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Bridging a Retirement Shortfall

Retirement Readiness Bootcamp Part 6: Working longer, delaying Social Security, and restructuring your portfolio are some options to make up a savings gap.

Jeremy Glaser: Welcome back. So far today we've assessed what kind of income you'll need in retirement and also if your portfolio will be viable to actually get you that income. But for lot of investors the answer to that question is going to be no. So, we're going to spend this last session looking at some things that you can do to help bridge that gap.

I'm joined again by Maria Bruno, she's a senior retirement strategist in Vanguard. Maria, thanks for joining us again.

Maria Bruno: Thank you, good to be here.

Glaser: And Christine Benz, our director of personal finance.

Christine Benz: Good to be here.

Glaser: So, before we really get going, Maria, I just wanted to ask you about when is the time to start maybe being concerned that you are not ready for retirement. What age is that something that you really need to start making some changes?

Bruno: I would say probably five- to 10-year mark …

Benz: At least. The earlier the better, right.

Bruno: And I hate to say concern, but more a question. Because then if you start to question then the concerns can come out, whether they really are. And the reason is because if you are in that position where you think you are falling short, you've got some possibilities on how to turbocharge, either your savings or things like that. So, the earlier you can do that the more proactive you can be in terms of understanding when you can make that switch and what dials are needed.

Glaser: Christine, what are some rules of thumb about deciding if you have enough depending on your age?

Benz: I like some benchmarks that Fidelity has put out, and people can find them Fidelity's website. They are very rough rules of thumb. But I think a lot of people are just looking at this as a black boxy thing, they have no idea whether they have enough. So, Fidelity's benchmark would be 2 times salary at age 35, 4 times salary by age 45 and by age 55 to have 7 times salary saved. For people close to retirement one rule of thumb that David Blanchett often uses is that you should try to have 25 times your spending target at retirement. So, if you are very close to retirement that's something you can use.

Glaser: If you do find yourself falling short though it might not make sense to just make your portfolio more aggressive to try to make it up. David Blanchett cautions why that could be a problem.

David Blanchett: One thing that retirees who aren't on track for success may be tempted to do is to swing for the fences and invest in a very aggressive portfolio. And I would caution that approach because while it may work out in your favor, you really can't afford a significant loss just before retirement. And today is not the right time to do that. I mean, individuals might start day-trading things and really you should think about safety first. While again it's tempting to say, well, David, I'm behind, I have no reason not to take on a risk on my portfolio. I would say, well, that's potentially true, but what if you miss? What if all of a sudden, the markets go down by 20% or 30%? I think in that instance there's a very good chance that you wouldn't actually stick it up.

Investors who stayed invested post-2008 actually made money. If you can stay invested for the long haul, you're not going to worse off. The problem though is that if you're doing this based upon emotions, to do something, there's a very good chance that if things go wrong, you'll pull out and won't realize the benefits. And so, I really caution people to make sure that your portfolio is consistent with your risk objectives, not just to try to fund a given goal.

Glaser: Maria, finding the next hot stock tip is not the thing that’s going to save your retirement. What are some of the levers that a potential retiree can pull then?

Bruno: I agree with David, when I talk with retirees or individuals that are thinking through retirement. It would be really to focus on increasing contributions. So, making sure that you are maxing out tax-advantaged accounts for both you and your spouse if you are married, and take good advantage of catch-up contributions as well once you've reached age 50, both employer-sponsored plan as well as IRAs allow you to contribute more. So, those are some tools that you have in your tool box, certainly from a budgetary standpoint if you can curtail some spending and then use those moneys to flow into savings that’s an obvious one as well.

Benz: It seems like a lot of these things go hand-in-hand. If you can jack up your savings rate even a little bit, if you can consider pushing out your retirement date a little bit, perhaps curtailing your in-retirement spending target, and start thinking through some lifestyle adjustments that you could make to support a lower spending rate in retirement--and also in the mix would be, which we talked about the delayed Social Security filing.

Bruno: Yes.

Benz: All of those variables together and they do all kind of bunch up together a little bit.

Bruno: They do, right. Yes.

Benz: So thinking about some of them in tandem.

Glaser: But if you are getting close to retirement does it make sense to be putting money into a traditional IRA? You are just going to have to take those RMDs out again. At what point should you just be saving in a taxable account, Maria?

