Why you can't bank on your house anymore

If you think you can sell your house when you retire and live off the proceeds, think again.

A mortgage used to be a form of forced saving that gave you an (almost) free place to live in retirement and a little bit of value when you sold the house, says Megan McArdle, a senior editor for The Atlantic who writes about business and economics.

We didn't realize that a number of developments had been pushing up the price of homes: 

a.  The development of the 30-year self-amortizing mortgage, which enabled people to pay a much higher price for a given house than they would have in the era of 5-year balloon mortgages. 

b.  The baby boom, which increased demand for houses as they aged 

c.  The run-up in inflation in the 1970s, which gave (relatively inflation-proof) real estate a boost--and then the subsequent decline in inflation (and interest rates), which gave people the illusion of being able to afford more house because the up-front payments were lower. 

d.  More widely available credit, which let more people take on bigger loans 

e.  The increasing value of (and competition for) a small number of slots at selective colleges, which put a rising premium on houses in good school districts 

These trends gave people the illusion that houses were, in some fundamental way, an "excellent investment".  But they're risky in all sorts of ways: neighborhoods can get worse rather than better, local economies can stagnate, the style of your home can go out of fashion.  

Houses, she writes, are still pretty expensive by historical standards, as this chart from Barry Ritholtz shows:

Not a pretty picture. If you can't count on a steep run-up in asset prices to build up your retirement savings, McArdle says, that leaves you with one alternative: save a much bigger chunk of your income.

Here's another thing to ruin your weekend

Is your pension safe? Your other retirement benefits? The courts are trying to answer.

Even solid companies may legally change the terms of their pension plans so that retirees get less than originally agreed to -- and they aren't always straightforward about it, Smart Money reports.

In 2001, after Cigna converted its defined-benefit plan (specifying a monthly payment in retirement) into a cash-balance plan (which uses a less reliable benefits-accrual formula), 25,000 employees sued the company over the change, claiming it offered less generous benefits but that "misleading" plan summaries made the terms sound better than they actually were. 

The case reached the Supreme Court, which ruled in May that the district court -- which initially found Cigna in violation of the Employee Retirement Income Security Act -- "revisit its determination of an appropriate remedy for the violations." While both sides declared victory, the decision "opens up a world of remedies that were previously thought to be unavailable," says Rebecca Davis, a lawyer for the Pension Rights Center, which counsels people on claiming pensions. Cigna says it's "pleased" the district court will have to "reconsider its initial decision" ruling in favor of plan participants.

I'm not sure who won. I am sure we all need to think about it. The Wall Street Journal advises:

To be sure, most employees can rely on what their employers tell them about their benefits. But regardless of how the Cigna case plays out, you need to be aware that if your employer gives you wrong information—even if it is in writing—and you act on it, you may be out of luck. 

It is especially critical to keep this in mind when making life-changing and often irrevocable decisions—such as whether to switch jobs, retire, take a payout or modify a life-insurance policy. Usually, the only thing that determines the benefit in the event of a dispute is the formal plan document.

A good rule of thumb: big corporations won't think twice about screwing you over if they can get away with it.

Think retirement will be fun?

The economist Arnold Kling on the coming retirement wars:

I don't think of the long-term budget fight as being between Democrats and Republicans or between rich and poor. I look at it as a fight between people with funded retirements and unfunded retirements. 

If I have saved enough to support my lifestyle in retirement, then I have a funded retirement. If my neighbor who teaches in public school wants to support a similar lifestyle based on her pension, then she has a retirement that is somewhat unfunded. That is, as of now, her pension plan has only about fifty cents for every dollar of promised benefits. 

Social Security and Medicare also are unfunded. Their "trust funds" consist of government bonds. If I took care of my own retirement the same way, the drawer where I keep statements from mutual funds that I own would instead be filled with IOU's from myself. 

More important, the actuarial shortfall in Social Security and Medicare, like that in my neighbor's pension plan, is very large. 

