When I was first discussing this book with potential publishing partners, one of them suggested writing a book about saving money. Wow, I thought; how quaint. Nobody talks about saving money. It seems so old-fashioned. Well, there is a reason for that: the Federal Reserve’s policy of easy money (superlow interest rates) over the last seven years means there are virtually no rewards for saving money, certainly few that beat inflation. And even though it’s better to build a nest egg than to spend money on things we don’t need, it sure stings to get so small a return. The Obama administration also seems to have declared war on savers, targeting favored savings vehicles and attempting to limit their utility with higher taxes. In this chapter, we’ll examine exactly how the government is making it more difficult to save and what you can do to fight back when you’re attempting to put together a nest egg for a down payment for a home, college expenses, or retirement. I’ll show you the best way to save and what to watch out for at every life stage. Remember, saving is the first step in building wealth because without savings there is no investment.
Ask any retiree. Saving money is difficult these days. Think about the placard in the neighborhood bank window. Is it advertising a 2 percent, 3 percent, or even 4 percent return on short-term money market funds? No, it’s advertising a return barely more than 1 percent! At those levels, you’re losing money to inflation. The Fed has kept rates near zero for seven years. There hasn’t been a rate hike in a decade. Borrowers are thrilled (if they can get a loan), but savers of every age are devastated. Every day I report yet another study or survey showing how Americans are woefully undersaved for retirement. But what about the people who are already retired? How are they faring? The truth is that the Federal Reserve’s policies are robbing their retirement caches. You simply can’t make enough money to stay ahead of inflation by using conventional savings tools such as certificates of deposit and Treasuries.
How did we get to the point where the government could blithely redistribute wealth? Essentially, the government’s policy during the Great Recession was to reward the profligate, those who couldn’t pay their mortgages and banks that had gambled on complex mortgage investments. Remember? Here’s the government response to the crisis in a nutshell. On September 8, 2008, our Treasury seized control of Fannie Mae and Freddie Mac as the market for mortgage investments collapsed. A week later, the government bailed out the global insurer American International Group. Private lending by banks ground to a halt during this period, and the Fed responded by cutting interest rates. President George W. Bush signed into law a $700 billion bailout plan to assist the nation’s lenders. After those first harried months of the crisis, the Fed embarked on a six-year program of stabilizing the nation’s financial sector by buying trillions of dollars’ worth of mortgage debt and Treasuries. In doing so, the Fed became a buyer of financial products and put a floor under government debt, dropping rates further. The Federal Reserve’s method of effecting all this was simply to print money. Interest rates were held at zero for seven years. Follow-on programs by Presidents Bush and Obama extended forgiveness to mortgage borrowers who had made bad deals.
The impact of this unprecedented involvement of the Federal Reserve in the financial sector is that banks and borrowers who had made bad bets were bailed out while savers were hit with a one-two punch. First their stock investments cratered, with many losing 40 to 50 percent as the stock market went into free fall. Then, as they sought stability in savings vehicles, returns on conventional certificates of deposit, money market funds, and Treasuries collapsed. There was no place to run or hide for the most responsible among us. According to the reinsurer Swiss Re, the Fed’s low- and no-rate policy cost savers $470 billion, an astonishing amount. Senior citizens suffer the most from low rates. According to a study from the Manhattan Institute, people 75 and older get 8 percent of their income from interest, dividends, and rents. Think of it this way: if you invested your retirement in one-month Treasuries under this Fed, it would take nearly 1,400 years to double your money. And that’s not the only effect low rates are having on the elderly. Low rates are causing premiums on long-term care insurance policies to skyrocket, and annuity payouts are falling to all-time lows. There are impacts for younger savers too. Putting together a down payment for a home becomes infinitely harder if the earnings on your savings are low. College savers are penalized similarly. In short, the Fed’s policy of low rates has been a boon for lenders and the markets but not for the rest of us.
