Building a Retirement Plan: Start Now!
by Edi Alvarez, MSc, CFP®
Recently,
I met a woman who thought she had planned her finances well, but over the last
five years had found otherwise. As an educated professional, she never imagined
growing old alone, facing financial obstacles she couldn’t easily overcome.
Combined with longevity,
women must also contend with a gender pay gap. Although the pay gap is
improving, women still earn about 83 cents for every dollar, leaving them with
less money to save and invest (4). Additionally, women are often called upon
to care for children, siblings, and even parents. On average, women report
that they delay saving for retirement two years after men begin (4). When
taking into account relative inexperience investing and an inclination toward
conservative investment choices, women are looking at a meager retirement
income.
Considering the stakes, women need to take control and have a strong focus on retirement planning. They also need to take a proactive approach to learning about finance and how decisions today will impact retirement tomorrow. Young women should be encouraged to have the discipline to save “until it hurts, then save some more” (4), to have patience, and to use every financial tool available, starting with their very first earnings.
But how is this relevant to
those in lasting relationships? A married couple age 83 and 85 met with me
last month, long after making a decision that they must now live with. When the
husband retired, they chose not to provide a pension for her, opting instead
to live on a slightly higher amount. Understanding longevity statistics for
women might have helped them make a different decision or at least triggered
the purchase of life insurance in the likely event that she outlives him.
Although much could have been done before he retired, the potential impact on
his wife is now clear.
Unfortunately, women don’t
generally plan for a financially independent retirement, one that is designed
to last beyond their partner’s life. Instead, we find that a majority of women
older than 55 depend on their husbands for retirement planning (3).
For some, they or their
partner will be among the lucky few (17% of those currently employed) who will
have a pension in addition to a 401K and Social Security (5). For the rest of
us (83 %), retirement will consist of a 401K (or other tax-deferred accounts)
and anything else we’ve managed to save, along with Social Security (5). It is
my experience that those with an employer-paid pension or an annuity feel that
they are covered for retirement because they have guaranteed income, but when
they take a closer look, many retirees find that their pensions and annuities
are not as they expected, particularly since they seldom are inflation-protected
or provide survivor benefits. On their own, most pensions are not sufficient to
support retirement needs. They can, however, be a tool that, when combined with
other retirement instruments, results in a financially sound retirement.
Why should women in science
be particularly mindful of this? Many women who have planned for retirement
have built their retirement nest egg by saving maximally over a long period of
time. Combining a strong saving ethic with good investment advice provides the
best scenario for retirement. In my experience, most scientists have little
time or money in the early years of graduate studies to save or plan
adequately. Further delays occur when women spend years under-earning to
accommodate family life and post-doctoral experiences. As a general rule,
women scientists must save more and sooner (I can’t emphasize this enough) to
benefit from the power of compounding interest and to allow time and a diversified
portfolio to work its magic.
I’d
like to address one specific tool available annually to some investors and
this year (2010) to all investors: The Roth-IRA. A Roth-IRA is an account that
contains after-tax funds and holds them until retirement, allowing the choice
of when to distribute them tax-free. A Roth-IRA account is a tool that when
properly used can provide incredible tax savings and flexibility for many
retirement goals. Of course, one should make certain that a Roth-IRA is
appropriate for one’s financial situation and personal investment strategy
(6), as well as determine one’s eligibility on a yearly basis. Most young
working investors qualify and should contribute at least some of their annual
income. This year the income limit is $105,000 (for singles) and $166,000 (for
married couples) allowing for a maximum post-tax contribution of $5,000 (or
$6,000 if over 50) annually (6). Even if one’s income exceeds contribution
limits, one can consider executing a conversion of at least a portion of tax
deferred funds to a Roth-IRA. The decision to make this conversion should be
made based on retirement projections using current tax and expected future tax
brackets as well as retirement cash flow.
How else might this account
be useful? Consider that tax-deferred accounts (such as traditional IRA,
SEP-IRA, SIMPLE-IRA, 401K, 403b) provide a tax deduction today but are fully
taxable when used. In addition, these accounts have a mandatory distribution
requirement based on age (starting at 70.5 years) and account balances that
will result in taxable income (the mandatory required minimum distribution or
RMD), whether you want to use that money or not. A Roth-IRA, on the other hand,
has no mandatory distribution age, which can add flexibility to retirement
cash flow, tax-free. It can also be inherited tax-free. If it fits into your
retirement plan, 2010 is a perfect year to do such a conversion particularly
since tax-deferred accounts may still be depressed. Converting and paying taxes
on a depressed portfolio allows for the recovery to occur tax-free.
There are situations in
which Roth-IRA conversions would be inappropriate, for example, if one doesn’t
have the funds to pay for the additional tax in 2010 and does not wish to
extend the income through 2011/12 (since tax rates in future years are still
unknown). It may also not be appropriate if projections show a disadvantage
either in taxes or in retirement cash flow. Finally, it may not be a good tool
if debt planning and emergency funds are not under control.
Women often live longer than their male partners, potentially
creating unexpected complications in their waning years. Relationships don’t
always last, and most don’t want to depend on family for retirement support.
You may have heard of “Bag Lady Syndrome” (the fear that we will someday be
left homeless and on our own). Such fears are completely baseless IF we plan
wisely, regularly, and effectively. Make use of all available tools annually
and start your retirement plan today!
============= # # # ==================
Thanks to everyone who shared their personal experiences. Your continued feedback helps to make the Money Matters column relevant.
References
1. Gleich, G. (2009
April 7) Geriatrics Inter clerkship. From: http://www.umassmed.edu/uploadedFiles/Gleich%20Large%20Group%20Demographics%20of%20Aging%20%20Geriatric%20Syndromes%202009.pdf.
2. Weeks, C. (2010 February 23). Life Expectancy gap closing between men and women. Globe and Mail. From
http://www.theglobeandmail.com/life/life-expectancy-gap-closing-between-men-and-women/article1478750/.
3. Fisher-French, M. (2010 August 24). The Financial Vulnerability of Women.
4. Wiles, R. (2010, September 19). The
5. Collins, M. (2010 June 11). Bloomberg. From:
http://www.bloomberg.com/news/print/2010-06-11/lawmakers-seek-to-extend-retirement-income-as-u-s-workers-outlive-savings.html.
6.
http://www.irs.gov/retirement/article/0,,id=137307,00.html – Publication 590
pages 56-58 in http://www.irs.gov/pub/irs-pdf/p590.pdf
© 2010 Edi Alvarez. All rights reserved.