The Simplest And Safest Way To Prepare For Retirement

retirement, boomers, parents

Photo: Flickr / Mariia Kravtsova I EamArt

As the clock ticks and retirement looms, millions of Americans are worried.Thanks to a combination of overspending, undersaving and damage caused by the recent financial crisis, too few have saved too little for their golden years.

The crisis has also caused retirement planning to be less of a priority for most citizens who are trying to make ends meet.

Alfonso Canella says the resulting retirement crisis should be obvious to everyone. The senior lecturer at the Brandeis International Business School in Waltham, Mass., says most workers will build their retirement on the principal of their savings, not on investment returns.

Retirement planning should not be pushed to the bottom of your to-do list. His message is that people must start saving immediately and must squirrel away more than they think they will need.

As he says, “It’s that simple.”

The recent financial crisis has had a major impact on all aspects of the retirement systemdefined contribution plans, such as 401(k) plans, as well as defined benefit plans, or pensions. What is most problematic from your point of view?

The largest problem is the woeful undersaving in the private and public sectors. If you have a defined contribution plan, or DC, which is the plan where you put away pretax dollars into, say, a 401(k) plan. These plans, which are most prevalent in the private sector, allow a worker to contribute up to $22,500 per year pretax. (Editor’s note: The limits are $17,000 for workers up to age 50 and $22,500 for workers 50 and older.)

Despite this significant tax advantage, most people don’t maximise their contributions or, for that matter, even contribute. According to Fidelity Investments, its average 401(k) plan balance as of June 2012 was $72,800. If you use a rule of thumb that you must start with about $100,000 to get $5,000 per year in sustainable income during retirement, these savings are not enough. While many have additional pension income coming to them, be it from Social Security, individual retirement accounts, or some other plan, the numbers underscore what we all suspect: Americans are not saving as much as they should, especially for retirement.

The situation is somewhat similar for public-sector workers. These workers usually have a defined benefit plan, or DB, which pays benefits based on salary and length of service. In many cases — too many, actually — these workers face some underfunded pension plans. According to Boston College’s Public Plans Database, the average funded ratio across all public plans in the U.S. in 2010 was about 77 per cent. This ratio, which summarizes how much has been put away as a per cent of projected payouts, summarizes the shortfall.

How can individual investors get ahead? Should they change their asset allocation strategy? How should they allocate their assets among stocks and bonds?

As I said previously, it is clear that workers must start saving as much as possible, especially taking advantage of tax-driven plans such as 401(k)s, IRAs and Roth IRAs. Let’s face it: In these volatile markets, you will retire mostly on the principal of your savings and not because you made a killing in your investments.

These investments should be diversified across asset categories — equities, bonds, foreign investments and real estate (this being mostly one’s home). Within these asset categories, there are different risk levels. Some equities, usually in new industries or in young companies, have more volatile returns than equities in more traditional industries or well-established companies.

Over time, these investments should be changed to lower risk as the investor approaches retirement and into retirement itself. To help out on this, most asset-management firms have target-date funds that are now popular. Mind you, they are not risk-free, but they make it easier to decide how to invest one’s savings over time.

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This story was originally published by Bankrate.

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