Down the road, someone is going to get the shaft. It could be my neighbor, it could be me, or it could be both of us. That is, people who are relying on the unfunded systems--public sector pensions, Social Security, and Medicare--might find their benefits cut. Or people who are relying on personal savings could wind up having those savings taxed away in order to address the shortfalls in the public systems. Or all of us could have our savings eroded by inflation, from which we may not be able to protect ourselves. 

Have a nice day.

Thanks a lot, Arnie.

The unpleasant reality of saving for retirement

The retirement savings plans that many baby boomers thought would see them through old age are falling short in many cases, The Wall Street Journal reports.

The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement, according to data compiled by the Federal Reserve and analyzed by the Center for Retirement Research at Boston Collegel. Even counting Social Security and any pensions or other savings, most 401(k) participants appear to have insufficient savings.

Megan McArdle, the business and economics editor for The Atlantic, writes:

Most people  likely to be reading this blog should be targeting a savings rate in the range of 20-25% of income, more if they can manage it.  Since this is approximately five times what the average American household is saving, this notion is likely to be met with fierce resistance by readers who can name an endless list of claims on their income: mortgage, utilities, car, kids' activities, clothes, visits home to see the family . . . 

Say you're a 40 year old couple with 100,000 a year in after-tax income, and you save 5% of that, the way ordinary Americans do.  (Assume further that it all goes in retirement).  $5,000 a year at 5% until the age of 68 will leave you with $293,000 in retirement funds, which works out to about $1,000 a month in combined investment returns and withdrawals if you assume that you will live to 88.  On top of your Social Security benefits, your household will probably net about $4,000 to $6,000 a month.  But you're used to living on almost twice that.

This will mean rather dramatic changes in how we measure the good life.

Confounded compounded interest!

We know that the earlier in life you can start saving the better. It's the power of compound interest.

If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you'll have around $560,000, assuming earnings grow at 8% annually. Now, let's say you wait until you're 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8% a year. When you're 65 you'll wind up with around $245,000 -- less than half the money.

However. Tara Siegel Bernard, a personal finance writer at The New York Times, throws some cold water on this rosy scenario.

The problem is that even if you do everything right and save at a respectable rate, you’re still relying on the market to push you to the finish line in the last decade before retirement. Why? Reaching your goal is highly dependent on the power of compounding — or the snowball effect, where your pile of money grows at a faster clip as more interest (or investment growth) grows on top of more interest. In fact, you’re actually counting on your savings, in real dollars and cents, to double during that home stretch.

Now my skill with mathematics, and hence my skill with money, is laced with magic, delusion, error and confusion, but I think I understand what she's getting at: the compounding kicks in in a big way at the end.

“The way the math really works out is unbelievably dependent on the final few years,” says Michael Kitces, director of research at the Pinnacle Advisory Group in Columbia, Md. “I just don’t think we’ve really acknowledged just what a leap the very last part really is.” 

Kitces explains the chart on the right:

While it is true that the client has accumulated $1,000,000 by the end of the 40-year time horizon, it's notable that after 30 years, the client still has less than $450,000! And of course, at that point the impact of a marginal $300/month of savings is fairly negligible; the client will succeed because of the investment returns. With an assumption of "just" 8% in growth, the classic rule of 72 means the client will double her wealth in 9 years.

Accordingly, by this savings approach, the best way to have $1,000,000 in 40 years, is to have $500,000 in 31 years, and then quickly double your money in the last decade and retire!

Let's roll out another scenario.

Consider the numbers for a 26-year-old who earns $40,000 annually, with a long-term savings target of $1 million. To get there, she’s told to save 8 percent of her salary each year over her 40-year career. Yet after 31 years of diligent savings, her portfolio is worth just slightly more than $483,000. To clear the $1 million mark, her portfolio essentially must double in the nine years before she retires, and the market must cooperate.

In my math brain, the market always cooperates, but I think I've read somewhere that it actually doesn't. Duh.

The problem, of course, is that twenty-somethings don't have money to save. I'm not sure I have an answer for that, except a radical change in how we view consumption in those years. Or lucking into a period later in life when some fool is paying you a huge salary and you can hide more under your mattress.

