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Whether you're 25 or 55, you need to have an effective retirement plan

THE BALTIMORE SUN

The recession, weak real estate markets and widespread uncertainty about any number of economic issues makes this a very tough time in which to plan and adopt a retirement strategy.

When so many potentially negative factors are out there, I become Mr. Worst Case Scenario and advise people to plan for the worst but (it is hoped) bask in the best when the time comes. When investment experts and institutions do this, it's called being prudent; when newspaper hacks adopt such a stance, it's called being too negative.

As far as retirement's concerned, your first order of business may be to ask yourself how well you'd handle the involuntary form of retirement, either through being laid off or pushed into an early-retirement program.

This question is of special interest to those aged 55 to 65 -- the primary group affected by early-retirement programs and, usually, the folks who find it hardest to find new work after losing a job. However, anyone who loses a job may be facing great hardships.

Advice is cheap, but please sock away some funds and assets in a worst-case family-protection program. Unless you're absolutely convinced your job will be there in six months (with you in it), you ought to increase your financial cushion against tough economic times.

Yet, despite some sporadic attention to retirement issues -- catastrophic health insurance, the adequacy of Social Security funding and better individual retirement accounts -- society is not well-equipped for the Age of Retirement.

What's more, neither are most individuals. And while you may not be able to do anything about society's larger problems, you certainly can do something about your own retirement future.

As today's installment of this series will stress, a dollar put aside today is worth three, four or more dollars put away down the road, when that "sometime" you're always talk

ing about finally arrives.

Stated more simply: Delay is deadly to your financial health.

Further, increasing life expectancies will create lengthy retirements for many of us. Anyone who is 55 years old today can be expected to live another 24 years, and if you've reached 65, you have another 17 years ahead of you, on average. Yet, as retirement years lengthen into retirement decades, so does the need for money. Escalating costs for health care and housing have become threats to elderly people, as well as object lessons about the need to shore up our retirement finances.

The cumulative effect of these social and economic trends is the sobering realization that the elderly are often on their own. And as tough as that can be under any conditions, imagine what it's like without a decent retirement program to at least provide financial support.

Fortunately, retirement planning for most people does not require fancy consultants or financial planners. It does require time. Most important, it requires a commitment and a willingness to take responsibility for your financial future.

If you are 25 years old, do you need to plan for retirement? Yes, in a sense. Every dollar you put into a retirement plan today will be eight times as valuable as the dollar you put away roughly 25 years from now.

One of the most impressive rule-of-thumb formulas I've ever seen is the one that calculates how long it will take a quantity to double if it's growing each year by a certain percentage. The rule says that if you divide a quantity's annual percentage growth rate into 72, the answer is the doubling time of that quantity.

So, if money is the quantity in question, and it's drawing interest at the rate of 8 percent a year, it will double in nine years (72 divided by 8 equals 9). After 18 years, it will have quadrupled and, in 27 years, it will be eight times its original size. If you were astute enough to earn 12 percent a year on your money, it would have a doubling time of six years, meaning that in 30 years it would have increased by a factor of 32 -- in effect earning a return of 100 percent on the original investment each year.

Applied to the examples of our doubling rule, the presence of inflation makes achieving a good return on your retirement funds that much more important. More to the point, even a single percentage point difference -- say, 8 percent a year instead of 7 percent -- will mean a great deal over the time frames involved.

As impressive as the statistical bit of wizardry surrounding the doubling rule might be, it won't be impressive enough to cause most younger people to plan for their retirements. Traditionally, retirement planning has been a very adult game played by the over-50 crowd.

For those who do want to play the game seriously, there really are only two parts to a retirement plan -- what do I need and what will I have? Neither exists independently of the other, of course. Even the richest person ultimately encounters limits that force him or her to alter spending plans. Likewise, your ideal retirement scenario may require frequent readjustments as you approach retirement. That's fine.

