Finally, someone has.  Pensions And Investments magazine reports that there is a new pension plan design that allows employers to drastically reduce their risk while still providing lifetime income to participants.  The key difference from a traditional DB plan is that the benefit received each year is adjusted from an original multiplier based on the previous year’s investment performance.  The plan design thus shares the investment risk between employees and employers while providing more retirement income security than a typical DC plan.

“It might be a lower benefit than the traditional defined benefit plan, but at least it’s secure,” said an official from the Pension Benefit Guarantee Corporation (PBGC), which guarantees DB plans.  The official added that the adjustable plan is more cost controlled than a traditional DB plan and not as dependent on big contributions.

What differentiates the adjustable plan from a cash balance plan, another traditional hybrid DC/DB plan, is that the cash balance plan benefit is determined by a benchmark such as 10-year Treasuries, while the adjustable plan’s benefit depends on actual investment performance of the plan.

An early adopter of such a plan is Consumers Union and its union, the Newspaper Guild of New York.  They plan to create an adjustable pension plan that will replace the standard DB plan for guild members starting June 1.  The New York Times also switched to the new adjustable plan for its members who are part of the same union.  Under the Consumers Union plan, the employer will contribute a fixed 6% of salaries plus $100,000 each year.  The New York Times will contribute about $9.5 million to its plan this year and a similar amount after that based on a formula.  However, both plans still need approval from the Internal Revenue Service, and that is not scheduled to occur before mid-2014 for The New York Times and early 2015 for Consumers Union. If the plans do not receive approval by those dates, they will revert to new defined contribution plans instead.

“It will vastly reduce risk and volatility for the company and still provide a lifetime payment and PBGC insurance,” said William O’Meara, president of The Newspaper Guild of New York.  “We’re hoping that this becomes a national model for others to adopt.  There is some upside potential and very little downside for employees” compared with participant risks in a defined contribution plan.

I am personally encouraged by the development of such a plan, which has great potential to reduce much of the investment risk that retirees have been forced to accept without consequent training and advice.  While not a panacea for retirement success, it may both provide a more secure stream of income to retirees and reduce the likelihood of pension underfunding on the part of employers and plan administrators.

“As Americans are required to take greater responsibility for their retirement saving, the issue of financial literacy becomes increasingly important,” said Alison Salka, corporate vice president and director of LIMRA Retirement Research. “Our study confirms what previous studies have shown – people need more help understanding financial concepts.”

The study found that of those that scored high on the test, implying a high level of financial literacy, men outnumbered women by 31% to 23%.  And older Americans did significantly better than younger Americans (40% to just 21%).  Participants who worked with a financial professional, had a college education, and more than $100,000 in household assets were also more likely to demonstrate a higher financial literacy.

The study also revealed that respondents were unsure of their own knowledge of investments and financial products.  One-quarter said they are “not at all knowledgeable” on financial products, yet 60% answered five to seven questions correctly.  And the few Americans who rated themselves as “very knowledgeable” (6%) actually scored poorly on the quiz.

LIMRA suggests four ways that financial institutions, schools, employers and the government can help Americans improve their financial knowledge:

• Educate Early.  According to LIMRA, those who are exposed to financial education in high school tend to have higher savings later in life.
• Educate at Work.  Worksite education programs that includes multiple sessions on life planning topics such as saving, debt, insurance, and retirement can be very helpful.
• Address Differences.  Men and women have different knowledge levels as well as different perceptions and confidence about their own knowledge.  These differences should be addressed as part of a targeted education program.
• Communicate Resources.  Make people aware of the many resources available to them, whether through a website, financial institution, organization, or advisor.  There are many ways to become educated; help people connect with the one that works best for them.

“Everyone wants to make good decisions and retire with security.” commented Salka.  “It is important that we all work together to help Americans improve their financial knowledge and make responsible decisions about systematic savings and retirement planning. This will help more people enjoy the retirement lifestyle they desire.”