God bless us all.

Watch your wallet -- and your 401k

For anyone with a 401(k) plan, stock market performance may be overshadowed by other worries: fraud and theft, Smart Money reports.

In the last three months, the Labor Department has launched 191 investigations into 401(k) fraud and theft, and secured 20 indictments – a whopping 43% more than the department has secured annually, on average, since 1995. 

In tough times, employers are more likely to raid their employees’ retirement funds, observers say, whether for personal gain, or to stretch to cover business expenses. This is especially true at small, private companies, where 401(k) plans are often run by a single person, like the company’s president or accounts manager.

Here are the Labor Department's top warning signs that something might be amiss with your 401k.

1. Your 401(k) or individual account statement is consistently late or comes at irregular intervals

2. Your account balance does not appear to be accurate

3. Your employer failed to transmit your contribution to the plan on a timely basis

4. A significant drop in account balance that cannot be explained by normal market ups and downs

5. 401(k) or individual account statement shows your contribution from your paycheck was not made

6. Investments listed on your statement are not what you authorized

7. Former employees are having trouble getting their benefits paid on time or in the correct amounts

8. Unusual transactions, such as a loan to the employer, a corporate officer or one of the plan trustees

9. Frequent and unexplained changes in investment managers or consultants

10. Your employer has recently experienced severe financial difficulty

Retirement planning isn't just for old codgers

Happy couple saved their pennies

Greg Daugherty at Consumer Reports has some suggestions:

Do the numbers

Anybody over the age of, say, 40 should have at least a rough notion of how much money he or she will need for retirement. That's just as true for people who swear they'll never retire as for those who are already collecting travel brochures.

Coming up with a workable figure is pretty simple: Estimate how much you'll be spending once you retire, using your current expenses as a baseline, then compare that with your likely sources of income, such as Social Security and any pensions. If there's a gap -- and there usually is -- that's how much your other investments will have to supply.

The common wisdom in financial-planning land is that you can withdraw about 4 percent of your portfolio each year, adjusted for inflation, with little risk of going broke during your lifetime. So if you need your investments to contribute $10,000 a year, for example, you'll have to accumulate at least $250,000. A specific goal like that not only focuses the mind but can also save you some needless anxiety if it turns out you're already on track.

Don't pass up chances to save

Our own surveys have found that if there's one widely shared regret among retirees, it's not saving enough or starting early enough. None of us can go back in time and fix that, of course, but we can make sure that we aren't making the same mistake now. For example, each year you can put up to a certain maximum amount in a 401(k) plan, if your employer offers one. Currently the limit is $22,000 for anybody 50 or older and $16,500 for everybody else. If you can afford to contribute the max and aren't doing so, that's an opportunity that won't come by again.

Same goes for maxing out your contributions to 403(b)s, IRAs, and any other tax-advantaged retirement accounts you might be eligible for.

Have more than one plan

You might want to retire early, late, or not at all, but fate (or your employer) could have other ideas. And even if you retire right on schedule, the economy, stock market, or any number of other forces beyond your control might disrupt your plans. So it's smart to have at least a Plan B and possibly a C, D, and so on down the alphabet.

Steve Vernon, an actuary and president of Rest-of-Life Communications in Oxnard, Calif., suggests thinking through some what-ifs, not unlike the "stress tests" used to judge the soundness of banks. What if the stock market melts down during your retirement? (If you're retired for decades, that's a real possibility.) What if inflation roars back? What if you live to 100? What if all of the above happen?

A sobering look at retirement

If you're depending on the stock market for your retirement nest egg, you need to consider the words of Rob Arnott at Research Affiliates, an investment management firm.

"I worry a lot about people reaching their golden years and discovering, 'Oh, I should've saved more,' and 'Oh, I don't qualify for Social Security any more because it's means tested'. We're headed for a retirement train wreck," he adds, "and it's going to get really ugly over the next 15 years." 