But be sure to begin your planning process with a hard-nosed assessment of what you'll need to live on when you retire. Fidelity Investments, the Boston-based mutual fund giant, produces a useful guide called "Taking Control of Your Future: A Step-by-Step Guide to Planning for Retirement." You can obtain it by calling (800) 544-8666. (You also might get some sales pressure to open an account with Fidelity -- I did when I called to get an updated version of the guide.)

T. Rowe Price, the Baltimore-based family of mutual funds, has a more detailed retirement planning kit that is available by calling (800) 638-5660.

Kemper Financial Services produced a slide-rule "Retirement Calculator" that can be easily and quickly used to provide some rough guides to retirement financial needs. Its number is (800) 733-7100.

I'd also recommend the 1990 edition of "Retirement Places Rated" by David Savageau (Prentice Hall Press, $16.95). It provides comparative evaluations of 151 retirement areas plus chapters addressing significant retirement variables, including money matters, housing prices, climate, personal safety, and services such as health care and leisure activities.

Some experts say to assume normal retirement living expenses will be 20 percent to 40 percent less than living expenses during a person's later working years. That's because of lower expenses for clothes, transportation, lunches and other assorted work-related expenses. But the figure obviously varies by individual.

To those normal expenses, you should add any new costs associated with your desired lifestyle in retirement. Leisure activities aren't free. You probably will want to travel more, even if it's just to spend that time with family and friends as you were always promising.

Also, while it may not be pleasant, you owe it to yourself and, for couples, to your spouse, to engage in some worst-case planning. Remember, this is for planning.

Assume you will live a long time, at least 20 years, into your retirement. Don't plan on needing funds only until you're 75 years old. Take a longer view and give yourself the chance to enjoy those years.

Further, assume you will have poor health for much of this period. Now how much money will you need in retirement? What does supplemental health insurance cost? Medicines? Specialized long-term care?

It is to be hoped that you'll never need to spend these funds because your health will hold up. If so, great. Leave the money to your heirs or take a trip to Monte Carlo to celebrate your 90th birthday. But if you don't have these resources and do encounter health problems, you may lose not only your health in your later years but also any sense of material enjoyment.

Last, consider your estate preferences in determining how much money you need in retirement. Is it important to pass on assets to your children, grandchildren, other heirs or charitable organizations? If so, you will want to plan your living needs to preserve these assets and not eat into them.

There are living trusts you could consider to preserve assets for heirs and just live off the assets' earnings during your life. If you want to leave your money to a charity, similar charitable living trusts are available.

The American Association of Retired Persons maintains a large stock of self-help publications. It has no toll-free telephone number, according to an "800" information operator. Its address is 1909 K St. NW, Washington, D.C. 20049, and its main phone number is (202) 872-4700.

Now, on to part two. What will you have for retirement? Start with known quantities. Perhaps you have a trust fund or other source of long-term income.

Then factor in Social Security, company pensions and any self-directed retirement programs, such as individual retirement accounts, 401(k) plans, Keogh plans, etc.

Get in touch with your nearest Social Security office to get information on how to determine your eventual level of payments from Social Security, including a record of where you stand now with the system. That record also can reveal if there are problems with your file, such as your not being credited with some or all of the payments you've made into Social Security. (Local offices are listed in the government section of the telephone book.)

Taking a longer view, no one knows what will ultimately happen to Social Security. If you're looking at a long time frame for your payments from the system, adopt a conservative assumption that your benefits will not quite keep pace with inflation.

So, when you estimate the value of your Social Security payments, figure on a loss of 1 percent of real value each year. If you're retiring in 20 years, figure that Social Security payments will be only 80 percent of their current value. If retirement is 30 years away, the appropriate figure is 70 percent. And so on.

If Social Security benefits are preserved at current levels, you'll have extra money, which is nice. But if you planned on no erosion in the real value of those payments, you could wind up unhappy and poorer if benefits are, in effect, cut.

You can go through a similar exercise with your company pension benefits. The question you want answered is, "If I continue working here until retirement in my current job and my salary keeps pace with inflation, how much money will you pay me each month when I retire?" That's an easy question to ask but a very tough one to answer, or at least answer accurately. There are lots of variables in these programs that make it tough for even the most sympathetic benefits administrator to provide an answer.

