The 3-step retirement check-up

Walter Updegrave, Money Magazine senior editor
October 22, 2008

A market dip in the years before retirement can be scary, but bailing out of stocks isn’t the answer. Here’s how to make sure you’re still on track.

Question:

I am 61 and plan to retire in about eight months. Given the current market, do you think I should withdraw some or all of my 401(k) money and put it in a safe place that is covered by FDIC insurance? This is part of my retirement income. —Peggy Wagstaff, Marietta, Georgia

Answer:

There’s no doubt that the older you are and the closer you are to retirement, the more frightening the current economic crisis is. After all, if you’re ready to retire or have already called it a career, you simply don’t have as much time to wait for stock prices - and your 401(k) account balance - to rebound.

If you’re drawing money from your retirement portfolio for income and your investments are dropping in value, the double-whammy of withdrawals and losses leaves you with less capital to participate in the market’s recovery, increasing the chances that you may run out of money later in retirement.

But moving your 401(k) stash and other retirement savings into safe options like CDs, a stable value fund or a money-market fund isn’t the right response.

What you really need to do is give yourself a more comprehensive retirement check-up that looks not just at your 401(k) investments but also helps you figure out what other moves you may need to make to assure a secure retirement down the road.

Here are three steps you can take to make that broader assessment.

Coolly review your investment strategy

Hunkering down in the security of conservative investments may be emotionally appealing. But unless you’ve got a huge nest egg, the yields you’ll earn on such options are just too low to provide adequate income and maintain your purchasing power in the face of inflation over a retirement that could easily last 30 or more years.

So while the stock market may be the last place you want to put any of your retirement money right now, the fact is that you still need the long-term growth that equities have historically provided. The key is to get that growth without being pummeled too badly during market downturns.

One reason so many pre-retirees are hurting so badly now is that they went into this crisis with far too much of their retirement savings in stocks. In recent testimony [www.ebri.org] before Congress, Employee Benefit Research Institute research director Jack Vanderhei noted that nearly four out of 10 401(k) participants in their mid-50s to mid-60s had 80% or more of their account invested in stocks in 2006.

Hey, I’m an optimist when it comes to the long-term outlook for stocks. But unless you’re holding a big cache of cash or bonds in some other account, having 80% or more of your 401(k) in equities is just way too aggressive for someone already retired or nearing retirement.

Reasonable people can disagree about what the exact blend of stocks and bonds should be, but for anyone on the verge of retiring or already in the early stages of retirement, something in the neighborhood of 55% stocks and 45% bonds is more appropriate.

As you age, you should cut back your stock holdings even more, until you’re down to 20% to 30% in equities by the time you’re in your 80s.

Determine whether your planned retirement date still makes sense

The key question you must answer here: Given your 401(k)’s current value, can you still draw enough from your account to live comfortably over the next 30 or more years without running out of money before you run out of time?

The only real way to know is to crunch the numbers. You must figure out how much income you’ll need to live comfortably in retirement and then see if you can realistically expect to generate that amount from Social Security, any pensions you may have plus what you can safely draw from your 401(k) and other retirement accounts.

Any decent financial planner should be able to help you with this sort of analysis. You can also do it on your own by going to an online tool like the Retirement Income Calculator in the Investment Guidance and Tools section of T. Rowe Price’s site.

Originally designed for people who were already in retirement, this tool has been re-tooled, so to speak, so that you can also use it if you’re still in the pre-retirement stage.

Plot a course of action

If you’ll have enough coming in to cover your living expenses, great. You can stick to your scheduled retirement date.

But if you’re coming up short - and I suspect many people will, given the toll the market’s decline has taken on retirement accounts - then you’ll have to make some changes.

One option might be to retire on schedule but work part-time in retirement. Or you might decide to work a couple of more years. That would not only allow you to accumulate a couple extra years of saving, it would also give your portfolio a chance to recover.

And there’s another advantage to working a few more years: a bigger Social Security check. Each year you delay taking benefits beyond age 62, you get “delayed retirement credits” that can boost your monthly check by about 8% for each year you postpone up to age 70.

Your Social Security check might go up even more because the extra accumulated wages can increase your benefit. You can see how much more you might receive by working a few extra years by going to Social Security’s new Retirement Estimator .

It’s crucial that you give yourself this sort of pre-retirement check-up before you leave a job that’s providing a good paycheck and decent health benefits. Otherwise, you may find yourself having to go back into the workforce where, as an older worker, you may have a hard time duplicating the pay and benefits package of your old employer.

Finally, whenever you eventually decide to retire, be sure to check in every year or two with a planner or calculator to assure that you’re not going through your retirement savings too quickly.

Starting with a modest initial withdrawal of around 4% of your retirement portfolio’s balance and then increasing that amount for inflation each year generally gives you about a 90% chance that your savings will last at least 30 years.

But if your 401(k)’s value takes a big hit early in retirement and you don’t adjust your withdrawals, those odds can plummet.

So if you retire into a slumping market like this one, you may want to cut back your spending a bit so that your savings well doesn’t run dry late in retirement.

After all, what could be more disconcerting than to realize that you’re in good enough shape to go another 10 or 20 years in retirement but your portfolio’s only healthy enough to make it another five?