Monday, August 27, 2007

Steering yourself toward retirement

If you want to be able to be seventy years young and not living like you're a nineteen year old street urchin, you better start steering yourself toward retirement now. It's kind of like mapquesting. You have a known point of origin, a destination that is unfamilar, and you need to know what roads to take to get there, distance markers along each path, and that it's almost gauranteed that the mathematical certainty of GPS coordinates matched with Rand McNally-like cartography will almost always be, at some pivotal point, outright wrong- to which end you will find out the hard way while you're mid trip and cursing the program that told you where to go.

The stats are sobering. In ten years it is expected that Social Security Trust Fund will pay out more in benefits than it will take in FICA taxes. By 2041 it is expected to run out completely. Just in time for our retirement. This is all from the horses mouth, or the 2007 Trustee report. Lots of things can happen to divert this- the GAO (Government Accountability Office) suggests that the year before Social Security goes bankrupt the shortfall could be met by cutting federal spending by 60% or by doubling taxes. Fun stuff. Or cutting Social Security and Medicare benefits. More fun stuff that won't happen on the Baby Boomers' dime, but on ours. All scenarios rely on politicians doing right by us. Therefore, moving right along...

Assume you will not see one penny of Social Security. Assume that unless you save for your own retirement your own damn self, you will be one piss poor i-pod deaf senior citizen. To get started we turn to the abacus. (Not really, but I saw you falling asleep at the wheel). Retirement calculators for people who freelance, or people who are in the restaurant & bar industry are about as helpful as an abacus. Why? Because online (and offline) retirement calculators take your pre-tax income and calculate Social Security taxes, after tax income, projected annual income raises, and other fun factors. All of which reflect the unpredictable to the straight up non-existent for a bartender whose entire income may be undeclared cash. Nevermind the fact that nobody is going to start voluntarily tipping $1.04 a drink instead of a dollar a drink, just because inflation went up 4% that year. So not only do New Yorkers live in a city that tends to have higher inflation and/or cost of living increases than the national average, freelancers and service industry worker bees have an income stagnancy not shared with many nine-to-fivers clutching contracts. I don't advocate tax avoidance, but let's just admit that everyone from your doctor (insurance co-pays are mostly paid in cash) to large corporations who DO exploit the tax code for their benefit in so many brilliantly legal ways that it makes people in the service industry seem soooo i-work-for-free, manage to jiggle the tax code, and move on from there.

If the online retirement calculators don't work, you have to come up with your own using a compounded savings calculator instead. I like's, which I used for the following example. First off, let's wrap our heads around the idea of inflation. In thirty years one million dollars will be worth just a hair over $400,000. In other words, 3% annual inflation (ie projecting how much things like the Consumer Price Index (CPI) go up, let's say your rent, the cost of dinner for two, utilities, etc.) means that in thirty years the buying power of a single dollar bill will have the same buying power as today's forty cents. And if you dream of retiring on a million of today's dollars, it will take you almost two and a half million dollars in 2035 to be worth equal buying power. Which means you better start saving now, because the statistics are outright scary if you don't.

But forget the million dollar retirement. Your destination is simply to be able to retire with as much money as you can save, by spending less than you earn and saving the difference. Let's say you're currently 35 and would like to retire at 65 but so far have nothing to show for it. So you start to sock away 10% of your income for retirement in a ROTH IRA. If you make $600 a week that's $240 a month. So if you have zero retirement savings right now, you save $240 a month for thirty years, you'll have $340,247 in the end. Don't let me lose you, if you know the difference between a fifteen percent tipper and a twenty percent tipper you can follow these numbers. Now this is the best thing about saving- compounded interest (which is tantamount to investment returns). Because while $240 bucks a month over thirty years is just $86,400 in money you put in, it's the 8% returns that have generated the other $253,827. That 8% annual (projected) return must come from the stock market. There is no other way for the small investor to generate a comparable return. I'll get into portfolio allocation later, but for now just know that in order for money to work for you, you have to be invested in stocks. And in order for you to get all of that money when you retire, you should invest in a Roth IRA, because all qualified withdrawals are tax-free. That's right, your Apple (AAPL) stock gains are all tax-free.

You should know that there are two different kinds of IRAs (Individual Retirement Accounts), the Tradional IRA and the more recent Roth IRA. The Roth IRA uses after-tax income (ie the cash sitting in your sock drawer) to invest in stocks and/or bonds, while the Tradional IRA uses pre-tax money (ie directly from your pre-tax paycheck). It's just a matter of when you pay the piper; in a Tradional IRA you pay taxes when you're retired and withdrawing the money, with the Roth IRA it's before you invest the money and have presumably paid regular income tax. The Roth IRA is better for people who expect to have a higher income tax bracket when they retire than they do now, and/or people who need the stock market's compounded return to come tax free, which is almost everyone I know. The idea is to pay the least amount of taxes, and for most it's before you invest, not after. The Roth IRA is your new best friend.

And if you are twenty five years old? Ten more years of investing $240 a month will bag you $778,033- more than twice as much money for less than half the amount of time and money invested. It's not that you can't afford to save, it's that you can't afford to wait. Because compounding interest/market returns work most of its magic in the later years. Obviously, years of an 8% average return on a few thousand dollars is nothing compared to years of an 8% return on a few HUNDRED thousand dollars.

Now that you know what to drive, next up I'll suggest where to park it. That and the shock and awe of what it takes to max out your annual Roth IRA contribution.

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