Revive Your Retirement

The Incredible Shrinking Nest Egg

QUIZ: Are You on Track to Revive Your Retirement?

But younger workers, with decades to go before they retire, may look back on the Panic of 2008 as one of the best things that ever happened to their finances. By continuing to contribute to their retirement plans, they can scoop up mutual fund shares at bargain prices. And thanks to a precipitous decline in home prices, many of them may finally be able to afford a house that was previously out of reach.

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But if you are age 50 or older, your picture is not so rosy. You may have to work a few years longer than you had planned, particularly if you're not covered by a traditional pension (most baby-boomers aren't). That will give you time to stockpile or replenish your retirement savings, delay claiming Social Security benefits until they are worth more at an older age, and give your current investments a chance to recover from the biggest market rout since the Great Depression.

If you are already retired, take a hard look at your finances. A popular rule of thumb suggests that to ensure you don't outlive your savings, you should limit your withdrawals to 4% of your portfolio in the first year and increase subsequent withdrawals by 3% a year to keep pace with inflation. Christine Fahlund, a senior financial planner for T. Rowe Price in Baltimore, says although that rule works in 90% of stock-market simulations, "there is another 10% scenario to talk about -- and we've just lived through it."

Fahlund recommends that retirees concerned about running out of money reduce withdrawals from their portfolios, if possible, or at least skip the annual inflation adjustment until the market rebounds. And if you've suffered substantial losses, you may want to reset your withdrawals altogether, using your new, lower portfolio balance as the basis for your 4% distribution. The biggest threat to your savings now is withdrawing too much from a declining balance because you may not have enough left to benefit from rising stock prices when the market finally turns around.

In the meantime, you have to play the hand you've been dealt. No amount of anger or frustration is going to restore your investment losses. But moving forward with a concrete plan will help you get back on the right track, no matter your age or where you are on the road to retirement.

Younger workers benefit

Wendy and Rodney Dunn are prime examples of young investors well positioned to profit from the market meltdown. Their portfolio lost nearly 40% in 2008, about as much as Standard & Poor's 500-stock index lost. But they have decided to stick with their long-term plan. Says Wendy emphatically: "Given our age, we're staying the course."

The couple have the time to be patient. A former portfolio manager for North Carolina's state pension plan, Wendy, 33, is now a stay-at-home mom in Benson and chief financial officer of her family's finances. "We are reevaluating our asset allocation and making sure that we are still in quality funds," she says.

Rodney, 36, plans to contribute the maximum $16,500 to his 401(k) this year. Lynne Ford, head of the Retail Retirement Group at Wachovia, which merged with Wells Fargo at the end of December, says that's what workers of all ages need to do: Keep contributing as much as you can to your retirement savings. "This is the era of YOYO retirement," she says, "which stands for 'You're on your own.'"

Tax-free future

The Dunns also plan to add $5,000 each to a nondeductible IRA and then convert the two accounts to Roth IRAs in 2010, when the current $100,000 income-eligibility limit on conversions disappears. At that point, they will owe taxes only on the earnings, not the after-tax money they contributed to their traditional IRA accounts. (This strategy works best if you have only nondeductible contributions in your IRA. If your account holds a mix of deductible and nondeductible contributions, only a portion of any amount you convert to a Roth IRA will be tax-free.)

A Roth IRA is an excellent way to diversify the tax status of your future retirement income. Although you can't take a tax deduction for contributions -- as you can with a 401(k) or similar employer-based retirement fund -- all withdrawals are tax-free in retirement. And you can even withdraw your contributions (but not earnings) tax-free and penalty-free at any time. Roth IRAs are particularly attractive to anyone who believes that tax rates will be higher in the future -- a plausible scenario given the nation's record budget deficit. Single tax filers can make a full contribution of $5,000 to a Roth IRA if they earn less than $105,000, and married filers can contribute the maximum if they make less than $166,000.

Oyuki Lopez has contributed to a Roth IRA since she began working as a flight attendant nearly ten years ago. The 31-year-old recalls that once during a five-hour transcontinental flight a first-class passenger lectured her about the magic of compounding and the allure of tax-free income in retirement. She's been a crusader for saving for retirement ever since, helping her friends become more savvy about money and later bribing her husband by offering him $500 to participate in his company's 401(k) plan.

It's been a rough year for Lopez. She got divorced, quit her job and relocated to San Francisco, where she landed a position with start-up airline Virgin America. Despite the temporary setbacks, she's still keeping her eye on the future, funding her Roth IRA each month until she is eligible to participate in her new employer's 401(k) plan. She expects to contribute 15% of her salary.

