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How is your nest egg?

Better check--it may not be as golden as you think.

If you're like the typical American, you save--on the average--about 3 percent to 3.5 percent of your income.

It's a start. But what happens when you retire? Unless you've made some pretty fabulous investments, or were highly compensated during your working years, that 3.5 percent might not be enough for the golden years.

Retirement planning includes a lot more than just deciding whether to spend the cold months in Florida or live there year-round. According to Mike Nicolini, vice president of employee benefits and investments at Miller Financial Services in Elkhart, other concerns include whether there is enough money saved at retirement, how inflation will affect purchasing power during retirement and whether income will be high enough to meet ongoing expenses.

Archie Spangler of American National Trust & Investment in Muncie points out that after retirement, you will be in a lower tax bracket, kids will be educated and out of the house, the mortgage generally will be paid off and you won't need as extensive a wardrobe, so you could very well keep the same standard of living with income that's just 70 percent of what it was when you were working.

Still, you'll need a larger nest egg than 3.5 percent can provide.

Social Security? Well, it'll probably still be around, Indiana experts predict. But at most, Social Security benefits will make up only a fifth to a third of your retirement income.

"I don't believe Social Security can continue in the same generous manner as it has," says Brent Americk, president of Comprehensive Financial Planning in Indianapolis. "For those people who are retired, Social Security will play a very important part in their retirement. For the younger generation that's in their 30s, most of them don't even realize that they can't start drawing Social Security at age 65. Social Security starts at older ages for the younger folks."

"When I do planning work for my clients," says Peggy Mungovan, president of R.K. Locke Retirement Planning Centers, "I tell them, 'If you're over 50, I'll count Social Security. If you're under 40, I generally won't count it.' If they're between 40 and 50, I tell people to look at it both ways."

According to Phillip R. Rodewald, director of South Bend marketing operations at Lincoln National Financial Services, Social Security is being used in a manner for which it wasn't intended. "It was never designed to be the answer for one's retirement, it was designed as an assistance to help those in need."

"In 1935 when FDR started Social Security," Mungovan says, "there were about 40 workers feeding into Social Security for every one person collecting. In 1990, that ratio went to 3 to 1. It's projected that by the year 2010 that ratio will be close to 1 1/2 to one."

But Social Security's problems aren't the only reason individuals should take the initiative and do their own planning.

"Probably 15 or 20 years ago there wasn't as great a need for that type of advice because people weren't living as long," Mungovan says. "Now, they're living to 82, 83, 85, 90, 100. It is not unusual for people to spend a fourth--sometimes a third--of their lives in retirement, with no income or wages."

"Even just 20 years ago, retirement age was 65 and people died at 75," she continues. "Now, retirements are three to four times longer than that. That's why people need to plan for retirement. They need more money to make it work the way they want it to work."

Where to start?

"One of the first things I would recommend that somebody do is interview several financial planners," Americk says. "They need to be aware of the different credentials that people have. A Certified Financial Planner is the designation of choice.

"Beyond that, it's very important that they talk to these people and understand, No. 1, 'How long has this person been directly involved working with clients in comprehensive financial planning?' They need to understand what the professional's typical client profile is. Do they work with retirees? Middle-income families? Or just highly compensated executives? They need to know what the financial adviser's areas of specialty are."

Also, Americk continues, "They need to know exactly how the financial adviser is going to make recommendations--all recommendations should be in writing. People don't remember all of what you tell them."

What about communication? Will there be newsletters, seminars or just telephone calls?

"The relationship between a client and financial adviser has to be mutually beneficial. If it's not, somebody's going to be short-changed and everybody loses," Americk says.

"People are quite capable of managing their money," says Jim Barnes, first vice president at McDonald & Co. in Indianapolis. If individuals choose to let someone else handle their finances, they should still try to educate themselves. "Two heads are better than one," Barnes adds.

"Retirement planning is not limited to someone in their early 60s who is really anticipating retirement in the next year or two," Rodewald says. "We seem to get people involved and interested in retirement planning at much earlier ages now. It's even dropping down to those in their late 20s or early 30s. Probably a majority of the people who get into retirement planning are age 35 to 60."

But it's not really age that prompts many people to visit a financial adviser or retirement planner, says Mungovan. "It's more a key life event that triggers people to say, 'I need to start thinking about retirement.' In general, it's when the youngest child graduates from college, gets married, moves out of the home," he says. "Sometimes when mortgages are paid off people start thinking about it. The most common one I get now is early-retirement offers--now they have to think about it. But most of the people we work with are within 10 years of retirement.