Bruno: Well I think it does vary by individuals. There are, I mean certainly the more you can max out tax-advantaged accounts, you can take advantage of that compounding on the accounts. Word of caution: those we've talked about with required minimum distributions from these tax-deferred accounts, so be mindful in terms where you are directing the contributions. Christine and I actually have talked about this as well. I mean you can also invest tax efficiently in a nonretirement account that builds tax diversification if you don’t really have that throughout the year. And it gives you flexibility in terms of accessing those moneys as well too.

So the first, of course, I think would be one to make sure that you know how much you are saving and then secondarily would be what type of accounts. But I still am an advocate for maxing out tax-advantaged accounts even if you are closer to retirement. You won't--the benefit of the compounding won't be there. but nevertheless, there may be some tax benefits.

Glaser: So it seems so that Michael Kitces has argued that there's years when you are kind of empty nest, or even before you retire could be a great time to catch up. Why does he think that's the case, Christine?

Benz: I love this research, and people can find it on Michael's Nerd's Eye View blog. The reason I like it is because it's so positive that people I think many people in their 50s for example, perhaps they have erred a little too much on the side of providing college funding for their kids and raising kids is expensive, period. So, they are finding themselves in that period maybe between age 55 and 65 where they really have to use those years for playing catch-up. And the thing I like about Michael's research is that he demonstrates that if people are in their peak earnings years during those years and they are able to really crank up their savings rates. So the example he uses in his article is for 15 years prior to retirement if they are able to save 30% of their incomes. It goes a long way toward making up a shortfall if you can kind of turbocharge your savings later in life.

So, it's not a lost cause. I guess that's a message that I would send as some people think, I'm just going to have to work forever. I sometimes hear that from people I know. And the fact is that there are still some things you can do to make your situation better, it's never a lost cause.

Glaser: But not everyone necessarily has that budgetary room to add those extra contributions working longer maybe part of the equation. Maria, what are some of the benefits maybe beyond the obvious of why working longer can help your retirement plan?

Bruno: Well, I think it's twofold. One is if you are working you are still contributing, potentially saving and that also delays having to spend from the portfolio. So, you've got a stronger wind in your sail going in once you start spending from retirement. Even if it's part-time income that's less spending or alliance you have in the near term on your portfolio and allowing that to grow.

Benz: And that can also go hand-in-hand with delayed Social Security funding, too.

Bruno: Yes. Correct.

Glaser: Christine, a lot of people, their achievement of retirement if not going to their job anymore. There are kind of creative ways people could maybe find income that's not part of the career that they've had for most of their life.

Benz: I think that’s well worth thinking about especially if you have a job that has not been a joy to you. There's no good to be had from sticking it out on a job that you absolutely hate. That might be good for your financial health, but it might not be good for your physical or emotional health. So, if you are in that position of feeling like you cannot continue to slog away at your current job, you should think creatively, and Mark Miller, contributor to, has written a lot about these encore careers, he calls them. This idea of picking up work later in life it may not be as remunerative as the work that was your main career, but picking up work that you find to be fulfilling and earning some income can maybe get you part of the way there. You can potentially delay full withdrawal mode for a while, you may be able to delay Social Security. Maybe it's consulting in the industry where you have your expertise, maybe it's working part time at a job that you think is just fun.

In fact, I have talked to my husband--I'm going to be in Whole Foods' cheese department. I think because I love Whole Foods, and I love cheese. But I think just being creative, brainstorming and one thing that came out in the round table video that we did with the retirees--they did miss that collegial aspect of their work environment. If you know that you are someone who has really derived a lot gratification from your work friends, think about getting some sort of second career where you can keep that social activity going.

Bruno: Before you said that I was going to reinforce that. A lot of them may think about going into more social type environments because they enjoy that socialization, because they may not be getting that from their prior career.

Glaser: Mark Miller does warn, though, that it can be challenging to work later, you can't 100% count on that. And he had this to say about it.

Mark Miller: From a retirement plan standpoint, the right way to think about this is longevity from age 65. And the gains from age 65 have also been impressive they are up about 10% since 2000. Men the average expectancy now is bit over 86, for women it's a bit almost 89. But the thing to remember there is those are averages. So, people hear these numbers and they--those numbers get stuck in people's minds and think well that's the number they are planning to but of course some will exceed those numbers and some will not make it to those numbers.

Glaser: So, that can be challenge to not know how long you are going to planning for and to know how long you are going to be able to work for there. But still you could, if you are not able to work longer you have to look at the other side of the ledger, which is spending. Maria, where are some places that retiree potentially could reduce that spending level?