Lopez concedes that her sizable 401(k) contributions may strain her cash flow in the short run. But she thinks it will be worth the sacrifice. Besides, the free-travel perks of her airline job allow her to live what she describes as her champagne lifestyle on a beer budget. "You just have to treat your retirement savings like your cell-phone bill," she says. "Pay the bill every month or they're going to shut off your service. It's the same thing with retirement: Invest for it now or you won't have one later."

Midlife crisis

Older workers may be less sanguine about their prospects for retirement. But in this age group, your best bet is still to keep shoveling money into your savings. Workers 50 and older can take advantage of the rules allowing catch-up contributions, which permit them to kick in an extra $5,500 in retirement-plan contributions (for a total of $22,000 in 2009).

Unfortunately, many mid-career workers are doing just the opposite. Nearly one in five respondents to a recent poll by AARP Financial said they had either stopped or reduced their contributions to their 401(k), IRA or other retirement account because of the economic slowdown. Another 20% -- all preretirees 40 or older -- said they had postponed their retirement date.

The financial turbulence of the past year wiped out virtually all of the gains of the past decade. You were probably counting on returns of 7% a year or more, but for the past ten years through December 5, the S&P 500 lost an annualized 1%. To make up those losses, you will have to save more or work longer.

Laurie Garrison plans to do both. Despite a well-diversified portfolio, the Edmond, Okla., woman lost about 20% of her investments over the past year. After carefully managing the life-insurance payout and retirement funds she received when her husband died five years ago, she had hoped to retire next year at age 55. But with one child still in college and her nest egg considerably smaller than it used to be, she now thinks she'll boost her 401(k) contributions and probably work until 60, when she can collect Social Security survivor benefits. "It's just so irritating," she says. "The big guys on Wall Street gambled with our money and lost, but we're the ones paying the price."

Bruce Davis, also of Edmond, intended to work for at least two more years, but his employer had other plans. After a 30-year career with Chrysler, Davis, now 60, decided to take an early-retirement buyout package in November. "It wasn't my game plan, but it's better to take a reduced benefit now with some income while I can," he says.

Davis hired investment adviser Greg Womack to try to salvage what remains of his 401(k) investments, which fell by 50% in just six months thanks to his very aggressive asset allocation. "I got sick every time I looked at my 401(k) statement," Davis says. "I decided that I'd probably be better off if I got someone who knew what he was doing."

Womack uses a combination of strategies and tactics to help preserve retirement assets. For example, he is using deferred annuities to create a "private pension" that guarantees future income, and defensive stock- and options-trading tactics to help protect Davis's portfolio against significant losses. In the meantime, Davis says he hopes to strike up a consulting arrangement in his area of expertise -- auditing warranty and sales-incentive programs -- with some local car dealerships.

Most planners urge investors to stick with long-term plans and avoid locking in losses by selling in a panic. Yet many concede that in these turbulent times, you should review your asset allocation to determine if it is still appropriate for your goals and risk tolerance. "If your portfolio makes it hard for you to sleep, then consider selecting one with a risk level more appropriate for you," says Mark Riepe, senior vice-president at the Schwab Center for Financial Research.

Riepe recommends that people in or near retirement keep at least a year's worth of expenses in cash and certificates of deposit, and another two years' worth in short-term bonds that can be liquidated in the event of a prolonged bear market. But don't abandon stocks altogether. Older investors should keep up to 50% or even 60% of their assets invested for growth early in retirement because they may need that money for 20 years or more.

For Mary McGrath, the past few months have been the most emotionally stressful in her 20-plus years as a financial adviser. "It is so difficult to suggest to a client who really wants to retire that he should postpone it for a few years -- or even worse, to tell someone who is 65 that he needs to go back to work," says McGrath, executive vice-president of Cozad Asset Management, in Champaign, Ill.

For her clients near retirement, McGrath explains the potentially damaging impact of withdrawing money from a shrinking nest egg. She also discusses the value of waiting to retire until age 65, when you will qualify for Medicare and a higher Social Security benefit. How long should you delay retirement? It depends on how much money you need, how much you have lost and how quickly the economy recovers. McGrath is telling most of her clients to plan on working an extra five years.

On the brighter side

Ricardo Torres, a former musician who is now a social worker in New York City, decided to make the best of a bad situation. With the balance in his traditional IRA down by more than 30%, he decided it was the perfect time to convert the account to a Roth IRA. "I didn't like looking at my IRA balance, but I was determined not to panic and sell," says Torres, 60. "I decided to convert it to a Roth and gamble that it would bounce back. All that growth would be tax-free."