Bashing the Fed is seen as the preserve of the far right. Libertarians demand an end to the Federal Reserve or ask for audits of the system. But voices of discontent can be found across the political spectrum. The Left thinks the Fed is too close to Wall Street, whereas mainstream Republicans worry that easy money has fueled a stock market boom that is unsustainable. Most mainstream financial journalists simply shrug when they hear these criticisms, but it’s time to think seriously about the enormous power the Federal Reserve has accumulated. The entire federal government is built on the idea of checks and balances that are intended to limit power. The House and Senate can make laws, but the president has to sign them. The Supreme Court can, in the end, override both the president and Congress. The idea is that no one branch of government can monopolize power. But the opposite is true of the Federal Reserve. Neither the members of the Board of Governors nor the chair is elected. Instead, the president appoints each with approval from the Senate. Board members serve 14 years (an eternity in Washington), but Fed chairs can serve for even longer. Alan Greenspan held the leadership post of the largest central bank in the free world for 19 years, having been appointed by Ronald Reagan in 1987 and serving three more presidents before his retirement in 2006.
With that power has come major criticism. Greenspan’s easy money policies, which is to say his penchant for keeping interest rates low, are all too well known and helped cause the dot-com boom and subsequent bust. It’s no surprise that a housing boom and bust followed. What is shocking to me is that there was never a serious reevaluation of the policies that ultimately played a role in the housing and financial crisis that plunged the economy into recession beginning in December 2007. Greenspan’s replacement, Ben Bernanke, kept rates near zero throughout the recession, and his successor, Janet Yellen, has done the same thing even as the economy has developed increasing momentum and strength. Many wonder whether the Fed is setting us up again for another bubble that bursts, creating yet another crisis that it will have to manage by—you guessed it—lowering rates. Ironically, it was a financial crisis that led Congress to set up the Fed in the first place. The Panic of 1907 in which the stock market quickly lost 50 percent of its value and a resulting wave of fear led to a run on banks, was the seed that led to the Fed’s founding with the passage of the Federal Reserve Act in 1913. When Lawrence White, a George Mason University economist, assessed the performance of the Fed on the hundredth anniversary of its founding, he concluded that the institution had presided over more rather than fewer periods of monetary and economic instability, which was the reason for setting up the Fed in the first place.
It’s not just the Fed that is crippling savers’ efforts. The White House has shown little interest in supporting individual savers. Some of the most prized savings vehicles for Americans, such as 529 plans for college savers and 401(k) retirement savings plans, have been attacked by the Obama administration. In his 2015 State of the Union address, the president announced his intention of eliminating the tax benefits of 529 plans, the savings accounts parents use to set aside money for their children’s college education tax-free. (Read on to find out how best to take advantage of 529s.) In its place, the president proposed a government-sponsored program to enroll college-age students in community colleges for two years. Neither suggestion received broad support. Similarly, his idea of capping retirement savings in tax-sheltered retirement accounts drew fire from retirement experts who said the limits would affect 1 in 10 savers negatively.
These pressures make it more difficult than ever to manage your savings effectively. What can you do to protect yourself from the policies of the Fed and the president and set aside money for your important life goals? Read on. I’ve organized this chapter with an eye to the life cycle of saving. I start with those newly on their own and just getting started and work my way through saving for a home, college, and finally retirement.
GETTING STARTED
First things first. To my mind, half of being successful financially boils down to avoiding fees or charges you shouldn’t be paying and squeezing a little extra something out of every penny you have. That rule goes double in a low-interest-rate environment because you can’t use high yields to cover your mistakes. It’s important to get started on the right foot. Think of saving money as something you will always be doing because once you achieve one goal, such as paying off college debt or assembling a down payment for a house, there will be a new goal. Because you’ll be saving over decades, every monthly charge matters. Start by choosing a bank that is interested in having you as a client. That means you want to open an account at an institution that doesn’t charge a monthly fee for the privilege of holding your money in a checking account. Fully 38 percent of checking accounts have no fee, and many banks will waive the fee if you agree to have your paycheck deposited in that account, maintain a preset balance, or use e-statements. Interest-bearing accounts generally aren’t worth the effort these days because of the low returns they offer and the high balances they require. Average interest-bearing account balance requirements rose in 2014 to $6,211, and the fee if you don’t meet those requirements rose as well. Yields, according to Bankrate.com, were just 0.04 percent, pretty punk, and if your balance dips below the balance requirements—well, did I mention that I don’t like fees? However, I am a fan of the old-fashioned bank because deposits up to $250,000 are guaranteed by the federal government. You might think that doesn’t matter, but we tested those limits in 2008, remember? Banks, even some of the biggest, were perilously close to shuttering. So go with a bank. Prepaid debit cards are a poor alternative because of their lack of backstops and their exorbitant fees. What’s more, you can’t buy a certificate of deposit from Justin Bieber’s prepaid debit card issuer, right? It’s a one-trick pony not worthy of your attention. I like solid midsize regional banks and credit unions because they can make local decisions to accommodate serious savers like yourself.
