US News and World Report

June 13, 2005


The Big Squeeze

The pressure is on baby boomers saving for retirement. Many also face college tuition and caring for a parent

by Paul J. Lim

In his State of the Union address, President Bush made a pledge to Americans 55 and older. Yes, it's true he plans to overhaul the nation's retirement safety net, he said. But "for you," he promised, "the Social Security system will not change in any way."

How about workers who were born in 1950 or later? What kind of guarantee do they get?

Apparently none in today's retirement world. For workers in their mid-40s and 50s, the specter of Social Security reform adds yet another air of uncertainty to their retirement plans. Already shaken by a three-year bear market at the start of this decade, and a listless market now, workers must also confront an ever-changing global economy and, for many, the squeeze presented by the need to finance college tuitions and care for aging parents. Many of them are facing this uncertain age with only the barest of financial preparation: Forty-one percent of workers ages 45 to 54 have less than $25,000 saved up for retirement.

But even those who have planned by the book are enduring their share of anxiety. For much of their careers, Paul and Margaret Eberts of West Chester, Pa., have done the right thing by saving 10 to 15 percent of their annual income.

The crunch years. But while Paul, 48, and Margaret, 47, make a decent living--he's a family practice physician while she works part time as a physician in occupational medicine--the Eberts aren't so sure they'll be able to keep hitting those targets. That's because "the crunch years" are just a couple years off, says Paul.

Paul and Margaret have four kids: two boys and two girls ages 16, 14, 12, and 10. Between 2007 (when their oldest starts college) and 2017 (when their youngest is expected to finish up her undergraduate work), the Eberts's biggest financial obligation will be paying for college "It's going to be a real question mark whether we'll be able to contribute the max to our retirement plans," during this stretch, says Paul who will be 60 at the end of it.

"Young boomers are running out of time to save," says Mike Scarborough, president of the Scarborough Group, a retirement planning advisory firm.

Assuming current expectations for Social Security benefits, only around 40 percent of workers born between 1951 and 1960 are on track to have enough money to cover basic expenses in retirement, based on their current savings and investment behavior. That's according to an analysis by the Employee Benefit Research Institute. "And that's just to meet basic living expenses," says EBRI C hief Executive Officer Dallas Salisbury. As anyone reaching middle age knows, life can throw out a curve ball, like an illness or the loss of a job.

Already, the boomer generation has borne the brunt of the seismic shift in the private sector, from traditional pensions--with their promise of income for life--to do-it-yourself retirement plans like 401(k)'s, which put workers at the mercy of the markets.

Even boomers lucky enough to be covered by traditional pensions are waking up to a new reality: It turns out those guaranteed benefits aren't necessarily guaranteed after all. Many pilots and flight attendants at United Airlines, for example, are likely to see their pensions slashed now that the struggling airline has been allowed to offload its pension to the federal Pension Benefit Guaranty Corp. Other employers could follow United's example.

And the boomers need to plan for long retirements. Modern medicine and better diets are yielding longer lives. The average American woman today can expect to live until 80, up nearly five years from 1970. Those who make it to 65 can expect to live until nearly 84.

Yet boomers also have to worry about higher expenses in their elongated retirements--and not just because of their propensity to spend. Only 13 percent of private-sector employers offer medical benefits to retired former workers, according to EBRI. And the promise of longer lives through better medicine has come with a price. Healthcare expenses could wind up costing retirees 20 percent of their annual income, according to the employee benefit consulting firm Hewitt Associates. This may explain why three times as many boomers say they fear major illness and healthcare expenses more than dying.

Here's another pressure point: With recent record low mortgage interest rates and surging home values, Americans have been refinancing their mortgages in droves. This includes young boomers like the Eberts.

Last year, the Eberts refinanced their mortgage and took some of their equity out of the home to pay for additions to their house. They redid their kitchen and added a bedroom and a garage for their growing family. To do so, they took an old 30-year mortgage--of which they already paid down 12 years--and replaced it with a new 30-year loan. This means Paul will be around 77 by the time his home is paid off.

Worse still, because of the renovations, the couple's monthly mortgage payments actually increased even though they refinanced at lower rates. "It bothered me a bit to take that on," says Paul, but "we really didn't have a whole lot of options."

Mortgage bonfire. The fact that so many Americans will be carrying mortgages well into retirement means that the old rule of thumb of needing to replace 70 or 80 percent of your preretirement income is out the window. "That may have been true in the old days, when retirees burned their mortgages before retiring," says Rande Spiegelman, vice president of financial planning for the Schwab Center for Investment Research. But today, he says, young boomers should plan on saving enough to replace 100 percent of their preretirement income--minus whatever they are setting aside to build up their nest eggs.

If only there were a federal Leave No Young Boomer Behind Act. But, says Daniel Houston, senior vice president for retirement and investor services at the Principal Financial Group, "there are no silver bullets. The Lone Ranger left the last one of those on the prairie."

So what should one do? For starters, young boomers simply have to save more money. Period. This may be difficult for workers who are simultaneously paying their children's college bills. But "if you don't cut your spending voluntarily now, you'll be forced to cut your standard of living in retirement," says Houston.

Consider this: Fifty-five percent of young boomers--those ages 45 to 54--have saved less than $50,000 toward their retirement, not including the value of their primary residences. Two thirds have less than $100,000 saved. And nearly 9 in 10 have less than $250,000.

Yet academic research shows that retirees who want to play it safe can afford to withdraw only 4 percent to 5 percent of their nest eggs each year in retirement--if they want them to last for 30 years or more. Even a person with $250,000 could afford to tap only $10,000 or so annually.

