Watch the Clock

Fate blesses each of us differently when it comes to income-earning potential, risk tolerance and financial savvy. Yet we are all given the same 24 hours each day and the same 40 or so years across our careers. How we utilize that time is up to us. Few things put the wind at our backs in retirement planning than a calendar. “Time is the great equalizer,” O’Hara says. “The longer you have time-wise, the better the chances of reaching you goal.”

Starting early — ideally with your very first paycheck, O’Hara says — is the one thing we can do to insulate our retirement savings from the harmful impact of poor investment choices or unfavorable market moves. “To a certain extent, all investment management is the assumption of risk over a specified period of time,” he says.

Bob Pavlik (left), an associate professor of finance at Elon University’s Love School of Business, volunteered to run a few numbers to illustrate the steep price tag that can come with procrastination. A 25-year old who begins saving $100 each month and earns a nine percent average annual return on his or her investment can look forward to a $471,600 nest-egg at age 65, Pavlik says. If that person waits 10 years to begin setting aside the same cash, she’ll amass only $184,400. Wait until age 45, and the savings dwindles to just $67,300.

Pavlik’s model illustrates the time value of money: the arithmetic that occurs when interest is paid on interest earned through the years. “The longer one waits to begin saving for retirement, the more one diminishes the beneficial effects of compounding,” Pavlik explains.

Starting to save early in life also has an important psychological benefit, Franklin Street’s O’Hara says. “The earlier you get used to the idea of setting money aside for retirement, the easier the habit becomes later on.”



Saving Means Work

Help for those interested in a financially secure retirement may be closer than many think. While larger corporations and public sector employers continue to offer traditional pensions with government-insured benefits for life, most of the nation’s retirement assets now reside in employer-sponsored savings programs such as 401(k)s, 403(b)s and the like. There were some 432,403 such plans in place as of 2002, according to the Employee Benefits Research Institute in Washington, D.C. A growing percentage of these plans are, in fact, found in firms with 100 or fewer workers.

By saving through company retirement plans, individuals can avoid minimum investment levels and high administrative costs. Best of all, about 95 percent of 401(k) plans provide some form of company match, typically 50 cents on the dollar up to the first six percent contributed by the employee. Still, an alarming number of Americans eligible for 401(k)-type plans are not taking full advantage of them. According to the Chicago-based Profit Sharing/401(k) Council of America, one out of five eligible workers doesn’t participate at all.

“You’d be amazed at how many people we talk to who aren’t maximizing their 401(k)s,” says Ruth Forehand, a financial adviser with RSM McGladrey in Raleigh. She and other planners recommend younger workers contribute at least up to the level of the employer’s match, and then increase funding gradually with every pay hike. Once contributions are maxed out, investors can then turn to individual savings vehicles such as an Individual Retirement Account (IRA) or other investment options that are not shielded from annual taxation. “People who want to retire early need to think about investing outside of a qualified (i.e., tax protected) plan,” according to Forehand, noting that 401(k)s and IRAs typically come with age-based restrictions on withdrawals.

Being realistic about one’s retirement age is a hurdle Sara Conway sees in many people she advises. “People don’t realize how long they’re going to live,” says Conway, a financial consultant with Culpepper Investment Group in Kinston. It is especially true with regard to women, she says, who likely will live about five years past their male cohorts.

But elevated life expectancies offer good news, as well. For those who failed to start saving early in life, time can be made up assuming they aren’t averse to remaining in the workforce beyond their mid-60s. “People are retiring way too early,” says Conway, whose firm is affiliated with Wachovia Securities.


Getting Real with Expectations

Underestimating life expectancies are just one of the problems Conway encounters in her efforts to help clients plan for a smooth retirement. “People have unrealistic expectations on several levels,” she says. Another costly planning mistake occurs when individuals overestimate the return they expect to earn on their savings. “They believe they will earn 10 to 12 percent annual gains. That holds down the amount they’re willing to save.” Conway recommends using an eight percent return assumption instead, “even if you think you’re an aggressive investor.”

Many jeopardize their retirement planning by using faulty assumptions about Social Security. “A lot of people make the mistake of thinking they can actually live off Social Security,” Conway says. In fact, Social Security was never designed to supplant personal savings. In March 2004, for example, the average recipient of Social Security “Old Age” benefits received $924, according to the Social Security Administration. Changing tax treatment of benefits, rising eligibility ages and questions about long-term solvency (see related story, page 14) should prompt people to save more, not less, when it comes to retirement planning.