If you’re interested in taking the quiz yourself, here it is: http://www.limra.com/Posts/PR/Industry_Trends_Blog/How%E2%80%99s_Your_Financial_Knowledge_.aspx

First of all, there are various ways in which you can find yourself in possession of a lot of money.  Besides winning a lottery, you can inherit cash or property, acquire control of assets through divorce, receive a lump sum or structured payout as a result of a lawsuit, or sell a business, just to name a few.  When such events occur unexpectedly, or the amounts received are unexpectedly high, you face the challenge of dealing with a level of wealth to which you may not be accustomed.

Carl Richards in the New York Times asserts that on average, 90% of lottery winners go through their winnings in five years or less.  That’s not an encouraging statistic.  Whatever the actual number is, the media is replete with stories of lottery winners who have squandered their winnings in foolish ways.  Take Willie Hurt of Lansing, Michigan, for example.  According to Bankrate.com, he won $3.1 million in 1989.  Two years later he was broke and charged with murder. His lawyer said Hurt had spent his fortune on a divorce and crack cocaine.  Then there’s Missourian Janite Lee, who won $18 million in 1993.  Lee was generous to a variety of causes, giving to politics, education and the community.  But according to published reports, eight years after winning, Lee had filed for bankruptcy with only $700 left in two bank accounts and no cash on hand.  Even worse is the case of Abraham Shakespeare.  John Campinelli in Ohio’s Plain Dealer reports that after winning a $31 million lottery jackpot in Florida in 2006, Shakespeare disappeared three years later.  In 2010 his body was found under a concrete slab.  “A woman who had befriended him — and fleeced him for $1.8 million, say police — has been charged in connection with his murder.”

Short of murder, what else can you expect as a result of sudden wealth?

One common experience is being deluged by people looking for a piece of your fortune.  You will hear from salesmen, agents, financial advisers, charities, et cetera promising great benefits to you for giving them your money.  They want to get to you fast (while you’re at your most vulnerable), since the longer you hold onto your money, the less likely you will give it up on impulse.

You will also hear from friends and family, including those you haven’t seen for some time.  Some may feel entitled to your good fortune and will expect you to share it.  You may find yourself paying for meals, drinks and other expenses whenever you get together.  Without careful planning there’s a good chance you will develop an entourage of moochers.

Then there are the psychological effects.  The MMCI Institute, which coined the term “Sudden Wealth Syndrome,” reports a number of symptoms.

• Identity confusion.   Having money is an opportunity to re-think your life, your relationships, your work, and your involvement in your community. Some people develop feelings of confusion and uncertainty as to who they really are and what is really important to them.
• Guilt.  People can react to sudden wealth by punishing themselves for having received what they subconsciously believe they do not deserve or are entitled to.  The result can be self-destructive behavior.
• Loss of control.  If one does not have clear, guiding values, paranoid thinking can occur, such as excessive concerns that other people are out to get you or to take advantage of you.

Any of these feelings can lead to an inability to make decisions on the one hand, or to act impulsively in ways that lead to wealth destruction on the other.  At the very least you may find yourself dealing with stress and depression.

What are some steps you can take to avoid ending up broke or in a mental institution?

The first step is not to act, but to take stock.  You’ve got to put something in place to control your behavior and make sure you don’t lose that money.  This is the time to create a plan for your future – your goals, your aspirations, and the costs associated with them.   If you are unable to do it yourself, get help from a financial planner.  You may consider this a retirement plan, or a ‘rest of your life’ plan.  Regardless, its purpose is to ensure you have a road map to follow to ensure you have enough capital to support your goals, both now and in the future.  Remember, it’s important that you look after yourself first.

The next step is to make sure to set aside enough of your wealth to achieve your plan above.  That does not necessarily mean invest in stocks, or real estate, or anything else.  If you have enough money to last you the rest of your life, why risk it?  Invest it instead in safe assets such as U.S. treasury bonds or bank CDs.  It will also be important to monitor your investments and your spending.  Discipline in managing your wealth will be critical to your ongoing success, and if you do not have a strong history of frugality, consider hiring a professional team consisting of a financial planner, tax accountant, and estate attorney to help you.