"If you do it 10 years prior to retirement and it doesn't look the way you want it to look, you have some flexibility; you can save more to make it work. If you're within two to three years of retirement you're kind of limited on what you can do other than work longer or spend less during retirement," Mungovan continues. "If everybody would start planning, seriously, 10 years prior to retirement, there probably isn't anybody who couldn't retire when they wanted to retire."

Actual retirement planning includes taking inventory of assets and income, projecting what your income will be, taking a client's "risk temperature" and recommending investment strategies, putting together a financial statement and doing annual checkups.

But saving should start much earlier in life. Time is money, say the financial experts, and if you start now, you won't have to make up for lost time.

Spangler at American National Trust & Investment Management Co. offers an example: One twin saved $15 each week from age 22 to 30--about $6,000. The other twin saved $15 each week from age 30 to 65--about $27,000. However, the first twin had more money at retirement because of compounded interest. The second twin had to deal with "the cost of procrastination."

The suggestion is to save 10 percent of gross income. Your lifestyle won't necessarily go down.

According to Lynn Simon, president of Evansville's Financial Security Planning, "you don't have to start big. Start small and on a regular basis."

The point is to start.

"We've a very spendthrift society," Simon adds. "We're one of the lowest--if not the lowest--percent income savers in industrialized countries." The average European saves from 10 to 12 percent of his or her income, with the Japanese saving 18 to 20 percent.

"Baby Boomers are the worst," he continues. "With education, we should be getting better. We haven't seen any hard times, we haven't seen depressions, we haven't seen problems. It's too much living for today and not doing any preparations for emergencies or for retirement."

Rodewald suggests, "Pay yourself first, then everyone else can have what's left over."

Besides savings accounts, there are two types of plans: qualified--government-regulated, pretax contributions--and non-qualified--non-regulated, after-tax contributions. On the qualified end, there are 401(k), 403(b), Keogh, pension and profit-sharing plans, and IRAs.

Participation in pension plans is falling because the costs are high, actuarial miscalculations can deplete funds and companies believe it places too much liability on them. So, corporations are shifting to 401(k) plans.

"Employers aren't putting themselves on the line quite as much as they were in the past," Simon says. "They're shifting some of their burden to their employees."

The advantages of 401(k)s? Contributions are pretax, a lot of companies match them and it's a disciplined way of saving because it's taken out of your paycheck.

For younger employees beginning a 401(k), tremendous sums of money can be accumulated. But, unlike pension plans, age really isn't taken into consideration, so older workers won't have time on their sides.

Depending on the plan, employees can contribute up to $8,994. The combined total of employee and employer contributions is 15 percent of employee compensation, up to $30,000.

Another method of saving on a qualified, tax-deferred basis is the IRA. Contributions can be made up to $2,000 per individual or $2,250 per couple. Earnings on contributions are tax-free until withdrawal. Other benefits are a flexible payout structure, and withdrawals don't have to start until age 70 1/2.

The 1986 tax reforms made some changes to IRAs, says Gene Griffin of Capital Planning Systems in Terre Haute. Limits were placed on deductibility. For those who make less than $40,000, all contributions up to $2,000 can be written off at tax time. Between $40,000 and $50,000 there's a phaseout on deductibility. For those with income exceeding $50,000, none of the individual's contributions are deductible.

More information can be found in IRS Publication 590: "Individual Retirement Arrangements."

For saving on an after-tax basis, certificates of deposits (CDs) and bonds are common, and safe.

But CDs may not be all that effective at generating income. For one thing, the current one-year rate is between 3 percent and 3.5 percent, so they won't necessarily protect against inflation.

"There might be people going backward at the current rate," Simon says.

Municipal bonds issued by the state or universities are attractive because the income generated is not taxable. However, Griffin warns, the interest rate is so low, you'd have to be in a high tax bracket to get anything out of it.

Government bonds are the best to buy--in terms of safety--but they're not tax free. And, again, they're subject to inflation. The real rate of return is the difference between the safe interest rate and the rate of inflation.

For that reason, you shouldn't put all your nest egg in one basket. Diversify.

Simon cites an example of poor planning: the person who buys 100 percent into CDs. "They're not diversified and they're not making any utilization of market conditions," he says. "They're so conservative; they've bottled themselves in."

Diversification is key, he adds, because it allows you to better tailor your portfolio to the risk you're comfortable with.

"It's been proven that if the person who invests 100 percent in fixed instruments would take even 10 to 15 percent of that and put it in stocks, that this mix of 10 to 15 percents stocks and 85 percent CDs would outperform the pure CD."

A guideline for how much you should put into fixed instruments and growth accounts is to use your age as the proper percentage to invest in fixed assets, while putting the rest into growth accounts like stocks, mutual funds and variable annuities, Nicolini says. For example, when you're 25, you can put 25 percent of your savings or investments into fixed-rate vehicles like bonds. The other 75 percent should be in growth accounts.