Or maybe you will get an answer but it will be so loaded down with assumptions, maybes and what-ifs that you might not understand it and certainly won't trust it. On the other hand, if you did get a neat, simple answer, it might be because you simply weren't being told about all the assumptions built into the figure you receive.

What should you do? Spend the time to learn about your pension. Is it a defined benefit plan that provides you with a fixed benefit regardless of how your employer fares or whether pension funds are invested wisely? Or is it a defined contribution plan, in which your employer promises to put so much money into the plan and you get your fair share of it when you retire?

In the first case, you need to be concerned about whether pension-plan assets are sufficient to pay you the defined benefit you've been promised. In the second case, you should know what your fair share of the asset total will be. It also might not hurt to know how your pension-plan assets are being invested and by whom.

Looking ahead, you also need to make some fair assessments about your future career position and earnings level. Odds are, your salary will not just keep pace with inflation but will outdistance it, because of promotions into new jobs. Again, it's wise to be conservative and assume modest pay increases.

If you have an IRA, a 401(k) or some other tax-advantaged retirement benefit, please take maximum advantage of it. These are terrific boosts to accumulating capital for retirement. They can allow you to invest pretax dollars and shield the investment earnings from taxation until you retire, at which time you'll likely have a lower income and thus be taxed at a lower rate than today.

To avoid giving away too many tax goodies to middle-income families, Congress reduced the appeal of IRAs and created a confusing set of rules. Basically, if you have no retirement plan at work (most permanent employees have some type of plan), you can invest up to $2,000 a year in an IRA and deduct the entire investment from taxable income.

If you're married and the only wage earner, you can contribute up to $2,250 a year for IRAs for you and your spouse, and you

can split your contribution however you like between these two plans. If your spouse has a job, he or she can contribute up to $2,000 separate from your plan. Again, taking a full deduction on this contribution assumes that your spouse has no other retirement program at work.

IRA contributions must be invested with some sort of sponsor, such as a mutual fund, bank or other savings institution. Your employer can also set up such an account, which usually will be linked with investment options provided by outside professional investment services. You can't just take the $2,000 and bet it at the track or play the market (although you probably can set up a qualified plan through your stockbroker).

Besides the deductibility of the IRA contribution, IRA earnings are deferred from taxation until at least age 59 1/2 and as late as age 70, when you must begin drawing funds that have accumulated in your account.

If, like most people, you do have some other retirement program at work (or your spouse is covered at work), the deductibility of your IRA contribution is sharply reduced, and it is actually eliminated for anyone making more than $35,000 a year and for any married couple making more than $50,000 a year.

Even if you lose the deductibility of your IRA contributions, you can still contribute to an IRA account and shield its earnings from taxes. This arrangement would certainly be more appealing than making many forms of taxable investments. There are three significant issues here:

* Do the restrictions on IRA investments -- the need to place funds with a sponsor in some form of mutual fund, investment contract or money fund -- make it worth your while to have totally unfettered investment use of the money in question? That is, do you think that investing on your own, you can earn a return high enough to more than make up for the tax deferral on the IRA's earnings?

* There are penalties for early withdrawal of IRA funds, so you need to make sure you can live with those withdrawal rules before making non-deductible investments in an IRA. (You need to make the same decision with a fully deductible contribution as well, but the advantage of the $2,000 deduction makes this an easier restriction to accept.)

* If you have any other tax-advantaged plan, particularly a 401(k) program, make sure you've taken full advantage of it before making non-deductible contributions to your IRA.

A 401(k) is similar in effect to the IRA but has two major enhancements that make it a superior retirement vehicle. Unlike IRAs, the 401(k) only exists if your employer decides to offer it as a benefit; you cannot set one up yourself.

(Self-employed people have their own form of tax-advantaged retirement programs, including what are called Keogh plans. I'm not going to discuss them here, but there are many good guides in your library and elsewhere that explain them. Fidelity Investments offers a small booklet, "Retirement Plans for the Self-employed." Its toll-free number is [800] 544-8666.)