Once you get your account set up, you’ll want to begin saving. Think of paying yourself first when it comes to saving. In the best-case scenario, you’ll be setting aside 12 to 15 percent of your gross income for the future. The best way to do this is to set aside this money before you can get your hands on it. You’ll never miss what you never had access to. Set up a separate account with an automatic deposit from your main checking account. This will be your emergency savings fund. Keep it at the bank, where it can be accessed immediately. Ultimately you’ll want six months’ worth of living expenses set aside for the inevitable car repair or dental bill that comes along. You can contribute to that emergency fund over time and, once you hit your goal, start saving for something else.
SETTING UP YOUR 401(K)
If you’re working, set up a 401(k) at the office. If you can afford to, set aside the maximum of $18,000 each year. If you can’t manage that, put aside as much as you can—ideally up to the level that your employer matches. People age 50 and over can set aside an additional $6,000 each year. This may sound like a lot, but remember that inflation even at its current low, low levels will cut the value of your savings over long periods. These days corporate 401(k)s tend to offer shorter menus of options. You’re safest starting out with index funds and exchange-traded funds with superlow fees (this was covered in Chapter 5). The matching contribution from your employer can often be 50 cents to a dollar for every dollar you contribute, up to a set maximum of 3 to 6 percent of your salary. This is free money that you shouldn’t hesitate to get. Young investors should remember that the employer’s match typically vests over time. That means that if you leave the company before the vesting period ends, usually three to four years, you will not walk away with that money. Otherwise, the matching funds are yours to keep.
SAVING FOR A HOME
One of the first big purchases you’re likely to make is a home. Putting together a down payment can be tough. The trick is to make it automatic. Start by finding out whether you can afford to buy a home by calculating the difference between your current housing costs and your projected monthly mortgage payment for an entry-level home or co-op and save that additional amount each month. This will help you get a feel for the impact a housing payment will have on your monthly budget without taking on the risk of actually having one. By test-driving the impact of a housing payment on your monthly budget, you’ll be less likely to spend too much on a home when you do purchase one. Just remember that lenders will not want your housing payments to be more than 28 percent of your gross monthly pay, and a mortgage shouldn’t bring total debt to more than 36 percent of your gross monthly pay. Down payments for first-time buyers can be as much as 3 percent to 20 percent of the purchase price of a home. Find out the average price for an entry-level home in your area and create a monthly savings plan for reaching your goal. It’s important to set a deadline so that other expenses don’t get in the way. A word to the anxious: your goal may seem difficult to achieve, but patience is important here. Once you achieve your goal, you’ll continue to set aside savings for new goals. Getting in the habit of saving is critical because once you buy the house, you’ll have other financial goals.
SAVING FOR COLLEGE
Far and away the best vehicle for parents (and grandparents) to save for college is the 529 savings plan. The tax advantages are simply unrivaled. You set aside money for your children’s education, and you tap it tax-free. Some states even offer deductions to parents who contribute to the state 529. The ceiling on the amounts that can be set aside in these accounts (more than $300,000 in most states) is so high as to be nonexistent for most savers. No other savings account gets such favorable treatment. We can thank former President George W. Bush for that. The college savings plans were introduced in 2001 as part of his tax cuts.