Now it’s time to consider others.  Do you have a brother-in-law that is looking for funding to start a business?  Or a nephew that wants to go to law school?  Or a friend with cancer and no insurance?  It’s fine to help them financially as long as it does not negatively impact your plan above.  It’s OK to keep $9.9 million out of your $10 million windfall all for yourself, if that’s what your plan says you’ll need.  After all, it’s your money, and you shouldn’t feel guilty about how you choose to use it.  If you’d rather spend more helping your friends, you should easily be able to utilize the plan to determine what you’ll need to give up for yourself.  And if you’re inclined to help others through charities, you can donate money directly to your favorite ones, or utilize donor advised funds.  If you have enough wealth, you may even be in a position to create your own foundation to improve some aspect of your community or world.  In any case, be sure to get help determining the tax consequences of your various choices, since you will be dealing with tax liabilities with which you are probably not familiar.

If you still have money left over after all these considerations, feel free to do whatever you want with it.  Go to Las Vegas.  Buy an RV.  But keep in mind that no one has infinite money to spend.  Even Bill Gates has a plan for his wealth.

But there’s a much more valuable way to look at SS benefits than simply as a break-even gamble against when you might die.  Social Security is the only lifetime-guaranteed payment that provides true longevity protection by adjusting for actual inflation every year.  Neither company pensions nor annuities do this, nor do any of the commonly considered safe investments such as CDs or money market mutual funds.  Some public pensions do offer a yearly inflation adjustment, but it’s usually capped to a very small amount, typically less than the actual rate.  What makes this kind of protection so valuable is the deleterious effect that inflation has on purchasing power.  Although it’s hard to imagine inflation being a problem right now, it’s actually averaged almost 3% per year over the last 80 years, and had climbed as high as 16% in the 1980s.  Consider this:  if you kept $100,000 in a checking account (paying no interest) over a 24 year period with an average annual inflation rate of 3%, at the end of that time you’d still have $100,000, but it would be worth only $50,000 in terms of what it could buy.  And that’s just with a 3% inflation rate.  Imagine how much worse the impact would be if, as a result of all the deficit spending in the U.S. over the last several years, inflation were to ramp up to double digits again.  With retirement lifetimes stretching well beyond 24 years, inflation has become the biggest risk to outliving one’s money.

Therefore, unless you have an urgent need for money, most financial planners would advise you to wait until reaching age 70 before collecting your social security benefits.  That doesn’t sound like a very complicated decision.  It does get more complicated, however, when you add the possibility of collecting spousal benefits if you are married, divorced, or widowed.  The concept is simple:  a spouse is entitled to collect either his/her own benefits or half the benefits of the other spouse, whichever is larger.  By knowing the SSA rules and by carefully planning when to file for benefits, which of the two benefits to choose, and when to change them, you can significantly increase the amount you collect over your combined lifetimes.

Here’s how it can work:  suppose Jack & Jill are married, are the same age, and have both just reached their full retirement age (FRA) of 66.  That’s the age at which your monthly benefit is the same as your primary insurance amount (PIA), the monthly benefit to which you are normally entitled and which is based on the highest 35 years of your earnings.  (If you file for SS benefits before your FRA, you’ll receive less than your PIA, and if you file later, you’ll receive more.  The FRA used to be age 65 for everyone, but in order to keep SS solvent, the federal government has been raising the FRA for younger workers, and it is now birth date dependent).

Continuing with our example, let Jack’s PIA be $2,200 and Jill’s $800.  Since they do not need the money right now, they decide to delay collecting their benefits for another four years.  And since Jill’s PIA is less than half that of Jack’s, she plans to take her spousal benefit (worth $1,100/month adjusted for inflation) rather than her own benefit (worth $800/month adjusted for inflation) when she signs up at age 70.  They are comfortable with their decision, knowing that they will be maximizing their SS benefits for the rest of their lives.

But will they?  Suppose instead that Jill were to file for her own benefits at age 66, and then Jack were to file for his spousal benefits at the same age (which the SSA allows him to do if he’s reached his FRA and his spouse has filed).  That’s $800/month for Jill and $400/month for Jack, adjusted for inflation, until they reach age 70.  At that point Jack switches to his own benefits, and Jill switches to her spousal benefits.  The result?  The same SS income as in the first example for the remainder of their lives beginning at age 70, but with an additional $1,200/month from age 66 until age 70.  Even without the inflation adjustment, that amounts to $57,600.  By simply knowing the rules and applying a little creative planning, Jack & Jill could have gotten the Social Security Administration to effectively pay for a new Tesla sedan for free!