Bruno: I think, Jeremy, that's a good question. When you think about spending, I liken them to two types of spending: discretionary versus nondiscretionary. So, nondiscretionary are the things that I had mentioned earlier where it's to keep the lights on, so it's food, it's housing, those types of things, insurance premiums, those things where you really need to take care of on a day-to-day basis. Then there is the discretionary which would be maybe leisure, travel those types of things.

Breaking down expenses with just that first two cuts I think is very beneficial because that will help you determine what flexibility you might have. Because certainly if you need to curtail spending it would be on the discretionary piece of it. At least even if it's temporarily.

Glaser: Healthcare costs are something that we've discussed could be a big part of that retirement spending. Particularly in later years. Are there any ways really to cut that or to think about reducing it maybe in the long-term care space, Christine?

Benz: Well, I think it's just important to be mindful of what long term care cost can entail. So, I brought some facts about long-term care and this is from Genworth's annual cost of care study and it's a really great resource. I know as I have compiled these every year. I look at 50 must-know statistics about long term care and I've relied heavily on this Genworth study. So, they just have some median costs of long-term care outlays and one thing that you see is that they do vary pretty significantly.

So, the median annual cost for a private room in nursing home facility nationally is about $92,000. But you can see huge swings based on geographic location. So naturally more rural, outside of big urban centers, cost of care is a little bit cheaper and much more expensive in big urban setting. So, Manhattan takes the cake, Manhattan, New York, $164,000 in annual cost for a private room in nursing home facility. So, take stock of those costs and how they could change.

Glaser: Relocation could be a viable option.

Benz: Absolutely.

Glaser: So, Christine I know that you've worked up some examples of kind of what this would look like in practice. How that might be helpful to go through now. Can you just walk through, theoretical retiree and what they could do to really get themselves ready?

Benz: Sure. So I prepared an example and the goal was to illustrate how there is not usually a single 'ah-ha' solution for solving retirement shortfall problem. So, the example I worked up was a 58-year-old person earnings $50,000 a year who expects to need about $40,000 in retirement. So, she's got roughly 80% in replacement rate. So, she knows that if she takes Social Security at age 66, in eight years she'll get about $23,000 a year from the program. She has $140,000 in her 401(k) and $25,000 in an IRA. So $165,000 in total retirement assets all tax deferred. So, she can invest $12,000 additionally per year--that's how much in her budget even though she can get up to $24,000 as someone over age 50, her budget allows $12,000 in additional contributions in that 401(k).

She has a pretty conservative portfolio mix. So, she has 30% stock, 50% bond, and 70% cash so she has pretty conservative mix. And given that her expected return from that portfolio is pretty muted over the next eight years, between now and when she retirees. So, I kind of low-balled the return expectations for the major asset classes, but in aggregate we come out with 2% expected return for that portfolio mix over the next eight years. Which frankly I think is realistic.

So, a few more details on to the next slide. Her portfolio's estimated value if she retires and makes those additional contributions and earns a little bit of growth would be about $315,000. The issue is as we talked about she's got all her money amassed in traditional tax-deferred accounts. So, she's going to pay her ordinary income tax on those withdrawals. So, after her taxes she'll have just under $300,000 in take home withdrawals from that portfolio. So, her safe withdrawal rate given that assuming she's using like 4% guideline would be $10,000 and change from that portfolio per year in year one of retirement.

So, that combined with her $23,000 expected from Social Security at age 66 rolls up to be $33,000. That's short of her $40,000 target. So, what do we do and this is a common scenario where someone's getting close to retirement they see that, well, I am short of where I hope to be. So, an obvious thing to look at would be, well, can you try to reduce your in-retirement spending but for a lot of people that’s not an option especially with someone like this where she doesn’t have a lot of room of error in her budget already.

So, what can we do to help bridge the gap? So, a couple of things, couple of ideas which may not be tenable depending on the individual. Let's assume she can find another $3,000 in here budget per year to invest between now and retirement. Let's further assume that she's willing to delay retirement just a couple of years--like not even out to the age of 70, but say she can retire at 68 and say she gives her portfolio a little bit of a more aggressive cast. Not full-on equities, which unfortunately I am little worried some pre-retirees are overdosing on equities, but gives it a nudge toward equity so she has roughly 60% stock, 40% bond portfolio, no more cash in the portfolio because she is not close to retirement yet.