The plans come in a couple of different flavors. There are savings plans that work like a 401(k) or IRA, which means you contribute monthly to an account invested in mutual funds that you choose from a list. Your account rises and falls with the market. Prepaid plans allow you to pay all or part of in-state public college fees up front. It may be converted for use at other institutions as well. Prepaid plans may be priced above today’s tuition rates. Check to be sure. Nearly every state has a 529 option, and now that you can use the proceeds of virtually any savings plan in any state, you should pick the state with the best track record when you are ready to invest. One reliable website for checking the performance of 529 plans is SavingForCollege.com. Not only can you find the top 10 performers, you can dig into other details about saving for college. At the time of this writing, Tennessee, New York, and Michigan had the best one-year plan returns. And remember, you can always invest in more than one state’s plan after you’ve maxed those benefits. As you shop, compare fees. More than half of 529 investors buy broker-sold plans, which carry sales charges and offer more investment options. If you don’t want to pay the fees for advice, pick a plan that offers a solid handful of low-cost index funds from a company such as Vanguard or Fidelity.
SAVING FOR RETIREMENT
People spend an inordinate amount of time thinking about how much to save for retirement, sometimes to the exclusion of actually setting aside money. Many of us, myself included, become obsessed with figuring out “the right number” because in our minds having a hard and fast goal makes it easier to plan. But the other reason, and I think the real reason, we are so keen on finding that number is that we believe that it represents safety. Once we hit that goal, ah! We’re safe. Retirement will be a breeze. Unfortunately, that’s not quite true. Situations change. Personal finance is really interpersonal. Your spouse or partner may find that the pension he or she was relying on isn’t available. Or maybe a relative leaves you a considerable bequest. Don’t get me wrong; I’m not saying you shouldn’t plan. But I am saying that flexibility is key. The reality is that different people will need very different amounts in retirement depending on their circumstances and expectations.
Even the experts disagree about the best way to calculate the number. Your financial adviser may ask you how much of your current income you’ll want to spend in retirement. This is tricky because you probably have little idea of your likely spending patterns once your career is in the rearview mirror. What’s more, your spending may be far different in early retirement from what it is later. Others believe that the best way to plan is to hit a savings goal that is a multiple of your ending salary, which presumably will be the highest you are ever paid. Fidelity, for example, has advocated saving eight times your ending salary, assuming you’re financing 25 years of retirement. The folks at Fidelity believe you should work up to this level of savings, putting away one times your current salary at age 35, three times your current salary by 45, and five times your current salary by 55. By following this formula, Fidelity estimates, retirees will be able to replace 85 percent of their final annual salaries. Benefits consultants at Aon Hewitt believe Fidelity is onto something but recommend a higher multiple of 11 times one’s ending salary. The mutual fund company T. Rowe Price has recommended 12 times one’s ending salary. Here’s another way to think about it from a company called BTN Research: for every $1,000 of monthly income you want in retirement, you need $269,000 in the bank at retirement. For example, an individual who wants $60,000 a year in retirement, or $5,000 a month (in addition to any pensions and Social Security), would need to have saved $1.35 million by the time he or she retired. Of course, all these rules of thumb have hidden assumptions about annual investment returns and consistency of saving that may prove inaccurate in the real world.
Here’s a simpler way to think about retirement savings. You probably know that whatever your final number is, experts recommend spending no more than 4 percent of that total every year. That’s the rate of withdrawal that is most likely to stretch your savings over a long enough period to last your lifetime. Let’s work backward from there. If you believe you’ll need $100,000 to live on each year (after Social Security), your number should be $2.5 million. That’s $100,000 divided by 0.04. This is, admittedly, a back-of-the-envelope calculation. To figure out how close you are to this target, start by multiplying your current savings by 0.04 percent. This will tell you how much you could withdraw each year from your current savings. If you have $850,000 saved, you could pull out $34,000 a year. Add in an annual value of your home equity by dividing your total home equity by the number of years you expect to live. If you are 55 and expect to live to 95 and have $300,000 in home equity, the annual value of your real estate is $7,500 a year. Add in any inheritance, again divided by the number of years you expect to live. Add in annual pension benefits, Social Security benefits, and any other remaining income you expect to get.