The rules for collecting SS benefits are straightforward, and a married couple’s ability to maximize their SS payments depends upon both the differences in their ages as well as in their PIAs.  Divorced spouses and widows/widowers also have the opportunity to maximize their SS income through creative planning.  The Social Security website (www.ssa.gov) contains a wealth of information on retirement benefits, including several calculators to help you figure out your FRA and your PIA (http://www.ssa.gov/planners/benefitcalculators.htm).  Unfortunately it does not provide the level of guidance needed to help you maximize your own benefits as above.  If you’d like to discover the best strategy for maximizing your own particular SS benefits, you should contact your financial planner.

The concept of Active Share is both simple and practical.  It is defined as the percentage of a portfolio that is invested differently than its benchmark index.  Numerically, Active Share will range between 0% (the portfolio is identical to the benchmark) and 100% (the portfolio is entirely different from the benchmark). Logically the only way you can outperform any index is to be different from it, so it is intuitively obvious that the greater the difference, the greater the likelihood that the fund will either outperform or underperform the index.

If we consider mutual funds to be nothing more than portfolios created by their respective fund managers, then we can identify them as being either passively or actively managed.  Passive managers simply replicate some index at a very low cost.  Such funds would have an Active Share close to 0%.  Active fund managers attempt to beat some benchmark or index in two primary ways: through superior security selection or by overweighting or underweighting entire sectors, industries, or regions.   Historically there’s been a measure known as Tracking Error that purported to measure the degree to which a fund’s portfolio deviated from its benchmark.  One of the findings from Cremers’ and Petajisto’s research was that Active Share does a better job than Tracking Error in measuring benchmark deviation based on stock selection.  Some other interesting conclusions reached were:

• Portfolios with high Active Share were more likely to outperform their benchmarks even on an after-fee basis.
• Active share is a highly persistent indicator compared to other more volatile statistics.  The level of a portfolio’s Active Share this year is a very good predictor of its Active Share next year and thereafter.

In other words, if you can find a mutual fund with high active share, it not only has a greater likelihood to outperform its market index, but also to do it consistently over time.  That’s pretty powerful!

If you believe only in passive investing, you would probably reject Active Share as a useful metric.  Not so fast, however.  One of the primary supporting arguments for passive investing is the reported fact that the majority of actively managed funds underperform their benchmarks after fees.  Cremers & Petajisto argue that the reason most active funds have underperformed is because they aren’t really active in the first place.  Petajisto states that “funds with low Active Share (20%-60%) had about 30% of all assets in 2003, compared with almost zero in the 1980s.”  They refer to these fund managers as closet indexers, who, “unsurprisingly, exhibit zero skill but underperform because of their expenses.”

For active management believers, Active Share probably sounds like the Holy Grail of investing.  Unfortunately, one of the biggest challenges in utilizing it is the lack of good data.  I have not found any consumer-oriented websites that measure and report Active Share for equity mutual funds.  And to do the job thoroughly, Active Share may need to be calculated from multiple benchmarks against which each individual fund may overlap.  There’s also no guarantee that the manager’s approach will work in all economic environments.  Nonetheless, Active Share represents an interesting new metric that, when used in conjunction with other measures, may help active investors improve their returns.  At the very least, it’s certainly better than simply basing an investment decision on a mutual fund’s past performance.

Here’s a link to the most recent of the three papers: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1685942

The short answer is that each different fund class has a different fee structure designed for a particular market segment.  Each share class includes some combination of three types of expenses.  First, there are the annual expenses (called expense ratios) which every mutual fund charges.  For some funds these charges are less than 0.10% of your investment, while for others they can eat up as much as 3 – 4% of your assets each year.  Funds utilizing more active management and/or those focusing on geographies or sectors – small companies in emerging markets, for example, where there is less available information – will typically have higher expenses, reflecting the additional research required.  The return to the investor from the fund is equal to the fund’s return less the annual expenses.

