numbers before contemplating a move. Think of them as "quality-of-life costs," says Susan Talton, an analyst with Seattle wealth-management firm Laird Norton Tyee.
5. Uncle Sam Has Got Your Back
The recent health care reform debate underscored how much Americans rely emotionally on Medicare's safety net. But evidence suggests that most people saving for retirement don't realize how much Medicare doesn't cover—such as routine eye care, dental work and some prescription drugs. Medicare co-pays can range from 20 to 45 percent of the cost of many types of outpatient medical care. And the most painful bite, by far, comes from nursing home and home-health care, where the average cost for a private room was more than $75,000 a year in 2010. The government rarely covers such care unless the person being cared for has already spent all of his or her savings; still, according to a survey by AARP, more than half of Americans over age 45 believe that Medicare pays those bills from the get-go.
Fact: Nursing care costs are all over the map.
Nursing home costs can take a big bit out of a retiree's savings -- and the costs of that care can vary widely from state to state. A year in a private room in a nursing home costs $51,000 in Louisiana but $137,000 in Connecticut, according to insurer Genworth.
With this gap in mind, many planners recommend that retirees cover what Uncle Sam won't. Financial planner Roman Franklin of DeLand, Fla., says that supplemental Medigap insurance—which typically costs between $150 and $250 a month per person—is one of the factors his clients most frequently forget to address when they're getting ready for retirement. Other planners recommend buying long-term-care insurance well before retirement starts. Long-term coverage has frustrated many consumers; insurers have tinkered constantly with their policies, and some have stopped selling the product. But if it keeps nursing care from ravaging a savings account, says Blayney, the consumer advocate, "that coverage is a form of wealth."