So with those tweaks we can see that her Social Security benefit increases from $23,000 earlier to $30,000 and with higher expected return from her portfolio because she added a little more stock exposure and higher contributions for a longer period of time so assuming she retires at age 68, her portfolio's estimated value at that point 10 years from now would be roughly $382,000, and we are not assuming really heroic returns from stock and bond still, but we are putting a little bit more into stocks and bonds.

So, after taxes assuming she's in the 15% tax bracket. She'd have $325,000 roughly available for withdrawals. Her safe withdrawal rate would be about $13,000 again assuming a 4% initial withdrawal. So, the combination of the delaying Social Security and enlarging benefits from that standpoint and making a few tweaks of the contribution, retirement date and portfolio level all of those things come together to help bridge the gap and get her comfortably over her $40,000 income target in retirement.

So, that’s just an example I would urge any retirees who are looking at this or any pre-retirees who are looking at their own situation and seeing that it looks likely that they will fall short relative to where they hope to be. See if you can make some moves around the margins that are comfortable for you from a lifestyle perspective to try to bridge the gap.

Glaser: So, no one silver bullet now that’s going to make this work.

Benz: Exactly.

Glaser: We are going to take some questions in a minute, but first I did want to touch on reverse mortgages. Mark Miller had done some research on this and he is going to talk about why retirees may or may not want to consider these products.

Miller: If it looks like your retirement plan is falling short, I think home equity is definitely something worth thinking about in the broad sense. So, it's often one of the largest assets in any household balance sheet. So, the options, I think, start with thinking about downsizing. In many cases, it's possible to downsize your housing, pocket some equity, invest that equity, reduce your out-of-pocket cost for housing. And that's where I would start in thinking about home equity. That's a highly personal choice obviously, but it's really a valuable thing to think about.

Beyond that we have reverse mortgages, home equity conversion mortgage or HECM for short. And this is a program that has struggled. It's still not very popular. The surveys show that most people are not interested in them. The program went through some reforms a few years ago, to try to make the loan safer, easier to use and there are some decent options there now. It's possible to get a very low cost HECM that can be used as a line of credit, for example. I think generally that's a safer way to use a HECM than using a lump sum drawdown. It's still important to be very careful. There have been problems with defaults on these loans and foreclosures that need to be avoided. A lot of the reforms were aimed at that. I do think it's something that can be worth a look if it's done carefully with some expert help. It's, I would still say, kind of a last resort.

Glaser: Our first reader question comes from someone who describes, what they describe as their forced retirement at 60 before they really expected to stop working. What kind of advice would you give someone like that who really had planned on working longer but it just isn’t going to on the cards for them. Maria?

Bruno: I think that’s an unfortunate instance.

Benz: But very common.

Bruno: It is common. Not everybody retires by choice sometimes it’s a situation where it may be forced upon them. I think in that situation there is a couple of things to think about. One is well, how are you going to close that income gap. Then also things like healthcare in terms of in the situation that might have extended healthcare coverage. But pre-Medicare healthcare costs could be significant. Social Security (one to) elect to that can come into play too. But I think the biggest focus in that situation would be how to close in on that income gap. Would you agree?

Benz: I would agree. And I think some people may really start to explore early permanent retirement at that point but I think unless you check in with an advisor and know that your portfolio is in really good shape. I think I would be inclined to say if you can still work to continue to try to find employment for at least a few more years in part because of some of those healthcare costs. That's what worries me perhaps more than anything.

Bruno: And the challenge may be, it may not be that type of work that you may have been used to. But it may be an employment that can keep you fulfilled but while also meeting these income needs for the short term.

Glaser: We have a question from a user from California who was thinking of relocating to a lower tax state, gets to that relocation piece we talked about during long-term care. I think they should watch out for in assessing where to move within the U.S. for lower taxes.

Bruno: Well I guess a couple of things one is the, it's the personal situation in terms of where you might want to live in terms of either, we talked about family or even cold winters versus warm weather winters. State income taxes is one consideration, I think Christine alluded to long-term care. You need to look at the state as a whole, not just the income tax. Because that could change over time as well.

Benz: Yeah, I love that advice. And the good thing is there are some tools and you periodically see articles that try to benchmark the best and worst states to retire into and many of them do try to take into account tax rates, whether withdrawals from various retirement accounts are taxed at the state level, all of those things can come into play. So, don’t just focus on your property tax, your state income tax rate, look at the whole gamut of taxes that you may face as a retiree as well as some of the lifestyle considerations.

Bruno: That is a good point. Because retirement distributions and some other types of income flows will vary by state in terms of whether or not or how much they are taxed.