In addition to the expenses above, there may be an up-front load, or sales charge, that some mutual fund classes include.  There may also be a back-end load, or redemption charge.  And, just to add to the complexity, the size of these loads can also vary from one share class to another.  While the impact of these different combinations of expenses on your returns will vary based on the length of time you hold the fund, knowing the basic differences between these share classes can help you make better choices even without knowing the future.  Let’s compare some of the more common share classes:

‘A’ shares (also known as investor shares) typically carry high front-end loads, no back-end loads, and relatively low annual expenses. For example, Pimco Total Return Bond fund ‘A’ shares (PTTAX) carry a 3.75% load and an expense ratio of 0.85%. That means that if you invest $10,000, you’ll pay $375 in sales charges right off the bat, leaving $9,625 to be invested in the fund. And each year the investment company will take out an additional 0.90%. Unless you plan to keep the investment for a very long time, the large up-front fee will significantly reduce your returns (relative to the fund’s returns). Class ‘A’ shares are typically recommended by commission-based brokers since the up-front fee represents their fee for selling you that mutual fund. If you’re buying shares on your own, you should avoid ‘A’ shares.

‘B’ shares typically have no front-end loads, higher expense ratios than ‘A’ shares, and back-end redemption fees, which sometimes decline the longer you hold the shares before selling them. ‘B’ shares aren’t usually very economical either, especially for long-term investors, because of their high expense ratios, as well as their back-end sales charges.  For example, the Pimco Total Return Bond fund ‘B’ shares (PTTBX) have a 1.60% expense ratio, nearly twice that of the ‘A’ class shares.

‘C’ shares are commonly known as “level-load” shares. They generally have no loads on either the front or back end, or if they do have a redemption fee, it’s usually much smaller and/or scales down much faster than the back-end loads of ‘B’ shares. But like ‘B’ shares, ‘C’ shares usually have high year-to-year expenses as compared to ‘A’ shares, again making them a bad bet for long-term investors. The ‘C’ shares of the Pimco bond fund above (PTTCX), for example, have the same high expense ratio as the ‘B’ shares. Some funds utilize ‘N’ shares, which are slightly cheaper versions of ‘C’ shares, but which still carry higher expense ratios than ‘A’ shares.

‘D’ shares are typically sold through mutual fund supermarkets such as Schwab or Fidelity. There are no loads (either front-end or back-end) and the expenses are usually more reasonable. The expense ratio for the Pimco Total Return fund’s ‘D’ shares (PTTDX), for example, is only 0.75%. But there might be a transaction fee you have to pay to the broker, which varies depending on the level of assets you are maintaining with them. Regardless, these are usually the best class of shares to purchase if you are a retail investor.

‘R’, ‘S’, and ‘Z’ shares round out the list, and are generally not available to retail investors. ‘R’ refers to shares that are explicitly created for retirement plans. The fees that these funds charge range widely. Some are ultra-low-cost, while others bundle in the record keeping and other administrative costs associated with running the plan. ‘S’ and ‘Z’ are usually share classes that have closed to new investors; if you want to buy into one of these funds for the first time, you’ll have to go through a broker and initially opt for the A, B, or C share class.

The best shares to own are the ‘I’ or ‘Y’ institutional shares – no loads and the lowest expenses in the mutual fund world. Our Pimco bond fund’s ‘I’ shares (PTTRX) carry an expense ratio of only 0.46%, for example. But ‘I’ shares require a minimum investment that is typically out of the range of most investors. For the Pimco fund it’s a cool $1 million! There are, however, two ways you can get access to such fund classes without being Bill Gates. One way is to utilize a financial planner who is also an investment advisor. Many advisors can get you institutional fund shares based on their aggregate investment (across all clients) in the fund or the fund family. Many advisors also have access to load-waived ‘A’ shares of many funds, which have the same low expense ratios as ‘A’ shares but eliminate the front-end loads. Load-waived ‘A’ shares are not always as good as ‘I’ shares, but certainly better than most of the others. Another way to invest in institutional shares might be through a retirement plan if you work for a large company. Unfortunately, many such plans utilize custom funds whose expenses can be opaque and, in some cases, even more expensive than retail shares.