Further north in the Empire State, Jean and Spencer Villagio of Troy have been planning their escape to early retirement for years. Despite the weak economy, they are still on track to reach their goal. They downsized to a smaller home three years ago, after their three daughters finished college. The couple paid cash for the house, leaving them mortgage-free.

Jean, 57, plans to retire as a teacher's aide in June. Spencer, also 57, will work one more year as head auto mechanic for the county government to lock in a higher pension benefit. Jean is also eligible for a small pension, and both will qualify for retiree health benefits. "We live a very simple life and we're super savers," says Jean, who notes that they saved most of her salary since she started working 15 years ago. "We never made a lot of money, but we were able to put three kids through private colleges."

The Villagios are looking forward to spending more time together enjoying inexpensive outdoor activities, such as biking, skating and camping. Between their pensions and savings, they'll even be able to splurge on a trip to Asia to visit one of their daughters, who teaches in Taiwan.

Guaranteed income

Paul Lemon, a fee-only financial adviser in Durango, Colo., believes the stock market will recover, but he's not so sure that some of his retired clients can afford to wait. Last September, before the market took a nose dive, Lemon advised some of them to shift a chunk of their investment assets into immediate-payout annuities to lock in guaranteed income and reduce their reliance on the volatile stock market. "I really had to start looking at the consequences of my advice -- that if they invested for the long term, everything would be fine," says Lemon. "My clients don't have a margin of error. If I'm wrong, they will go hungry."

To be extra cautious, Lemon divided his clients' investments among several highly rated insurers, so that no single annuity contract exceeds Colorado's insurance guaranty association limit of $100,000. (To check your state's guaranty limits, which range from $100,000 to $500,000, go to the National Organization of Life & Health Insurance Guaranty Associations, at www.nolhga.com, and click on "State Associations.")

In one case, Lemon used more than half of a retired couple's assets to buy immediate annuities, some with annual cost-of-living adjustments and some with fixed rates but higher initial payouts. The couple's monthly income is now larger than they could safely afford to withdraw from their previous investment portfolios, and it is guaranteed for the rest of their lives. They still keep a portion of their assets invested in stocks and have other money available for emergencies.

Joseph Leonard, a financial planner in Southport, N.C., who specializes in retirement issues, says most of the retirees that he meets are more concerned about generating income and preserving their savings than they are about future growth. For example, Leonard says, a 67-year-old retiree recently sought advice after watching his portfolio shrink from $800,000 to $510,000. Leonard recommended using a portion of his nest egg to buy an immediate annuity to generate income for the next five years while investing the balance in a deferred annuity to lock in future growth at the rate of 7% a year, even if the value of the underlying investments declines. He could start taking withdrawals from the deferred annuity after the five-year immediate annuity was exhausted. Fees associated with deferred annuities are higher than with simple immediate-payout annuities. But they allow investors to recover some or all of their initial investment penalty-free after the surrender period, which usually lasts from two to ten years.

Retire on the house

While other retirees are worried about how to stretch their shrinking nest eggs, John and Phyllis Harper are reveling in a new source of cash: their home. The Harpers, who live outside of Denver, decided to take out a reverse mortgage to finance about $60,000 worth of needed home improvements and to boost their income by about $800 a month.

With a reverse mortgage, homeowners who are 62 or older can tap the equity in their home in the form of a lump sum, a line of credit, monthly payouts or a combination of their choosing. No repayment is due until the last homeowner moves out or dies, at which point the home can be sold to pay off the debt. And loan repayment can never exceed the home's market value (even if it declines), absolving heirs of liability for any shortfall. "We discussed it with our children, and they said, 'It's your money -- enjoy it,'" says Phyllis, 72.

Older homeowners can now borrow up to $417,000 through a reverse mortgage. Thanks to new rules that took effect January 1, they can even use a reverse mortgage to buy a new home, which could be a good option for seniors who want to move but don't have enough income to qualify for a traditional mortgage. A calculator on Golden Gateway Financial's Web site (www.goldengateway.com) allows you to estimate the payouts and costs of a reverse mortgage, which can be substantial, and compare offers from several lenders.

Let's say your current home is worth $700,000 and you want to downsize to one that costs $500,000. If you pay cash for your new home, which many seniors choose to do, you would have $200,000 left over to add to your savings. But now you can use a reverse mortgage to cover some of the initial cost of buying a home -- say, $200,000 -- and pay the $300,000 balance with proceeds from the sale of your old house. You would double your cash reserve from $200,000 to $400,000 and never have to worry about repaying the loan while you live in the house.