First, the maximum amount of pretax money that can be contributed to a 401(k) plan is more nearly four times the IRA limit. Your exact limit depends on whether you have other tax-advantaged retirement plans, so you need to check with the benefits office where you work.

Second, employers can match much of your contributions, with matches often ranging from 50 percent to 75 percent of your contribution, up to a specified percentage of your pay, with this ceiling being 6 percent to 8 percent.

This combination of features makes 401(k) plans (the name comes from the portion of the tax code containing the provisions) almost a must-use retirement program.

/# If you're unfamiliar with these

programs, learn about them and find out if they're offered at your place of work.

Also, learn more about the types of investment programs your employer has chosen for inclusion in your 401(k) or, if your employer has one, IRA program. The aggressive pursuit of 401(k) benefits should be matched by active monitoring of how your investments are performing.

It might help you to review earlier installments of this series dealing with stocks and mutual funds to get a better handle on which options to choose for your plan (or, for the truly adventurous, whether to suggest to your employer that a different option be considered).

Again, as with the pension plans, assume continued funding of these programs and conservative earnings performance. I'd assume the money was growing by the rate of inflation plus 2 percentage points.

The stock-market boom of the early '80s spoiled many of us into believing that even retirement programs, which ought to be the most conservatively managed funds we have, should post annual returns of 20 percent or so to be judged any good.

Last year's market decline made us appreciate less exalted returns, and I'd not scoff at anyone who opted this year for a nice bond fund or a guaranteed investment contract, or GIC (so long as the insurance company offering the GIC is in tip-top shape and is not investing your money in "junk" bonds or other risky holdings).

A fairer test of conservatively managed capital would be if the investment kept pace with inflation and added 3 percentage points of return. Inflation-plus-3 doesn't sound like much to celebrate over, but through the years, that's a darn good return. I'd use the lower 2 percent figure in my planning just to be conservative.

Other experts may use different figures, perhaps assuming you'll beat inflation by a wider margin if you follow their advice. Fine. That might be true. But don't count on it. Plan conservatively and bless your stars if you do end up with a nice cushion.

So, do you have a total yet? Probably not. I told you this was hard work. Fortunately, you don't have to do it every day. It's like being examined by your physician -- do it every several years until your 50s and then review more closely as conditions warrant.

In addition to these goodies, you probably own a house, or will by the time you get serious about retire

ment planning. If you feel you must tap the equity in your house to fund your retirement, go ahead. But be careful not to "burn up" your money too soon.

Don't get a reverse mortgage that pays you for 10 years when the odds favor your living for 20. Also, guard against placing yourself in a corner where you have to sell your house even if the market is poor at the time.

By this point, you've probably had to revise your financial needs once or twice to more closely reflect how much money you're likely to have for retirement. That's what planning is about.

Last, there's whatever nest egg you have of personal savings and investments. For most people, these funds are the difference between frugality and fruition in their later lives. The earlier parts of this series dealt with some of the investment options for these funds: individual stocks and bonds, mutual funds, insurance products and real estate.

The process I've just laid out is a lot easier to describe than to do. Give yourself at least two weekends to do the bulk of it. Spend the first weekend filling in as much of the information as you can and making a list of the questions you'll need help to answer. During the next week, get the preliminary answers and then fill them in over the following weekend.

Assuming you have shown the common sense to care about your financial future and have gotten this far in retirement planning, you might be advised, depending on your age, to seek professional legal and tax assistance. (Regardless of age, you should already have a will.)

Is there an easy way to do this? I've always followed employment-related or personal leads, talking with people at work or friends to track down potential sources of help, or at least referrals.

You can check out reputations with professional organizations, but you'll probably depend most on word-of-mouth assessments.

When you do talk with a professional, don't be embarrassed. Ask him or her about fees, and make sure your needs are suited to the service being provided. To do this, you'll need to be forthcoming about your own financial situation.

It would help, of course, if you really had a good understanding of your financial situation.

Next week, the final part of this series will help you reach such an understanding by presenting financial-planning information about household budgeting, taxes and investments.

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