The good news is many young boomers, like David Fooshe, 50, are getting the message. Fooshe, an engineering project manager in Portland, Ore., has always made the maximum contributions allowed in his 401(k)'s and IRA s. But in recent years, he has also begun taking advantage of the so-called catch-up provisions in tax-deferred retirement plans. Next year, workers 50 and older are allowed to put an additional $5,000 into their 401(k)'s and $1,000 into their IRA s.

It helps to start the saving habit early. The Schwab Center for Investment Research concluded that all workers should start saving 10 percent to 15 percent of their income in their 20s. That way, they can maintain that rate all their working life. If you wait until your 30s to start, then you need to set aside 15 percent to 25 percent of your annual income for the rest of your career. Workers who haven't started by their early 40s will need to sock away 25 percent to 35 percent of their incomes annually to make up for lost time.

For many, this represents a huge undertaking. But keep in mind that if you're maxing out your 401(k) and contributing to an IRA, you may already be close to hitting 15 percent.

You may think you can play catch up with the stock market. Think again.

David Darst, chief investment strategist of Morgan Stanley's individual investor group, says today's young boomers are "facing relatively mundane and mediocre returns in the stock market." After a 20-year stretch of better-than-average returns, equities are likely to underperform in the coming years. He predicts annual equity returns of around 6 to 8 percent a year, well below their historic long-term average of more than 10 percent.

Savings edge. Moreover, Christine Fahlund, senior financial planner with T. Rowe Price, recently studied the probabilities of meeting retirement goals and discovered that saving more is far more effective in improving your odds of funding retirement than investing more aggressively.

But all is not lost. Young boomers have other assets at their disposal--such as real estate.

James Diamond, 48, has been buying real estate in recent years not for speculation but for income. Diamond, an estate planning attorney, purchased several rental properties in Southern California over the past two decades. When he leaves the workforce, he doesn't plan to sell those properties but rather to use their rent as supplemental income.

Dennis Poisson, 51, of Macomb Township, Mich., has a simpler plan in mind. While Poisson, a manager for General Motors in its design division, is eligible for a traditional pension, he says he and wife, Danielle, want to play it safe. Once they retire, in about a decade or so, their intent is to sell their 3,000-plus-square-foot home and downsize to a 1,500 square-foot condominium. "That's our insurance policy that we'll be able to travel and do all the things we like to do," he says.

But for many, if not most, the simplest option will be to work longer. A decade ago, with a bountiful stock market, the vast majority of Americans ages 45 to 54--83 percent--said they planned on retiring at 65 if not earlier. Today, with stocks trading below the highs they reached in 2000, a majority say they plan on leaving the workforce at 65 or older. One in 10 young boomers says he or she never plans to retire.

Part of this is tied to the current state of young boomers' finances. But it also has to do with the different views that young boomers have about work and retirement than those of their parents.

A recent Merrill Lynch survey of boomers found that only 17 percent want to retire for good. A majority want to either work part time or to cycle back between work and leisure. "What many boomers are beginning to realize is that maybe a life of complete and total leisure is first of all unaffordable," says Ken Dychtwald, chief executive of Age Wave, a consulting firm that focuses on boomer and retiree behavior. "And secondly, they are finding out that it may not be as satisfying as we once believed."

For young boomers, this attitude is a major asset, as working longer--whether part time or in another capacity--for even two more years can drastically improve a retirement plan.

A study by Hewitt Associates last year, for example, found that workers ages 50 to 54 at large U.S. firms--many with rich retirement plans--were on track to replace nearly 89 percent of their income if they retired at 65. This figure includes not just 401(k) balances but proceeds from pension plans and Social Security.

However, delay retirement to 67, and they would be able to replace more than 100 percent of their preretirement income.

This is why Patti Brennan, president of Key Financial, a financial planning firm in West Chester, Pa., says it is important for young boomers to plan for a so-called transitional phase between work and full retirement.

You can use this transitional phase to test the waters for retirement. The last thing you want to do, says Brennan, is step out of the workforce and begin tapping your nest egg just as a big bear market approaches.

Back to work. This transitional phase can also be used to build up additional savings by working longer. This is what the Eberts say they plan to do. After their youngest child finishes college, Margaret may shift from part-time work back to a full-time schedule while Paul might work well through his 60s to compensate for the years in which their retirement savings were diverted to college bills.

The good news is young boomers are by nature flexible. A recent survey by Principal Financial asked workers 45 to 54 what they would do if they found Social Security doesn't provide them the income they expected. The vast majority said they would either work longer or phase into retirement.

These are folks like David and Kim Scofield. The Ocala, Fla., couple spent years working on commission as sales agents in the tile and flooring industry. Because they weren't on a fixed salary, though, saving a regular amount of money each year was always a challenge, says Kim, 48.

Though she and husband, David, 53, always wanted to save 10 percent to 20 percent of their incomes, the reality is, they had less than $100,000 in their IRA s. "It's not very much money," she says. On top of that, they had amassed more than $25,000 in credit card debt.

Recently, the couple took a leap of faith and opened their own small business, which distributes tiles, matted rocks, and other flooring materials. Kim says the couple was able to more than double their income over the past year with the new business. As a result, they've been able to increase their IRA balances by more than 50 percent. But without a pension plan, the Scofields realize that they need to save more to make up for those lost years.

Kim says the couple plans to work well into their 60s, if not early 70s. Then, they may work part time while their son takes over the business. "We were in a situation, before the business, where we felt that we had to work the rest of our lives just to make ends meet," says Kim.

"We've been able to turn our finances around. But now, I'm having so much fun I don't even consider retiring." That may be just the attitude that young boomers need to make the new retirement model work.