Fortunately, there are many calculators on the Web that can help you determine what your number should be. If you are between 55 and 64, BlackRock Investments uses current data—interest rates, inflation, and others—to calculate a potential annual income given your current savings. The Vanguard Retirement Income Calculator packs huge computing capability into its calculator, which delivers potential monthly retirement income that is based on a range of investment returns that you choose and allows you to add in Social Security and pension incomes. Sliders allow you to finesse the data. Finally, the MarketWatch Retirement Plan allows you to add in factors such as home equity and taxable accounts. I like the way it helps you visualize your income in retirement.
One word of warning: a lot can happen over 25 or 30 years of retirement. You can expect inflation over three decades of retirement to cut your spending power in half. Medical costs are escalating, and estimates of the cost of hospital and doctor bills not covered by Medicare range from $230,000 to $450,000. Carrying debt into retirement changes all the estimates of how long your savings will last. According to the New York Federal Reserve, Americans age 60 and over owe $36 billion of student debt. The most useful rule of thumb for most savers who aren’t yet at the threshold of retirement is to try to save 15 percent of your gross income for retirement over your working life. That should provide a nest egg that can provide you with 85 percent of your final year’s salary. Remember that you’re likely to live a long time. Experts predict that today’s 65-year-old has a 45 percent chance of reaching 90. Plan for living for a long time.
SAVING MONEY IN RETIREMENT
No doubt retirees are in the tightest spot when it comes to navigating a low-rate environment because their prime earning years are behind them. They can’t go out and make up for the fact that their money is earning precious little in conventional savings vehicles such as money market funds, certificates of deposit, and savings accounts. Every year their dollars lose buying power to inflation. One analysis of those trends showed that bank account depositors lost $635 billion in buying power in the four years that followed the end of the recession as inflation ate into their savings. It’s no wonder that retirees are facing major headwinds. A Kaiser Family Foundation analysis of Census Bureau poverty estimates for seniors found that 9 percent of people 65 and older live in poverty. Add in other information such as out-of-pocket medical costs and the high cost of housing, and 15 percent of seniors are living in poverty.
The answer for many seniors will be shopping around for the best returns and not locking down too much money in 5- or 10-year certificates of deposit in case interest rates zoom higher. Currently, the spread on rates paid on products such as certificates of deposit aren’t very wide. Yes, some of the most competitive will pay 5-year rates that are double the rates on 1-year CDs, but the difference is still only a single percentage point at this writing. When rates are so low and the difference between those on short-term investments and those on longer-term ones is so small, it makes sense to keep your powder dry. Sure, use CDs, but don’t lock up your money in long-terms CDs so that you can take advantage of rate hikes when they do finally occur. Websites such as Bankrate.com can help you figure out which institutions in your area are offering the best rates. One piece of advice here: the most generous terms typically are offered by online banks because they are trying to grow their business. Finally, don’t get too carried away with investing in stocks. You still need to keep some of your money in cash. In the last few years, stocks have been on a roll, but that can change quickly. It’s important to invest in stocks, which historically—over time—do deliver better returns than does parking your money in a bank account. But decide what proportion you want to keep in the market and stay on top of that asset allocation.
When it comes to the markets, you’ll want to look for investments that offer income. Dividend-paying stocks are a good place to start. Fortunately, you’ll find plenty of mutual fund offerings, both traditional and ETFs, that can fill the bill without your being forced to double down on a single company. Other options that deliver income include high-quality bonds and real estate investment trusts.
Next, let’s look at some of the products you may be tempted to turn to in a low-rate environment, such as rising-rate certificates of deposit. According to Bankrate.com, which surveyed 150 banks and credit unions, these products almost always favor the financial institution. They include the following:
LIQUID OR NO-PENALTY CDS: These products promise private investors a way to access some or all of their investment before maturity without a penalty. However, Bankrate found that three- and five-year liquid CDs with yields higher than 1.05 percent still fell short of what could be obtained on top-yielding, nationally available three- and five-year traditional CDs.
BUMP-UP CDS: These products give investors the option to increase their rate at some point during the term the product is held if interest rates rise. However, the yields offered on bump-up CDs covered in the survey fell short of those of the top-yielding national traditional CDs of the same maturity, often by a wide margin. According to Bankrate, there is simply no hope of bumping up enough to offset the lower initial yield. The highest-yielding two-year bump-up CD in the survey paid 0.85 percent, whereas the top-yielding national available traditional two-year CD paid 1.5 percent.