Glaser: We’ve had a lot of questions about advice and there is one from someone who said they actually had some pretty bad advice through accumulation, putting a lot of high cost funds that had been losing for years. If you are in that position where you've had some bad advice, is there still time to turn that around, where would you go out to seek maybe another opinion that can help get you back on track?

Benz: I would say simply because you haven't had good advice in the past does not mean that all other advice will not be good. There are plenty of very competent professionals in the realm of financial advisors and financial planners. So, do your homework. I personally always recommend the fee-only model. It makes sense to me that the decisions that the advisor makes on your behalf or the recommendation shouldn't be tethered to commissions in anyway.

So I would say perhaps start with that fee-only type advisor and look for someone who is fiduciary whether there is a fiduciary rule in place or not, I think that’s still something to ask any prospective advisor about: are you legally required to look out for my interest before anyone else's? I think the CFP credential is an important one to look for to make sure that the person has a basic, at least a basic grounding in the key aspects of a financial plan maybe not just one little area, but the whole gamut. So I would look for that three things: fee-only, fiduciary, and CFP.

Bruno: I would agree, and CFP board website will have--if you put your ZIP code and it will have a network of advisors who are certified as well. But advisors, they need to provide their disclosure brochure as part of the initial discussion. So, I think that is, how their compensated, what their investment approach is or investment philosophy--those things can come together holistically to make you feel comfortable.

Benz: I often recommend the website, which is the group of fee-only financial advisors so that's a good place to try to sort advisors in a given area.

Glaser: We have question about creating value for yourself before retirement, but if you do end up having to work longer. Is there anything you can do to maybe make those years a little bit more tolerable? What are some potential solutions there?

Benz: One thing we were talking about off camera, T. Rowe Price did some work. It must have been like a decade now. But I thought it was really impactful where they looked at someone who understood the benefits of staying in the workforce, that ability to delay retirement withdrawals, continue to earn an income and so forth. So, if someone buys into the fact that, OK I have got to continue working it's better for my financial health, the T. Rowe Price research pointed to if one thing you can do to make it palatable for yourself is to not focus so much on additional contributions. What T. Rowe found was that those late in life contributions tend to be a little less beneficial than the ones that you would make very early in your career.

So, if you can free up a little bit of spending money by not saving quite as aggressively if it means that the trade-off it makes working more palatable--so maybe you can do that trip to Disneyworld with your whole extended family. Spend some of the money that you would have otherwise saved, that that is a good trade-off all in all. So, that’s something to consider ideally you'd continue to make those contributions but if it's a way to make yourself to make it more palatable to stay in the workforce that’s one idea.

Glaser: Well I just have one final question, then, kind of as a capstone for today. What would really be your final piece of advice to pre-retirees or retirees? Christine, what would you say?

Benz: I've only got one. I would say …

Glaser: Piece of advice we should say.

Benz: … get help. Because as much as I am a believer and I see so many of our enthusiasts on creating their own really sensible portfolios--get some sort of second opinion on your plan. At a minimum get an investment buddy to keep an eye on, to help you keep an eye on what you are doing to use as a sounding board for your plan. I think that can be really valuable. I had a dad who experienced cognitive decline, and I was his buddy through that period. But I want everyone to make sure that they have a trusted, knowledgeable person working with them on their financial plan. So, whether that's a paid financial advice or maybe just a very trustworthy financially savvy adult child--whatever it is. Get yourself some help, get yourself that sounding board.

Maria Bruno: I would agree, I would add a couple of points. One would be try to simplify so later in life you may have different types of accounts try to do consolidation to keep the portfolio management as easy as possible. And the sooner you start the more confident you feel in your decision-making and it's not once and done--you want to go back and revisit that plan. Just keep it alive as you progress and for many years we saw during the video today, it's very enriching and rewarding experience. So, it can be with anything it's try to do your education and feel more confident in your decision-making.

Glaser: Maria and Christine, thank you so much for being with us all day and for helping us kind of assess retirement readiness.

Benz: Thank you, Jeremy.

Bruno: Thank you, it's great to be here. Thanks.

Glaser: And thank you for joining us. Just as a reminder we'll have replays of all these sessions available on soon. So, stay tuned there to see when those will be available. We'll also email everyone who is registered for the event those links to the replays directly. We're also going to compile all the picks from our panel with Karen Wallace so that you can see some of those great investment selections as well.

Again, thank you so much for joining us and have a great day.