Making Up for Retirement Shortfalls

Question: I've been using some online retirement tools, and most indicate that my portfolio might not last throughout my retirement years. What now?

Answer: It's small comfort, but you're far from alone. According to the 2010 Employee Benefit Research Institute Retirement Security Projection Model, 47.2% of early baby boomers (born between 1948 and 1954) were likely to have insufficient retirement income to pay for basic retirement expenditures as well as uninsured health-care costs. The percentage risk for late baby boomers (born between 1955 and 1964) and generation Xers (born between 1965 and 1974) are 43.7% and 44.5%, respectively, according to the EBRI research.

Prospects look grave given the backdrop of economic uncertainty and the rise in both life expectancy and medical costs. But for those who aim to retire with peace of mind, there are a few key levers you can pull to ensure that your nest egg lasts throughout your retirement years. Here are the key ones:

Work Longer
Pre-retirees may not want to hear that they may need to work longer, but that has become the increasing reality for those facing shortfalls in their retirement savings. According to T.Rowe Price's studies on optimizing retirement income, working at least beyond age 62 is the single best decision pre-retirees can make to improve retirement security. Continuing to work full-time could boost pre-retirees' expected inflation-adjusted annual income by about 7% for each additional year of work and contributions. Working an additional three years--from age 62 to 65--and continuing to save 15% of one's salary during that time could increase annual income from investments by 22%, as well as by 39% after working an additional five years.

Working longer allows you to contribute to your savings for a few more years while staving off the need to dip into existing savings. Under that logic, a part-time job doing something that you love would deliver similar benefits. Check out this video with retirement expert Mark Miller to learn more about the rewarding benefits--both financial and emotional--of working longer.

Reduce Spending During Accumulation Years
One of the best ways to make up for an anticipated shortfall in retirement is to stash more away prior to retirement. And the best (and only) way to save more is to spend less. Andrew Tobias, author of The Only Investment Guide You'll Ever Need, devotes a chapter to tips on spending less. He offers practical advice, such as buying items in bulk or buying store-brand versus name-brand merchandise. He also provides warnings against common pitfalls: Don't fall for financing offers on cars because you'll end up paying more than you should; take the cash-back offer instead. Skip insurance that you don't need, such as credit life insurance (except for the elderly or terminally ill), flight insurance, and appliance insurance.

Tobias does make the caveat that some time- and money-saving investments such as buying a TiVo product or subscribing to Netflix can make sense but only after you've taken care of your other burdens like credit card debt. Moreover, setting explicit goals for where you want to be financially a year from now, having a clear understanding of your net worth and annual earnings, and carefully tracking your expenses are essentials to effective penny pinching.

Reduce Planned Expenses in Retirement
In addition to cutting costs to save more during the accumulation phase, pre-retirees can also make their nest eggs last by ratcheting down their planned expenses during their retirement years. Of course, that trade-off may not be palatable: According to a Center for Retirement Research study at Boston College, most retirees are willing to work longer rather than save more or reduce their standard of living in retirement.

However, it may be possible to cut some costs--by downsizing to a smaller home, for example--without sacrificing quality of life. Just be realistic about what you'll actually be able to save after you've retired. While expenses for work clothes and commuting will go down in retirement, other expenses, such as medical and travel costs, might be much higher than they were pre-retirement.

See what other Morningstar Discuss Forum participants are saying about the 80% rule, which estimates that you will need 80%-90% of pre-retirement income to live on as a retiree, by checking out this Discuss thread. Mark Miller also addresses the 80% rule in this video.

Reallocate Your Assets
If you're nearing retirement, a portfolio that is too conservative is just as risky as one that is too aggressive, particularly when you consider the drag of inflation and taxes. In general, the best way to kick up the longer-term return potential of your portfolio is to increase your stock allocation, but do so judiciously: Adding stocks will also jack up your portfolio's volatility level. Morningstar's  Asset Allocator is a good starting point for finding a stock/bond/cash mix that balances return potential with risk control. Click here for some of Morningstar director of personal finance Christine Benz's favorite core stock funds for retirees and other ways to hedge against longevity risk. Benz has also constructed an aggressive exchange-traded fund portfolio for retirees and an aggressive portfolio of traditional mutual funds. And this article provides some additional benchmarks for retiree portfolio asset allocations.

Delay Taking Social Security
Holding off on taking Social Security benefits can help increase a retiree's income significantly. If you're healthy and expect to live beyond average life expectancies, waiting until age 70 to receive Social Security benefits results in a meaningfully higher payout (there's no increased benefit by delaying beyond age 70, however.) A combination of working longer and delaying your Social Security benefits would significantly decrease the strain on your retirement nest egg. (Of course, individual circumstances may require that you begin taking Social Security benefits right away.) Read this article by Christine Benz that delves deeper into some key considerations for optimizing Social Security into your retirement plan, and read this one about Social Security planning for married couples.

For additional tips on ways to maximize your nest egg, check out MetLife's compilation of ideas including amping up your employee retirement plan savings as well as making the most of your health-care and medical benefits.