STEP-UP CDS: These products promise predetermined increases in the rate at specified periods during the term. In all the cases analyzed by Bankrate, the blended interest rate fell short of that of the top-yielding traditional CD.
CALLABLE CDS: These products can be called in before maturity at the issuing financial institution’s discretion. If the yield is attractive, they probably will be called so that the institutions can reissue at a lower yield. The result? A heads you win, tails you lose proposition.
In short, these new innovations on certificates of deposit are no replacement for the old-fashioned original.
MANAGING THE BIG KAHUNA: SOCIAL SECURITY
In such a low-rate environment, it’s more critical than ever that you manage your Social Security as carefully as possible. In Chapter 1, I wrote extensively about the spiraling costs of entitlement programs and criticized the increasing number of Americans who rely on the government to pay their freight through antipoverty programs such as SNAP and unemployment benefits. But Social Security, as Fox Business Network viewers continually remind me, is different. If you’ve worked throughout your life, you’ve paid into Social Security’s “lock box,” as Al Gore used to call it. That’s the line item on your paycheck called FICA, or the Federal Insurance Contributions Act. In other words, it’s your money. You salted away Social Security savings each and every year, and it’s only right that as you retire, you take what you are due. Here’s how it works: once you qualify for benefits, so may your spouse, your ex-spouse, your younger children, your disabled children, and even your parents. These folks could receive benefits on the basis of your work record. The flip side is true as well. You can receive spousal benefits, survivor benefits, and divorcee survivor benefits that are based on the work records of current or even former spouses.
What’s astonishing to me is just how much money Social Security represents for so many families—over time. Imagine a 60-year-old couple that starts working at age 25, paying $22,900 in 1979 in FICA, the maximum at that time. Over the years, they continue to work and continue to contribute the maximum amounts to Social Security. (The maximum income level at which Social Security tax was assessed was $118,500 in 2015.) If they retired at age 66 and began collecting benefits, they’d get $31,972 per year each, or $63,944 together. That stream of payments from Social Security would be worth $1.2 million over time, according to Boston University professor Laurence Kotlikoff’s excellent book Get What’s Yours (he also sells a $40 online tool at MaximizeMySocialSecurity.com). Most people don’t have that much money saved even when they include the value of their home. As Kotlikoff told me, Social Security for most people will be their biggest asset or one of their biggest assets when they retire. Therefore, deciding to take those benefits can make a huge difference in how much you collect over your lifetime. Being patient and waiting to take the benefits can have a huge consequence. Consider our couple who retired at age 66 after a lifetime of maximum FICA contributions. If they had waited until age 70 to take Social Security benefits, delaying just four years after what Social Security calls their full retirement age, they would have collected $42,203 individually per year, or $84,406 together—fully a third more. According to Kotlikoff, that represents lifetime collections of $1.6 million. A good rule of thumb is that taking retirement benefits at age 70 will result in lifetime benefits 76 percent higher than that of people who start taking benefits at the earliest age possible, 62.
But the devil here is in the details. Despite the fact that most retirees rely on Social Security for 50 percent or more of their retirement income, a lot of us are leaving money on the table. As I mentioned, waiting to take benefits is important, but it’s also necessary to understand all the benefits you may be eligible for. The list includes the following: retirement insurance benefit, spouse’s insurance benefits, divorced spouse’s insurance benefits, child-in-care spouse’s insurance benefits, widow(er) insurance benefits, child insurance benefits, disabled child insurance benefits, and surviving child insurance benefits. But here is the Social Security Administration’s big gotcha: you can’t take two benefits at the same time. Instead, the SSA will pay you the larger of the two, and if you file for your retirement benefits, it will wipe out any spousal or divorced spousal benefit if you try to take both benefits at the same time. The trick, says Kotlikoff, is to optimize benefits, ensuring that you get the greater of the benefits you are eligible for. According to the Center for Retirement Research, most Americans don’t do that, leaving as much as $10 billion on the table each year. Plus, there are traps in Social Security that can reduce your benefits forever. For example, according to Kotlikoff, if you get divorced from your spouse just one day shy of 10 years of marriage, neither you nor your spouse will collect a dime in spousal benefits.