Many learn the hard way just how costly retirement can be. Sure, the mortgage may be paid and the children safely out own their own, but the soaring cost of healthcare can quickly erode even the most impressive nest egg. “Most people think the cost of healthcare will go down when they get Medicare,” McGladrey’s Forehand says. “Actually, costs go up significantly.”

In fact, couples retiring at age 65 can expect to foot $175,000 for out-of-pocket health expenses over 20 years, according to a recent study by Fidelity Investments. Alarmingly, the analysis included Medicare’s new prescription drug benefit and excluded the costs of nursing home and other long-term care expenses.

Long-term care, when taken alone, is an area of great denial. The average cost of skilled nursing-home care in the state’s metro areas approaches $125 per day. The amount goes up in cases where a resident suffers from Alzheimer’s disease or has other specialized care needs. Health and long-term care costs are definitely an important piece of the retirement planning puzzle, says Arne Morris, director of wealth management at RSM McGladrey. That’s why he and Forehand, who provide clients with a team-oriented planning approach, consider choosing the right long-term care insurance policy just as critical as selecting the best performing mutual funds.

“Long-term care insurance is becoming more affordable as insurers gather more rating experience,” Morris explains. Most products are now reasonably priced if purchased prior to reaching the late-60s. But there are reasons individuals and couples should consider long-term care insurance as early as age 50, Morris says. “With a high rate of cancer, stroke and heart disease, people may need skilled nursing care in their 50s.” And once an adverse health condition occurs, it may be impossible to obtain a policy at any price.

As with the purchase of any insurance product, it’s best to shop around. “You want a policy that is appropriate for specific needs,” Morris says. Package discounts are available for couples. Give due consideration to the company’s financial strength and commitment to the long-term care market, he cautions. “Look to see if the company offers a group long-term care plan. That means there’s a broader risk pool,” Morris advises. Affinity long-term care insurance products — those offered through membership associations — are not usually the best choices, he says, due to adverse selection driving up premiums. “If you’re already in poor health, they may be the only option.”


Pay Now, Pay Later

Navigating the world of long-term care insurance may require the experience and expertise of a fee-based planner. A poorly designed policy may leave unique risks exposures, for instance. One that offers features that are irrelevant will result in unnecessarily high premiums. Paying a qualified planner to locate and tailor the ideal policy could easily pay for itself many times over.

Financial professionals also can help with asset allocation decisions. Software programs can match risk-reward criteria with a client’s planning goals, resulting in a portfolio structure that can withstand market meltdowns like the one many investors suffered in 2000-2002. McGladrey’s planners advocate an approach known as “modern portfolio theory,” which can take much of the heartburn out of short-term market upheavals. “It’s based on diversification and asset allocation, not stock selection or timing,” Ruth Forehand explains. “It’s about 94 percent of your performance,” adds colleague Morris.

Professional planners are also skilled at ferreting out the most cost-effective investments. Working alone, for example, individuals are not able to invest in institutional mutual funds classes, which often offer lucrative returns at very low operating costs. But such shares are available when purchased through a planner. “If you want to stay ahead, you’ll need a professional,” says Sara Conner of Culpepper Investment. And good planning involves more than an asset allocation pie chart. “There are so many assumptions involved.” Better still, an experienced planner will insulate clients from fads and hysteria often hyped over the Internet and in the financial media. “There’s too much bias there in one direction or the other,” adds Conner.

Many investors shoot themselves in the foot by changing course too frequently, which adds real costs and potentially adverse tax consequences, and rarely makes things better over the long haul. “Put a prudent asset allocation in place and look at it maybe twice a year,” suggests O’Hara of Franklin Street Trust. That doesn’t necessarily mean making dramatic changes to it every six months. When significant adjustments are warranted, planners say, it is usually the result of a major life event — marriage, a career change, widowhood or the like — not because of shifting market winds or business cycles. “One can do broad macro-level asset allocation by using the Internet,” O’Hara says. “But when you begin executing across different areas, that action needs to be in the hands of a professional.”

