The unemployment rate is near historic lows, but that does nothing for the retirement savings of the 1.23 million Americans who’ve been looking for a job for more than six months.
What’s worse, many of these unemployed have dipped into savings and piled up credit-card debt to cover expenses in the absence of a paycheck.
This combination of reduced savings and increased debt can derail the plans of those close to retirement or depress younger workers’ long-term returns and ability to retire.
How, then, can one make up for lost time in saving for retirement upon returning to the workforce?
The first step, according to financial planner Michael F. Maloon, is to never leave money on the table. Maloon, principal of California Financial Advisors in San Ramon, said newly hired workers—even those with credit-card debt and depleted savings—should take full advantage of matching 401(k) contributions from their new company if such a retirement-savings plan is offered.
If a company matches 50% of its employees’ contributions up to 10% of their salary, Maloon said, then workers should invest every bit of that 10%. “Go for the free money first,” he said. “That free money is worth more to you than your credit-card debt is costing you. But if there’s no employer match, then I’m looking to pay off any credit-card or high-interest debt first.”
Contributing to a 401(k) also lowers an employee’s taxable income, creating tax savings.
“Any dollar you bring home has to go through Uncle Sam first, so it makes a ton of sense to bring home as little money as possible by increasing their 401(k) contributions,” said Steve Arceo, an adviser at Talon Wealth Management in Orlando, Fla. “It’s a tax savings. That’s low-hanging fruit.”
For workers whose employers don’t offer retirement-savings plans, traditional individual retirement accounts and Roth IRAs are the most logical alternatives to ramp up savings for retirement.
Debt and savings
Brock Jolly, a financial planner at Veritas Financial in Tysons Corner, Va., said he points newly re-employed clients with debt to a third-party resource like creditcards.com to find a credit card with a 0% introductory interest rate and low- or no-cost balance transfers. He said the goal is to chip away at credit-card debt while capitalizing on employers’ matching 401(k) contributions.
“Ideally, you’d simultaneously focus on building up your assets while paying down any debt that has accumulated,” he said.
He also recommends that clients who’ve rejoined the workforce build up emergency savings in the event of another period of unemployment. A decade ago, he says he told clients they should have three to six months of wages in their savings accounts; with today’s lower interest rates, he says fixed-income mutual funds and short-term CDs, among other vehicles, are better forms of liquid savings for many clients.
Still, replenishing savings should be a lower priority than fully attaining employers’ matching 401(k) contributions and paying off debt, Maloon said. “If you pay off the credit card, it’s not ideal, but you still have the credit card for an emergency,” he said.
Where to invest
Maloon said a typical client might have about two-thirds of his 401(k) invested in mutual funds—with about 50% in domestic equities funds, principally an S&P 500 index fund, and the other 15% in international mutual funds—and the other third in stable-value funds that protect against market declines. The management fees should average 1% or less, he said.
He pointed to the recession of 2008 as a warning against becoming overly aggressive and investing almost entirely in mutual funds, especially for clients within a decade of retirement. “Ten years ago, a lot of equities indices lost 60% in less than a year, and I think we all have to remember that it can happen again, and how are you going to hold up if it happens again?” Maloon said.
Maloon said he talks with clients about building a “defensive barrier,” money to live on while waiting for stocks to recover from a recession. He said most clients want a 10- to 15-year barrier, so if a client is five years from retirement and has five years of retirement income in stable-value funds, the client is protected from a downturn.
“The idea is to establish a timeline by doing the math,” Maloon said. “If you have your defensive barrier, you can hang in there when the market takes a hit because you’re not touching the money you have allocated to stocks for another 10 years. Historically, hanging in there has been the best thing to do, so I want to set people up so that if things get panicky like they did 10 years ago, the vast majority of clients are going to hang in there.”
For younger workers, maxing out their 401(k) contributions likely is the right choice for generating future retirement income, Talon’s Arceo said.
But workers in their 40s or 50s who have equity in their homes or other assets should consider buying an investment property and renting it out to generate monthly income, he said. Real estate can’t be sold off quickly in an emergency, Arceo said, but it could provide reliable income long term. He cautioned investors, however, that real estate should represent only a portion of retirement savings and shouldn’t be seen as a substitute for steady 401(k) contributions and other savings vehicles.
“You might be able to take $20,000 and get into that first real-estate investment, and maybe it puts $500 a month into your pocket,” Arceo said. “The stock market wouldn’t be able to give you a $6,000 income off a $20,000 investment, but real estate might. If you have equity in your home, it would make a ton of sense to tap into that equity and get your first investment property because interest rates are ridiculously low.”
Jolly said he recently advised a client who had been out of work for three years to invest in variable annuities with guaranteed lifetime-income riders. He said the client did odd jobs while he was unemployed, so he hadn’t eaten too deeply into his savings, but he had missed out on three strong years for the market because he had switched to low-volatility investments.
“We told him that you’re never going to make up for the lost opportunity of being out of work, but we could replace the income that he would have in all likelihood had, but with less risk, by using those products,” Jolly said. “What you’re really trying to do is make up for the loss of potential future income and guarantee him income in his retirement years.”