Here's why. The returns you will get from your stock funds can only come from four things: dividends, earnings growth, inflation and changes in valuation.

Using numbers from Research Affiliates, Brett Arends reports in The Wall Street Journal:

• Right now the dividend yield on U.S. stocks is about 2.2%, they note. Historically, earnings have only grown by a surprisingly low 1% a year in real, inflation-adjusted terms. Mr. Arnott tells me the average since 1900 is only about 1.2%, and in the last half century just 0.6%. Will we get more in the future? With the U.S. population ageing and heavily in debt? It's hard to imagine. Throw in a 2% inflation forecast–more on this later–and Research Affiliates forecasts a long-term return of 5.2%. 

• What about changes in valuation? Some generations are lucky. They invest in the stock market when it's depressed and shares are cheap in relation to earnings. This was the case in the 1930s and the 1970s. Then they retire and cash out when the market is booming and shares are expensive in relation to earnings–such as in the 1960s and 1990s. 

• People today are not so lucky. The stock market's latest rally has lifted shares already to pretty high levels in relation to average cyclically-adjusted earnings. This so-called "Shiller PE" (named after Yale professor Robert Shiller, who popularized the notion) has been an excellent indicator of market value. Right now it's at about 22–well above its historic average of 16. The only time the market has boomed from these levels, was in the late 1990s bubble–an atypical moment unlikely to be repeated any time soon.

What does this mean for your bottom line?

An investor with 60% of his portfolio in stocks and 40% in bonds, a standard, if conservative, allocation, can expect a weighted average return from here of only about 4.1%. Strip out 2% inflation and investors can only expect about 2.1%.

Someone who saves $10,000 a year for 30 years and invests the money at 5.5% a year will end up with $760,000. Someone who only manages to earn 2.5% on their investments: Just $420,000.

"Neither pension funds nor private investors seem to have fully absorbed the grim lessons of the past decade," Arends writes. "Returns are going to be much lower. People need to save more, much more, for their retirement. If the market rally this year has given them false hope, it will have turned out to be a curse more than a blessing."

You can read the report on which this article was based here.

"Unretirement": the new normal

An "unretirement index" based on surveys by Sun Life Financial indicates:

• More than 8 in 10 American workers believe they will need at least three years to rebuild their retirement savings as a result of the economic crisis — up from 64% a year ago. 
• More than half  the working Americans that responded (52%) expect to work at least three years longer than originally planned — with just as many believing they will retire at 70 as those who believe they will retire at 65.
• 70 is the “new 65” in terms of the expected retirement age in America, with just as many Americans expecting to retire at age 70 as those at age 65.

Unretirement is defined as working at least 20 hours per week after the age when one is eligible to receive Social Security benefits. Here's a picture of the current index.

You can create your own personal index here.

Thinking about retiring? Think again.

According to the Barclays Wealth survey, some 60 percent of respondents said they envision always being involved in commercial or professional work of some kind, whatever their age.

Although for some the decision is driven by the expectation of a longer lifespan and concerns about the accompanying financial uncertainties, there is a good chunk of the group that believe their work is their passion, and to stop would be unthinkable.

In the United States 54 percent said they would want to continue working in retirement.

Matt Brady, head of Wealth Advisory at Barclays Wealth Americas, said there are several things going on, starting with the fact that people of retirement age today are healthier and more vital than they used to be. There also were some financial concerns expressed by the group.

One telling observation was that 85 percent of those who were under 45 years old said they were looking forward to spending more time with their family in retirement, but of those who were already over 65 years old, only 68 percent said that was how they were spending their time.

Even more eye-opening was that only 25 percent of the retired American high-net worth individuals described their retirement as "the best years of my life."

The study quoted John Llewellyn of Llewellyn Consulting, an economics consultancy, who expects the older generation could drive economic growth.

"The concept of a blessed retirement used to be relevant, when the body was exhausted from physical labor. But it is not the case anymore for many people; not everyone wants to be told they have to leave work and play golf."

Still, I'd like to have a gold watch.