It’s Time to Retire That Old Game Plan

Workers nearing retirement age who have watched their nest eggs crack under the weight of a 2 1/2-year bear market need to act quickly and decisively if they want to salvage a little glitter for their golden years.

Even if the stock market recovers from its worst swoon in a generation, there’s not enough time for those within five years of retirement to regain the 30% to 40% losses that many portfolios suffered.

Instead of hoping for salvation from the stock market, near- retirees need to focus on things they can do that could significantly improve their retirement prospects: spending less, saving more, working longer or part time and securing an income stream over the long haul.

“The past is the past and there’s nothing you can do about the mistakes you have already made,” said Christopher Jones, executive vice president of financial research and strategy at Financial Engines Inc. in Palo Alto.

“Now, you have to look forward and see what you can do to be successful. For a lot of people, that means they’ll have to make some tough choices about how long they are going to work and how much they are going to spend.”

Here’s the game plan:

* Assess your position: First, find out whether the bear market derailed your retirement. Take a look at what you intend to spend after you retire and how much will be covered by Social Security and a defined benefit pension--if you have one. Whatever isn’t paid by those sources must come from your own savings and investments.

If Social Security and pension payments will cover the bulk of your expenses, allowing you to withdraw no more than 2% to 4% of your retirement savings each year, you’re still fine, said Mark Brown, partner with Denver investment and financial planning firm Brown & Tedstrom Inc. But if you will need to drain more than 6% of your savings each year, something has to give, he said.

“Some people may have lost 30% of their portfolio in the past two years, but they’re not in trouble. They just have less cushion,” Brown said. “Others are in a ‘spend less’ or ‘work longer’ situation.”

Those who don’t know how much of a gap they’ll have between retirement savings and retirement income need to draw up a retirement budget.

On one side of the ledger, list estimated expenses including mortgages, car payments, income taxes, food, utilities and entertainment costs. On the other side, list regular sources of income, such as employer-provided pensions, Social Security, rental income and trust fund payments.

If the expenses exceed your expected income, the gap must be filled by your retirement savings. For example, someone with $250,000 in retirement assets should worry if he or she needs to draw more than $10,000 annually--4%, or $833 a month--from their savings.

* Plan to spend less: Those who withdraw 6% or more of their savings each year face the very real prospect of running through their savings before they die, and they need to make adjustments, Brown said.

Fortunately, workers who are nearing retirement typically are in a good position to make these adjustments, said Ellen Hoffman, author of “The Retirement Catch-Up Guide” (Newmarket Press, 2002).

The five-year period before retirement is when people usually earn the most and have the lowest fixed expenses. Most of life’s biggest costs--buying a home, raising children and sending them to college--are taken care of, and disposable income rises accordingly.

In better days, those approaching retirement often used that money to ramp up their lifestyle--traveling more and buying nicer cars and vacation homes.

But those who aren’t well prepared for retirement would be better off reducing their spending and using the extra cash to aggressively pay off debts, including credit cards, car loans and even mortgages, Brown said.

They’ll lose a valuable tax deduction if they pay off the mortgage, but retirees who are debt-free won’t have to take taxable income out of savings to make debt payments. The net tax effect is a wash, Brown said.

Moreover, as consumers generally pay higher rates of interest on debts than they earn on savings, paying off a loan pays a higher return than parking cash in something such as a money market fund.

Planning to spend less once you’re retired also helps.

“No one ever talks about the consumer end of retirement planning,” said John Scott, vice president of retirement policy at the American Benefits Council in Washington. “But it’s pivotal. If you spend less, you need less saved.”

For each $50 cut in monthly spending, you reduce your savings needs by about $10,000, assuming you’ll need retirement income for roughly 30 years.

Specifically, assuming a 5% rate of return in retirement, someone who needs $2,000 in monthly income from their savings needs a nest egg worth $372,563. If this person needs just $1,950 monthly, $363,249 in savings would be sufficient.

* Save more: Lower spending also means you have more money to save. And the federal government recently made it possible for individuals to put more money into tax-deductible retirement accounts than ever before.