The older you get, the less money you should spend in risk-oriented ventures, because you don't ordinarily have the time to ride the market's ups and downs.

Mutual funds work great for the smaller investor who needs diversification. Different mutual funds have different philosophies: international stocks, growth stocks, speculative stocks and startups, government and corporate bonds.

"The things they all have in common is they're diversified among different securities," says Spangler of American National Trust & Investment Management Co.

Or you could build your portfolio with individual stocks. For the past 60 years or so, the average return on stocks has been 10 percent, a 7 percent clip above inflation. Dividends are taxable, but you don't have to pay taxes on the appreciated value until you sell it.

Deciding what to buy can be difficult, so "buy what you know," suggests Barnes at McDonald & Co. The larger companies--such as Coca-Cola, Procter & Gamble, Hershey and Wrigley (which has grown 34 percent per year over the last 10 years), Kellogg and Campbell--are safe stocks.

When should you invest? Barnes says when you have the money (regardless of whether the market is up or down) and a fixed amount of money at regular intervals.

"Just buy them and hang onto them," Barnes adds. "When you're 60, 65, you can thumb your nose at everybody--except your broker."

But stocks are not the total answer. Annuities are another investment option. Basically, an annuity is a contract between an investor and an insurance company. It is not an insurance product, but rather, an accumulation vehicle.

A fixed annuity works like a CD on a year-to-year basis. Unlike a CD, Nicolini notes, an annuity offers the advantage of triple tax-deferred compounding: earnings on the principal amount; earnings on earnings, or compounding; and earnings on money that would otherwise be lost to taxes. But, because they're fixed, they aren't a good hedge against inflation.

Variable annuities on the other hand, fluctuate with market conditions. "You may think of it as a mutual fund in a 'tax wrapper,'" Americk says. "It is an annuity, but the moneys are invested in a variable, mutual-fund-type account." The tax wrapper allows the account to accumulate tax-deferred.

Nicolini recommends variable annuities as a retirement supplement for those who have maxed out on qualified plans. These annuities offer tax-deferred compounding until withdrawal and, with 19 options, investment flexibility. The actual value can drop, he says, but there is a guaranteed death benefit in which the beneficiary receives either 100 percent of what the investor put in--minus any withdrawals--or the current value, whichever is greater.

The risk is higher, he adds, but there are other benefits such as having the right to transfer money among portfolios tax-free as objectives and market conditions change, providing better protection against inflation, having the money set aside in a separate account from the insurer's general funds, and delaying withdrawals until age 85.

Because of the variable nature, this vehicle is recommended for long-term investing, says Simon. "I look at the variable annuity as retirement savings because it's longer term."

Then there is the private pension plan, which is an investment-oriented life-insurance contract. The premium deposits go toward the actual life insurance with the rest going into an investment account for stocks, bonds or international funds. According to Nicolini, this type of plan provides participants and their families a tax-free retirement income and survivor benefits. Also, the contributions are unlimited and flexible, assets accumulate tax-free, account values are fully protected from creditors and funds can be accessed in case of emergency.

And there are other ways to enlarge your nest egg. Simon recommends prime-rate trusts, available to individuals through mutual funds for only the past four years. These notes are a low-market risk and work like preferred loans to top corporations. He explains that the notes are fully collateralized by property or inventory from 120 to 150 percent of the loan. Also, they're senior obligations, meaning they must be paid first before stockholders, bonds and payroll.

The current prime rate is 6 percent. Says Simon of their safety: "You're loaning to very creditworthy institutions, they are senior notes, they're fully collateralized--your chances for loss are reduced very substantially--and they've been growing so quickly."

Utilities make another sound investment, Simon adds. "They're very resilient: People are going to have to use them, and the performance has been very good." His company's experience is that utilities have grown an average of 12 percent every year in the past 10 to 15 years.

Americk believes real estate should play a role in everyone's financial plan; but it depends, once again, on age. "It's a great diversification," he says, "but the manner in which you do real estate is important. If they're working with real estate they need to know what they're doing or are working with someone who is experienced and understanding of risks and time constraints. "It's a long-term investment that's less suitable for people very near retirement.

Regardless of how you build your nest egg, the key is make a plan and stick to it.

"The discipline that it takes in doing a financial plan is self-driven because of how much they want to assure their retirement standard of living," Americk says. "Once someone understands how much money it's going to take by the time they retire, you don't have the question as to how much discipline because they now have the motivation. The more they understand, the more motivated they are to do the financial planning."
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Title Annotation:Retirement Planning; retirement savings
Author:Gilbert, Jo
Publication:Indiana Business Magazine
Date:Nov 1, 1993
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