If you think these cost differences are minor, think again!  Over time they can have a big effect on your returns.  Suppose the Pimco Total Return Fund returned an average of 8% per year over the last five years, not including these fees.   If you had purchased $10,000 worth of PTTRX, after the five years you’d have ended up with $14,383.  PTTAX, on the other hand, would have returned you only $13,594.  That’s almost a 6% difference.  And we’re talking about the very same fund!

To summarize, ‘I’ shares are the best, followed by load-waived ‘A’, ‘D’, and ‘N’ shares.  Remember: there are many strategies you can follow for picking a good mutual fund. You can consider cost, or management strategy & expertise, or historical performance, or any number of other attributes. But once you’ve made your selection, paying attention (when the investment company offers multiple classes) to which share class to purchase is a simple way to further improve your portfolio returns.

As a financial planner I understand this well.  I once had a client that had extracted all the equity out of her home in addition to having run up a fairly sizeable credit card balance in order to send her children to private school for 12 years.  And there are many parents who feel that they have to do everything short of selling their home in order to finance their children’s college education.  Many of us truly want to continue to financially support our children even after they’ve left the nest, through gifts and other demonstrations of our love and affection.  Or possibly because of guilt.  Regardless, what impact does this have on our finances?

Have you ever paid attention to the admonition during the pre-flight instructions on a commercial aircraft: ‘If you are travelling with a young child, please first put on your own oxygen mask before helping your child.’  The same is true with your finances.  Every dollar you contribute to your children – whether as minors or as adult – is a dollar less to use for your own future expenses.  It’s important to make sure that your own retirement is protected before attempting to take care of your children or other family members.  That said, what are some ways to avoid putting your retirement at risk for the sake of your children?

Probably the most important thing you can do is to create a retirement plan for yourself or your family.  The plan should identify everything you want to do for the rest of your life, the priority of each goal, and the cost of each goal.  As I’ve written in a previous article, once you have such a plan, it becomes much easier to identify whatever tradeoffs you might need to make in order to give money directly or indirectly to your kids.  You can even compare scenarios with and without that college loan you are taking out for your child or that $50,000 wedding for your daughter.  Once you can quantify how much you are sacrificing, it becomes a lot easier to resist if necessary.  You’re not being selfish if you really need the money to support yourself either right now or in your future.

Another approach is to focus on your values rather than on your money.  Helping your children in ways other than financially can be even more rewarding than focusing on material things.  They are your children, after all, and you presumably not only know them well but also what’s important to them.  Helping them get jobs, find places to live, and coaching them in learning about how to navigate our complex society are some inexpensive yet valuable ways to show that support.

Think also about the impact of your own financial future on your children.  What would happen if you were to put yourself in a position of having to move in with them or require their financial support when you become older?  If you think about it, you’re actually helping your children by ensuring you do not become a burden on them later in your life.  That’s a pretty valuable gift!

We all want to do the right things for our children.  But putting yourself at financial risk is not a good strategy.  Always keep that in mind when opening that money spigot.

Starting this year the new 3.8% Medicare surtax on net investment income kicks in as part of the Affordable Care Act.   And the tax code excludes IRAs and 401(k)s (among other types of accounts) from having to pay this tax on withdrawals.  As a result, non-deductible IRA contributions represent a new strategy for high-income taxpayers to proactively avoid this new tax.  If your income and/or participation in a company 401(k) prevents you from making Roth or deductible IRA contributions, not only will non-deductible IRA contributions allow you to permanently avoid the 3.8% tax, they also enable you to defer taxes on any investment gains until you retire, when your marginal tax rate presumably will be lower.  Of course, with a $5,500 contribution limit per year (or $6,500 if you are age 50 or over), you won’t be sheltering a lot of your income.  Nonetheless, every little bit helps.

Michael Kitces in his Nerd’s Eye View blog explains this strategy in more detail.  Here’s the link: http://www.kitces.com/blog/archives/451-Will-The-New-3.8%25-Medicare-Surtax-Reinvigorate-Non-Deductible-IRA-Contributions.html.