O’Hara also recommends staying focused on what’s ahead — not what’s behind you. “Don’t necessarily confuse the past with the future,” he says. Nor is it wise to get too clever with investment strategies based on things such as demographic trends. A lot of people talk about what the aging of the baby-boom means for pharmaceutical stocks or cruise ship lines, but ignore the impact that an “echo-boom” nearly as large is making as it purchases its first homes and cars.

According to O’Hara, American investors also tend to be too “folk-centric” — reluctant, that is, to think globally when it comes to economics and investment opportunities. He believes a good retirement savings portfolio should include foreign stocks and bonds, though finding the right ones definitely requires the help of an experienced pro. “Think about China and India,” O’Hara advises.

Above all, retirement planning calls for common sense, O’Hara says. “Before you spend $25,000 on a car, you do a lot research. The same should be true when investing $25,000.” The really important concepts don’t take the help of a financial planner to explain, he says: starting early, being realistic about the future, maximizing employer-sponsored programs, remaining adequately diversified. “People are smart enough to know what’s going on. It doesn’t have to be difficult.”



How Secure Is Social Security?

Along with home equity, personal savings and employer pensions, Social Security is considered part of the “four-legged stool” of sound retirement planning. But what happens when the solvency of America’s largest and most popular government program is called into doubt?

“It’s a basic issue of demographics,” explains Max Pappas, a policy analyst with Citizens for a Sound Economy (CSE), a Washington, D.C.-based organization that promotes market-oriented public policies. “When Social Security was created, there were over 30 people working for every one retiree. There will soon be only two.” That, he says, means today’s younger workers will suffer a negative rate of return on their contributions into the system.

CSE, along with other groups, is now advocating a fundamental change to the way Social Security is managed. Its reform plan would allow individuals to channel the individual portion of their FICA contributions (6.2 percent of earnings, a figure that is matched by employers) into personal savings accounts that could be invested in government-approved securities offered through the private sector. It would mark an historic departure for the politically sensitive program, which will begin drawing down trust fund assets as early as 2016. Government projections anticipate those assets will be depleted by 2042, potentially leading to reduced benefit levels for recipients.

But the idea of personal accounts is not without controversy. “We’re opposed to private accounts,” says Bob Jackson, state director for AARP-North Carolina. He says such “carve outs” would potentially deprive retirees of an adequate base, putting millions of wage-earning Americans at risk. “There are significant challenges to this model, though it looks good to some on paper.”

Instead, AARP, which has 950,000 members in North Carolina, advocates other solutions for addressing the program’s long-term woes. One option is raising the earnings cap on payroll contributions, currently set at $87,900. “The cap has not kept pace with salary increases in recent years,” Jackson says. AARP also supports moving some portion of FICA receipts into marketable securities, much the same way the pension fund of North Carolina government workers is invested in the private marketplace. Currently, Social Security funds may only be invested in a type of U.S. Treasury bond that cannot be traded on the open market. Jackson says the group would also like to see contribution limits lifted on IRAs and 401(k) accounts. “We believe Americans ought to be encouraged to save more,” he says.

AARP’s concerns about basic changes to Social Security are shared by some in the academic community. “The theory behind the program is that it’s insurance,” says Stanley Eakins, professor and chair of the finance department at East Carolina University. “It’s a backup to your financial plans.” He believes much of the alarm surrounding Social Security is overblown. While the program’s long-term financial health isn’t ideal, its massiveness means that relatively minor changes can make big differences over the coming decades.

Eakins says one idea is to extend eligibility for benefits out another six to 12 months. “As people are living longer and working longer, they will likely be able to delay benefits,” he says. He also suspects that recent waves of immigration, which have brought a legion of younger workers into the system, have not been factored into solvency projections by policy planners.

That’s not enough to convince leaders of Citizens for a Sound Economy, whose active North Carolina chapter has 23,000 members. In April, the group held a series of town hall meetings on the issue in four cities. CSE took its private accounts vision to retiree-dense Asheville and Tryon, and was encouraged by the response received by local seniors who attended. “Once people understand this is not a proposal that reduces their benefits, they see the value in it,” says Alan Page, state director for CSE in North Carolina. The group is planning additional meetings in central and eastern North Carolina over the summer, leading up to the fall elections. “A lot of education needs to be done on this issue,” Page says. -- Lawrence Bivins

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