Rightsizing your retirement

As the stock market sags, retirement savers must revisit their long-term options.

With continued volatility in the stock market, 6.5 percent unemployment (a 14-year high), and October consumer confidence numbers at their lowest ever recorded, Americans are grimly facing what economists predict will be an extended recession.

Of immediate concern to Main Street investors is the tremendous drop in their portfolio values, depleted approximately 18 percent in the year preceding Sept. 30, 2008, according to the Urban Institute.

Applying an 18 percent loss to a $500,000 retirement portfolio would net a deficiency of $90,000. Assuming a $6,000 annual contribution invested at 4 percent, it would take nearly five years to regain the dollars lost.

Immediate retirement losses, as painful as they may be to individual investors, become magnified when a harsh light is cast on the broader issue of retirement security. According to the Employee Benefit Research Institute (EBRI), roughly a third of workers had less than $10,000 in total assets, not including the value of their primary residence; 1 out of 4 workers had saved $10,000 to $50,000; 12 percent had set aside $50,000 to $100,000; and 27 percent had over $100,000.

With low investment returns predicted several years into the future, it will be challenging for workers who have not already accumulated a sizeable nest egg to build sufficient wealth by the time of their expected retirement.

Few Americans have actually calculated the amount of dollars they'll require to live comfortably during retirement, particularly given extended longevity projections. One out of 3 American women and a little over 1 out of 5 men now age 60 are expected to live to 95, according to TIAA-CREF, a financial-services company in New York.

Many Americans near retirement today will be unable to increase their retirement contributions as they pay down credit-card debt or manage higher mortgage payments. But financial advisers strongly urge those who can afford it to max out their 401(k) contributions. For 2008, the maximum amount is $15,500. Those over 50 can contribute as much as $20,500.

"It is absolutely essential to take full advantage of 401(k) contributions, if you are over 50," comments Hal Burnstein, a CPA with Burnstein & Associates in Gaithersburg, Md. "It is a sound investment strategy to set aside maximum tax-free dollars if you are to regain the losses you have suffered as a result of a declining financial market."

Take a moment to review your own portfolio, examining your most recent investment statement. Utilizing the retirement savings calculator from T. Rowe Price (troweprice.com/ric), calculate the probability of your portfolio extending until age 95 given a specific withdrawal rate, an asset mix, and a 3 percent inflation rate.

Consider a 65-year-old retiree with a $500,000 in retirement assets allocated to 25 percent stocks, 50 percent bonds, and 25 percent cash/money markets. Drawing down $5,000 a month, they would have a 0 percent chance of their savings lasting until age 95. Reducing their monthly draw to $2,000, the probability of their savings extending to 95 increases to 53 percent.

In a portfolio with 75 percent bonds and 25 percent cash/money-market funds, which generates a lower return, drawing down that reduced $2,000 a month cuts the probability to almost a third that the money would last until 95, significantly less than the higher return equity-weighted portfolio.

The four lessons from this much-simplified retirement savings analysis are stark:

•Withdraw less than 4 percent of your retirement savings initially and, perhaps, less than the 3 percent average inflationary rate, extending funds for your entire retirement.

•Work longer. The Urban Institute estimates that working an additional year would increase a typical retiree's Social Security benefit by 9 percent. Delaying retirement by five years would increase total benefits by 56 percent.

•Earn higher returns on your investment portfolio, translating into greater retirement security. Those over 50 should carefully examine their investment allocation to confirm their risk tolerance. If you can rely on other funding sources early in retirement, or plan to work longer, a heavier allocation in equities would allow your stock portfolio to gradually rebound as market conditions improve.

•Save more. As the principle value of your portfolio increases, your retirement security is extended.

Target your retirement date with at least two years notice to perform careful tax and estate planning and a rigorous comprehensive review of your projected post-retirement budget. Make certain you have included sufficient dollars for escalating health costs, insurance, and extended longevity.

• Dr. Kathleen Connell is a professor at Haas Graduate Business School, University of California, Berkeley.