January 4, 2013
The year begins with a walk to the edge of the "fiscal cliff" and a nauseating look below.
Have you dared look over the edge of your own cliff, or has the fear of falling kept you from contemplating the possibility of another recession, job losses, tax increases and likely cuts in your Social Security and Medicare at some distant date?
No need to fear. Rather, walk to the edge, look down and then picture your own safety net ready to stop the fall. Install one now to save yourself from the ongoing risks you and your family undoubtedly will keep facing during the next few years.
The recent federal debate about tax increases and government spending cuts has just begun. Regardless of what happens in the near term, the nation will be trying to whittle away at its gigantic debt for years. That means your taxes are likely to rise at some point, and when you arrive at retirement you will need more of your own savings to survive because the government will pull back.
Here's how to erect your safety net now, before tax increases kick in months or years down the road:
Keep an emergency stash. Does your employer depend on the government as a customer, or will your employer face pressure to attract customers if taxes increase and people cut back on spending? That could lead to new layoffs, so have at least six months of savings in case you lose your job. According to the Urban Institute, in the last recession 1 in 4 people age 25 to 34 lost jobs but most found new ones within six months. One in 6 older than 50 lost jobs, and most were still looking for work more than six months later. Those who found jobs took a 23 percent pay cut on average.
Rummaging for cash. Americans have been living more frugally the past few years, but even the most frugal can find savings if they go through credit card bills and checking accounts and list items they've been buying that they don't truly need or want. Many waste money on duplicative Internet and phone services, have more cable access than they truly need or may have life insurance that can be whittled back after children leave the home. With home values rising somewhat, it may be possible to refinance your home and get monthly payments down. On a $200,000 home that used to have a 4 percent interest rate, the homeowner might end up with about $100 more a month for living expenses or to save if they refinance now. Try Zillow's mortgage/refinance calculator at bit.ly/RjmHcy. And, of course, cash reappears after you pay off debt. Always pay more than the minimum on your cards.
Cozy up to a budget. Many people consider budgeting a pain, but those who live within a 50-30-20 budget eventually have peace of mind because they no longer feel out of control when bills arrive. For necessities, spend only 50 percent of the pay you have left after paying taxes. Necessities are mortgage/rent, insurance, food, utilities and so on. Thirty percent goes to wants, like vacations and gifts, and 20 percent goes into savings. In other words, savings are not what's left over. If you aren't saving now, start by making cuts in necessities and wants. Maybe you take a different vacation, carpool to work, turn off lights, turn down the heat.
Saving for retirement.Saving for retirement has always been essential, but it is likely to become even more crucial as government deals with the nation's debt by making some cuts in Social Security and Medicare. Young workers who don't want to be stuck in a La-Z-Boy without cable at 70 are going to have to take saving more seriously than previous generations. According to the Employee Benefit Research Institute, 44 percent of baby boomers and Generation X households are at risk of being short on retirement money if they retire at 65.
What to do? Start saving on your very first job, ideally 10 percent of pay. But if you can't, start smaller and every three months consider increasing the amount by a percent. Devote half of every raise to a 401(k) or IRA. Remember, a person saving just $25 a week in a Standard & Poor's 500 index fund on their first job could end up with close to $1 million. But a person waiting until their 40s would have to invest almost $300 a week to get to the same point. See how you are doing with the ballpark estimate at choosetosave.org.
Where to save. Do your retirement savings at work if you have a 401(k) 403(b) or other workplace plan, especially if your employer will give you free matching money if you do. Outside of 401(k)s, Roth individual retirement accounts are more appealing in an era of rising taxes. Anything you save in the Roth is supposed to be yours to keep — free of taxes for life as long as you don't touch it until you are 591/2 years old.
Invest well. Saving for retirement in a bank savings account earning less than 1 percent will never put food on your table in retirement. If you are 30, and have $30,000 in a savings account, you will be lucky to have $45,000 by retirement. The same amount in a so-called balanced mutual fund in a 401(k) or Roth IRA could grow to about $300,000.
Historically, such an approach — investing about 60 percent in stocks and 40 percent in bonds — has provided about an 8 percent gain on average annually, but not every year. Between 2008 and 2009, balanced funds lost 29 percent; $10,000 turned into about $7,700, and then climbed to about $13,000 three years later. In a 401(k), consider a target date fund with your retirement date in it. Some balanced funds for a Roth could be Vanguard Wellington, Vanguard Wellesley or Mairs & Powers Balanced fund.
Don't retire too early. Before retiring, make sure your savings will stretch far enough. Calculators like this one will help: bit.ly/VjugBZ.
You can only use 4 percent of your savings in the first year of retirement, and up it slightly for inflation each year, if you want to make sure the money lasts 25 years or more. Increase Social Security 8 percent a year for each year you wait to retire after 62.