What is the retirement gap? The retirement gap is the difference between your retirement income and the actual expenses you will have after you retire. The number one cause of this gap is that people are living longer. It makes sense that if you live longer you will need more money. The second major cause of the gap is the decline in employer-sponsored pension plans. For many years businesses have been switching from pension plans that require them to put in most of the money for their employees’ retirement to 401k plans where the employees must save for their own retirement with the employer maybe matching some of the money they put in.
Most people get their retirement income from a combination of sources. A few people have rental income, pensions or other income, but, for most people, Social Security and investment income is the only income they will have in retirement. Social security is an essential part of retirement income for most people and it’s important to maximize that income and manage when you begin taking payments. But the retirement gap usually shows up because there is a lack of savings to generate the needed retirement income above and beyond what Social Security pays. So how can you avoid this shortfall?
The No. 1 thing you can do is start investing early. It’s hard to convince a young person to start investing. They can’t see how a relatively small amount invested now will do them any good in 40 years. But if you put $1,000 this year ($83 a month) into a diversified stock investment that might earn 9 percent annually, your investment would be worth over $31,000 in 40 years. So, if you invest more as you earn more and continue investing, it can be done. But what if you are older?
The closer you get to retirement the fewer options you will have. Many people become worried that they don’t have enough money to retire and many become desperate. This is not good because when you are under the gun you grasp at straws and consider risky options you never would have before. If an investment is complicated, “guaranteed” or promises to pay high interest with no risk, be careful! These are almost always better investments for the salespeople than they are for you.
Outliving your money is a lot less likely if you do some planning. What everyone should do is monitor their expected retirement income long before they retire. You should estimate your Social Security and your savings for retirement. Then you will have an estimate of your retirement income. As I said before, it is far easier to address your retirement income gap 10 or 15 years before you retire than it is 3-5 years before retirement.
The one thing I see more and more of today is that people are retiring when they still have debt. They still owe money on their house and sometimes they have other debt, too. So a big portion of their limited retirement income goes to pay debts before they even get to their living expenses. This makes an already hard problem to solve almost impossible. If you have a $1,000 a month house payment after you retire it would take $300,000 in savings just to pay the $12,000 payments a year at 4 percent withdrawal rate. It should be a goal when you buy or refinance a home that it be paid off before you retire. Again, planning now can keep you out of trouble later and reduce the retirement gap.
Another thing I see is that many people are way too conservative with their investments both before and after retirement. People save instead of invest. It is sad to see people that have saved regularly throughout their lives but they put their savings in very low-paying, high-fee or just bad investments. If they would have just put that money in long-term investments instead of savings accounts, CDs, bonds, annuities or whole life insurance they would be in a much better financial situation. The difference between earning 3 percent for 30 or 40 years and earning 7 percent could be the difference between really struggling in retirement and being very comfortable and worry-free.
Finally, one popular way to close the retirement gap is the reverse mortgage. Because of the lack of savings or just bad investing, I think we will continue to see more people using their home as a source of income. Reverse mortgages are an option. In my opinion, they should be used only as a last resort. This is because a reverse mortgage is expensive. You are taking out a loan and paying interest on any payments you get and rolling the closing costs, fees and interest into the loan. Another thing to be aware of is that if you ever need to enter a long-term care facility for more than a specified amount of time, the loan would become due.
Bill Oldfather is a fee-only financial planner and investment adviser. Oldfather Financial Services is an SEC Registered Investment Adviser based in Kearney.
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