Those 50 and older can contribute $12,000 annually to a 401(k), 403(b) or 457 retirement plan. Many individuals also may contribute as much as $3,500 annually to a Roth IRA, which doesn’t provide upfront tax deductions but provides tax-free income in the fu- ture.

Even at today’s low interest rates, a couple saving the maximum amounts in both work-based and Roth IRA accounts each year could stockpile $167,000 over the next five years. That assumes they earn just 3% on their money and each contributes $1,291.67 to savings each month--the maximum allowable.

If they have more disposable income to save, they could put that additional money into taxable savings accounts. Each additional $100,000 that’s invested at a 5% return can generate $537 in monthly income over 30 years.

* Work longer: The most common advice planners give to those unprepared for retirement is to continue working, said Ellen Boling, a director in Deloitte & Touche’s financial planning practice.

Delaying retirement even a few years can dramatically improve your chances of hitting your retirement goals, said Jones of Financial Engines.

“By working an extra couple of years or taking a part-time job, you can make a really significant difference,” Jones said. “You can go from having a 5% chance of meeting your retirement goals to having a 70% chance.”

There are three reasons working longer has such a huge effect. You’re not draining your savings, so they can keep earning investment returns. You’ll be able to add to those savings. And by delaying retirement, you shorten the time that your savings need to last.

Here’s a fourth reason: Social Security imposes a penalty on anyone who takes benefits before his or her normal retirement age. The cost of that penalty depends on how far you are from that age, which is slowly creeping up from 65 to 67.

If you retire early, you permanently lose 20% to 30% of your monthly benefit. In simple terms, a person who retired three years early could see the monthly Social Security check drop from $1,000 to $800.

Here’s how that all can add up. A hypothetical worker plans to retire at 62, but his $300,000 retirement fund has been whittled down to $200,000 by the bear market.

If he retires at 62 as planned, figuring that he’ll live to 92, that $200,000 has to last for 30 years. Assuming he can earn 5% on his money, he can withdraw just $1,073 a month--and some, such as Brown, would argue even that withdrawal rate is too high. After all, you could live longer. And it’s a third less than the $1,610 a month he had expected from his $300,000 account.

However, if he retires at 67, his savings could grow to $256,672--assuming he can get a 5% return--and need to last 25 years. Now his monthly income from savings is $1,500.

If he’s able to save more money over these five years--for example, he puts an extra $1,000 a month into savings during that period--he does even better.

Now, instead of $256,672, he has more than $324,000--an amount that can pay him $1,894 each month for 25 years.

* Secure lifetime income: But what if the person in this example doesn’t die at age 92? The possibility of outliving your savings is the reason some experts suggest individuals consider buying immediate annuities.

These annuities are the equivalent of buying a lifetime pension, said Brian Cressy, director of TIAA-CREF’s Los Angeles office.

Someone putting $100,000 into an immediate annuity today would get a guaranteed $670 monthly payment for the rest of his life, Cressy said. The assumed interest rate on immediate annuities is fairly modest--usually 3% to 6%.

But unlike living off savings, an annuity has an insurance component that guarantees that you’ll never outlive your savings.

* Get help: If you’re close to retirement and your portfolio has taken a massive hit during the current bear market, your investment mix probably was inappropriate for your savings goals.

Brown said he just took on a 60-year-old client who lost $2 million of his $3-million portfolio because it was so heavily weighted in technology stocks.

Now, not only will the client have to delay his retirement, he will have to scale back his lifestyle expectations.

What’s tragic is that losses of this magnitude can be avoided by diversifying your portfolio so it includes a mix of stocks, bonds and cash that’s appropriate to your age. In general, the closer you are to retirement, the more conservative your portfolio should be--and that means a higher proportion of bonds and cash.

“Any credible advisor would have had him diversified,” Brown said. “For anyone who is nearing retirement, it’s time to get serious about creating a plan that’s realistic.”

If you don’t have the skills to go it alone--and if you suffered massive losses in this market, you probably don’t--you need to get help.

Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com /perfin.