Suppose you inherit some money or receive a bonus at work.  What should you do with the cash?  Invest it?  Take a vacation?  Remodel the house?  A retirement plan creates a context in which you can take into account any future tradeoffs that may be required as a consequence of whatever decision you make.  Without it, the best you can do in making financial choices is to hope they don’t leave you in poverty when you’re too old to be able to do anything about it.

Here’s how it works.  First, you put down in writing all your future goals.  Goals may be basic (like your food preferences) or they may be big and expensive (like buying a plane and taking flying lessons).  You can assign costs to each goal and prioritize them.  Once you have completed such a plan, you can then use it to identify specific future tradeoffs every time you make a financial decision.  In our example above, suppose you decided that remodeling a bathroom right now was more important to you than taking ski trips after age 65.  You have just made a fully-informed choice.  How much more comfortable would that make you feel as compared to spending the money on the bathroom without knowing the future financial consequences?

A client of mine wanted to spend money on some expensive worldwide travel for herself and her family.  “I’m tired of scrimping.  I want to enjoy my money now!” she told me.  The fact that we had completed a retirement plan for her allowed her to choose what to give up during her retirement as a result.  Surprisingly it was travel in retirement that she chose to forego.  “I’ll probably be too tired then to do it anyway!” she joked during our meeting.  Having the retirement plan empowered her to make a tradeoff decision that she felt good about.  And when she takes her trip she won’t be worried about whether or not it was a good decision or whether or not she’ll still have enough for retirement afterwards.  It was a good decision because she made it with full knowledge of the ramifications.

Think about investing.  Most people invest their savings in something – the stock market, real estate, whatever – because they think they have to grow their savings or they won’t have enough money when they retire.  For most of us that’s absolutely true.  But have you ever thought about how much you actually need to grow your money?  When you invest, you are putting your savings at risk.  And when you invest in assets promising a higher return, it means you are taking on even more risk.  Maybe you don’t need to be growing your savings as much as you thought, and can consequently lower your investment risk.  The only way to find out is to complete a retirement plan first.

Of course, any plan dealing with the future is loaded with assumptions and goals that are likely to change as you move through your future.  Nonetheless, having a goal-based retirement plan puts you more in control of your financial future.  What better way to achieve financial peace of mind?

I put together a simple spreadsheet to do just that, and the results are not encouraging.  First, the assumptions:

• You graduate college at age 22, and work for 42 years.
• Your salary keeps up with inflation.
• You get a 5% bonus (or change to a 5% more lucrative job) every five years.
• The growth rate of your savings is 7% annually (both before and after retirement).
• You retire at age 65 and live until age 95.
• Your post-retirement expenses are similar to your pre-retirement expenses.
• Social Security covers 20% of your retirement expenses.

Assuming the above, it turns out that you need to save about 18% of your salary during each of your working years in order to maintain your standard of living throughout your post-retirement years.

Of course, these assumptions will not apply to everyone’s situation.  For one thing, our savings are not consistent from year to year.  We buy houses, we have children, and we discover new hobbies and interests as we journey through our lives.  We may even end up in significantly higher-paying jobs and possibly save more than 18% in our later working years.  Or alternatively become used to a higher standard of living, requiring an even larger nest egg at retirement.  Then there’s Social Security, slated to go bankrupt in the near future unless our political leaders are able to compromise on a fix.  What do you think the most likely outcome of that debate will be?  Investment growth rates are another factor that will have a significant effect on our total savings.  How realistic is 7% on average each year?  Given current world economic conditions, coupled with the potential for a long period of rising interest rates, many advisors (me included) see 7% as a fairly aggressive long-term target growth rate.  (As an aside, I ran the numbers with a 6% growth rate instead, and that resulted in a requisite 24% annual savings rate!).

The point here is that saving 6% a year for retirement is nowhere near enough.  Even if you max out your 401(k), you may not be accumulating a sufficient level of savings to last throughout a long period of retirement.  If you haven’t already done so, you should plan what you would like to do in retirement and how much it will cost, then make sure to allocate a sufficient amount of your family’s budget to cover your anticipated future needs.