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The retirement challenge facing baby boomers

By David Luhman on Sun, 05/10/2009 - 00:10

The retirement challenge facing baby boomers

Why you should listen to this tape

Hi I'm David Luhman and welcome to "Retirement Planning for Everyone". In this tape I'd like to discuss the need for retirement planning, your Social Security benefits, the magic of compounding and the retirement plans available to you.

We've got a lot to cover, so let's get right into it. You probably already have an idea of the need to save and plan for your retirement, but you may not be aware of the magnitude of the problem facing you.

Retirement challenge facing baby boomers

The baby boomers will face a big challenge as they begin to retire around the year 2010. Although this may sound like a long time away, unless you start saving and investing right now, the problem of saving for retirement will change from merely challenging to nearly impossible.

There are several unmistakable long-term trends which will make retirement more challenging for the baby boomers than it was for their parents -- many of whom were able to retire early.

Baby boomers means glut of retirees

First, the baby boomers represent a large wave of people moving through the population. In 1940 the US birth rate was about 2.2. In other words, each woman bore an average of 2.2 children in 1940. By 1950 that figure was above 3.0, and reached a peak of 3.6 in 1960. By 1973 the birth rate had dropped back to around 2.0, where it has remained since.

So the 20 years from 1945 to 1965 represent a truly phenomenal increase in the birth rate which represents a problem for Social Security. Social Security is a pay as you go system. If the birth rate had remained stable at around 2.0, Social Security would still face a squeeze, but the baby boomers will place pressure on the system when they begin to retire.

People are living longer

Another reason why Social Security will be facing a pinch is that people are living longer after retirement. When Franklin Roosevelt started Social Security in 1935, he set the retirement age at 65. At that time the average life span was only 64 -- one year less than the retirement age.

Say what you will about Franklin Roosevelt, but he was a smart politician. He set up a system to provide for a minority of people who were fortunate to live past 65, but he billed it as a system for everyone.

Now however, the average life span is around 75 years, and it is expected to increase to 78 over the next 20 years. This means that instead of supporting a few people in retirement, Social Security must support a large portion of the population for many years.

Workers supporting retirees is dropping

Here's one way to look at the effect that longer-living baby boomers will have on Social Security. In 1950, there were 17 workers supporting each Social Security beneficiary.

Now that number has dropped to 4.7. By the year 2030 there will only be 2.8 workers for each retiree. These are reliable projections based on stable demographics that probably will not change so the problem is real.

Company pensions are disappearing

The other problem facing future retirees is the lack of adequate company-provided pensions. In the 1960s and 1970s many large, stable companies provided good pensions to their long-term employees.

Today, however, large companies like AT&T or Eastern Airlines have split up or gone bankrupt, and the newer companies simply don't offer traditional pensions because of liability concerns. So employees need to save for themselves and manage their own money to a degree unknown by their parents.

Unfortunately, evidence indicates that few baby boomers recognize the challenge facing them. Studies indicate that America's 80 million baby boomers are only saving about a third of what they need to fund their retirement. Personal savings are critical since less than half of men receive pensions, and less than a quarter of women receive them.

The three-legged retirement system

So although our retirement system is supposedly built on three legs -- Social Security, company pensions and personal savings -- you can see that two or even three of the legs are wobbly for most people.

Need perhaps $250,000 in savings

If you don't qualify for a pension, you'll need a solid leg of personal savings to retire at age 65. With no pension but with Social Security, you'll need at least $250,000 in income-producing assets to provide for yourself during the 15 years you'll probably live after age 65.

And this $250,000 is priced in today's dollars, as if you were to retire today. With even mild inflation, if you're 35 years old now, you may need to have $750,000 in income-producing assets to retire comfortably at age 65. And this assumes Social Security benefits won't be cut over the next 30 years.

This may sound like a lot, especially when you consider that half of today's seniors have less than $10,000 in savings. But it will help a lot if you own a home. In this case, you can tap into your home equity by taking out a reverse mortgage or even selling your home.

But you'll gain peace of mind if you start saving a little for retirement at an early stage.

But if you're 35 now should you even worry about retirement? After all, retirement is 30 years away. You're probably thinking, "This guy on the tape sure is a killjoy. He expects me to start saving all my money when I'm young and can enjoy myself?"

Requires savings levels at 25, 35, 45, 55

Well, I'm not trying to be a killjoy, but if you start early enough, you can get by with saving a little of your salary. Because of the "magic of compounding" if you save just 5 percent of your salary at age 25, and keep on saving that 5 percent, you probably can retire comfortably at 65.

If you wait until you're 35, you'll need to save about 10 percent of your salary. Note that this is twice as much as a percentage of your salary, but saving 10 percent shouldn't kill you.

If, however, you wait until age 45 before you start saving, you'll need to save about 20 percent of your salary. Now it's starting to hurt. Also notice the percentage you need to save doubles every ten years you wait.

Finally, if you're 55 and are just beginning to start saving, you'll need to save over 40 percent of your salary to retire at age 65. Either hope for winning the lottery, which I don't recommend, or plan on working past age 65.

So as long as you start saving by your mid-30s or early forties, chances are good you can retire at age 65 if you save only 10 percent of your salary.

Save through retirement accounts

And saving 10 percent of your salary shouldn't break you. People in other countries save 15 or even 20 percent of their pay. You can too.

If you need help figuring out how to increase your savings, check out my tape on introductory personal finance where I discuss budgeting and provide some savings tips.

But once you've started to save, the best place to put your savings is in a tax sheltered retirement account. These accounts not only let your money grow faster through tax deferral, they also give you tax savings right now.

This means you don't have to cut your spending as much because putting money into retirement accounts cuts your taxable income. So don't grimace when I talk about saving for something 30 years in from now. Instead, think about how much you're cutting your taxes right now!

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