TAPPING YOUR RETIREMENT SAVINGS
I have to think that few things are more nerve-wracking than breaking into your retirement nest egg for the first time. After all, you’ve spent your entire working life making sure to leave your retirement savings alone (at least I hope you haven’t tapped your savings). When you decide to retire and start taking money out, you’ll want to make sure you meet the federal requirements so that you don’t owe a huge tax bill. The rules are the following: You must take your required minimum withdrawal (RMD) by April 1 of the year after you turn 70½. This applies to tax-deferred accounts such as IRAs, 401(k)s, 403(b)s, and 457(b)s but not to Roth IRAs, in which taxes are paid up front. Normally, annual withdrawals must be made by December 31, but the IRS gives you a little more time with the first withdrawal. The amount of the RMD is based on a uniform life expectancy table in IRS Publication 590 and the amount in your plan. The RMD is calculated by dividing the year-end account value by the life expectancy value. If you run afoul of these rules and fail to take an RMD, you owe taxes of 50 percent on the amount that is not withdrawn! Amazingly, 59 percent of Fidelity Investment customers had not taken the full RMDs from their IRAs as of December 26, 2014, and 43 percent hadn’t taken any money out at all. Frankly, I think the entire idea of a required minimum distribution is ridiculous—and the penalties, of course, are even worse. To my mind, you saved your retirement nest egg and should be allowed to access it any way you want. Obviously, federal tax law doesn’t agree with that view and applies a heavy penalty to people who ignore the rules. It’s cold comfort that you can turn around and invest that money in a brokerage account if you like.
In subsequent years, you’ll want to minimize the tax bite. Leave your money in tax-deferred accounts such as an IRA or 401(k) as long as you can to allow that balance to continue to grow without the drag of taxes. In the early years, take some of your money from taxable accounts as well as tax-deferred accounts so that you pay the lowest possible tax rates on withdrawals. By keeping withdrawals at a level of 4 percent of your total savings you’ll give yourself the best chance of not outliving your money. If you can’t get by on a 4 percent withdrawal rate, you may want to consider downsizing or taking out a reverse mortgage to make up the difference. If you’re able to follow my advice and wait until age 70 to take Social Security but still want to retire at 65, there are a couple of ways to draw income from your savings. You can take cash out of your savings or convert some of those savings into an annuity. For every $10,000 you have in savings (in an account managed for income, not growth), you can draw $400 a year, or $33 a month, and not affect your balance, according to the Financial Security Project at Boston College. In other words, if you have $1 million in retirement savings, you can withdraw $40,000 a year to pay the bills and not worry that your money will evaporate. Another option would be to buy an annuity that pays $500 a year, or $42 a month, for every $10,000 you invest. Most retirees can come up with an estimate of their monthly costs, but determining medical costs over time is nearly impossible. Medicare will pay many of your healthcare costs in retirement, but you will be responsible for premiums, co-pays, deductibles, and other items that Medicare doesn’t cover. Private Medigap policies can make up much of the difference. However, the big exception is long-term care. Although Medicaid pays for nursing home care for people with low income and few assets, others have to fund the cost themselves. Considering that one-quarter of Americans over age 65 are expected to spend an average of one year in a nursing home at a cost of $75,000, it makes sense to consider buying a long-term-care insurance policy. The cost is about $200 a month for a policy bought at age 65 that pays up to $60,000 a year.
MY LAST SAVINGS WORD
The single biggest mistake I see American families making when it comes to saving is spending too much money on their kids. I understand the impulse. All parents want to give their children the best of everything. This becomes particularly troublesome during the college years, when parents know all too well how difficult it is to start one’s adult life with a heavy debt burden. But the sad truth is this: no one is going to pay for your retirement but you. There are loans for college but not for retirement. Prioritize your savings just as you do paying off debt. Your retirement should be a top priority.