A Late Bloomer's Guide to Saving

Editor's note: This article is adapted from Kiplinger's Retirement Planning 2007 guide. Order your copy today.

Baby-boomers closing in on retirement with nest eggs that are a few zeroes shy of their goal know what John Lennon meant when he wrote, "Life is what happens while you're busy making other plans." As the vanguard of the 78-million-strong generation turns 61 this year -- one year away from the age when many Americans retire -- some will have to alter their financial strategies in the wake of job layoffs, investment losses, the kids' college bills and unforeseen family expenses that cut into their savings.

If you count yourself among these late bloomers, don't panic. You can still afford to retire. It will mean ramping up your savings and might mean delaying retirement. But here's the good news: With increasing life expectancies, you still have plenty of time to get it right.

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Start a new career

Jerry Hays spent his whole career as a small-town banker -- until a few years ago, when a national bank bought the savings and loan where he worked. He was offered another job if he was willing to relocate, but Jerry didn't want to leave Bloomington, Ind., where his family has lived for five generations. So at 59, Jerry decided to launch a new career. He is now a broker for reverse mortgages and life settlements, linking providers of financial services with seniors who want to tap their home equity or sell their life-insurance policies to raise cash.

Fortunately, Jerry had a home-grown adviser to guide him and his wife, Jeanne, through a sometimes difficult transition. His son, financial planner David Hays, of Comprehensive Financial Consultants, recommended that they sell their big house and use some of the profit to fatten their retirement savings and fund the new business. Jerry and Jeanne sold their home for about $400,000 and bought another for less than half that price, cutting their monthly housing costs from $2,000 to $800.

Although things didn't turn out the way Jerry had planned, he's excited about getting in on the ground floor of a new business. "I always thought I would retire at 60," he says, "but here we are starting over with a new house and a new career."

Extending your career by even a few years can have an enormous impact on your nest egg. It gives you more time to save for retirement, delays the start date for collecting Social Security (which boosts your benefits), and reduces the number of years you'll have to rely on your savings.

Today, more than half of all workers start collecting Social Security payments at 62, even though their benefits are permanently reduced by about 25%. Benefits can be cut even further if you continue to work and earn more than $12,960 in 2007. The earnings cap disappears once you reach your normal retirement age, which is 65 and 10 months if you turn 65 this year (it increases to 66 for those born between 1943 and 1954).

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But basing your retirement plans on working longer can be a gamble. A recent survey by McKinsey & Company found that what pre-retirees plan to do doesn't match the experience of current retirees. While more than half of pre-retirees said they planned to work past 65, only 13% of the current retirees had done so. In fact, many current retirees said they retired earlier than they had planned because of health problems or job layoffs.

Cut spending

A more prudent course is to trim your spending now and to boost savings while you can, rather than being forced to spend less later, says Rande Spiegelman, vice-president of financial planning for Charles Schwab. "Otherwise, it could be like going from driving a BMW to riding the bus." But that's easier said than done. Although 32% of pre-retirees in the McKinsey survey said they plan to reduce spending in retirement, only 10% of retired respondents said they had succeeded in reducing their spending significantly.

That's not always the case, though. William Borgilt, a recent retiree in Jacksonville, Fla., says he lives comfortably on about 40% of his pre-retirement income. He fills his time with volunteering, gardening and discount travel, all covered by his government and military pensions. He also has access to generous retiree health benefits. Borgilt, 58, stresses the importance of drawing up a budget based on your actual expenses before you retire. He doesn't expect to touch his retirement savings until he has to begin taking withdrawals at 70 1/2. It also helps that he paid off his mortgage, reducing his monthly cash-flow needs.

Go the Roth route

Randy and Robin Crook of Tulsa, Okla., are in their mid fifties but are just now getting serious about saving for retirement. Randy is a pastor with no workplace-based retirement plan; Robin stayed home for the first 20-plus years of their marriage to raise their two daughters. With their younger daughter, Erica, graduating from college this spring and getting married, they can focus on their own financial future.

Thanks to their frugal lifestyle, the Crooks have managed to save more than $100,000 in traditional IRAs. But they qualify for special tax treatment, reserved for members of the clergy, that allows them to deduct their housing costs. As a result, they're in a low income-tax bracket and get little tax benefit from traditional IRAs. In their 15% federal tax bracket, every $100 they contribute to an IRA saves them just $15 in taxes.

Robin recently landed a part-time job with a Tulsa law firm that provides full-time benefits, including health insurance and access to a 401(k). The company-subsidized health insurance is already saving them $600 a month, which they plan to devote to retirement savings after their daughter's wedding. Robin contributes 3% of her pay to the company 401(k) plan, enough to capture her employer's matching contribution. She plans to direct another 7% of her income to a Roth IRA in order to take advantage of tax-free income in retirement.

Roth IRAs are particularly attractive to young workers (who can count on years of tax-free earnings) and to anyone who expects to be in a higher tax bracket in retirement or wants to leave a legacy. With traditional IRAs, you're required to start taking distributions each year once you turn 70 1/2, and you must pay taxes on those withdrawals. With Roth IRAs, there are no distribution requirements, and Roth payouts are tax-free to owners as well as their heirs.

Pay off your debt

It's been a rough few years for Catherine Chaffin, but she's committed to rebuilding retirement savings that were decimated by an 18-month layoff. To make ends meet, Chaffin, 45, drained her 401(k) and ran up significant credit-card bills.

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Tapping retirement savings early is an expensive source of funds, as Chaffin discovered. Her $21,000 distribution was reduced to $16,000 after she paid state and federal income taxes plus a 10% penalty for withdrawing money before age 59 1/2.

On the plus side, she managed to hold on to her home outside Los Angeles because she took in a boarder to help pay the mortgage.

When Chaffin thought she would relocate to take a new job, she bought a house in Pensacola, Fla., using some of her retirement savings for a down payment. She has since rented the house, which brings in enough money to cover that mortgage plus an extra $300 a month.

Although Chaffin is now employed, she can't join her employer's 401(k) plan until she has worked there for a year. She's using all of her spare cash to whittle away her high-interest credit-card balances.

A better strategy would be to use a home-equity loan to wipe out her credit-card debt. That would lower her interest rate and make her interest payments tax-deductible.

If you, like Chaffin, got a late start, take heart. You can still build a substantial nest egg. For example, a 50-year-old who earns $50,000 a year, contributes 15% of his or her salary to a 401(k) with a typical employer match of 3%, and stashes another 6% in an IRA could save close to $400,000 by age 65 (assuming a 7% annual return and yearly pay hikes of 4%). Not bad for a late bloomer.