How To Beat 4 Threats to Your Retirement

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The path to retirement is never perfectly smooth, and in these uncertain times you should probably expect to hit some roadblocks on the way. What can go wrong? Plenty. Your employer can freeze its pension plan, leaving you with a shrunken benefit, or cut its retiree health benefits, dashing your dream of retiring early. The stock market can tank, decimating your savings. After you retire, inflation can eat away at the buying power of your money.

Any of these can derail the best-laid retirement plans, but there are steps you can take to stay on track. Here's what to do.

Your employer freezes your defined-benefit pension plan

Many workers (20% in fact) in private industry participate in pension plans, and 19% of them are in frozen plans, according to the Bureau of Labor Statistics. When a company freezes its pension plan, some or all of the workers stop earning some or all of their benefits from that point on. But an employer can't take away benefits already earned.

Employers usually calculate pension benefits using a formula that takes into account your years of service and highest pay. When a company freezes its plan, the benefits that you've earned to that point might be what you'll get when you retire. Or they might continue to grow but under a less generous formula.

What you can do

Fortunately, most companies that freeze pension benefits offer a new or enhanced 401(k) plan that employees can use to supplement their diminished pensions. Sometimes employers kick in a more generous match. You might be able to make up the rest of the benefits you lose by putting the maximum amount into your 401(k). For example, consider the predicament of the 55-year-old earning $150,000 a year that's illustrated in the table below. He expects to retire in 10 years with a lump-sum pension of more than $535,000. But then his employer freezes the pension plan, reducing his expected benefit by more than 60%. At the same time, the employer boosts its maximum match on 401(k) contributions from 4% to 7%.

To make up for more than $300,000 in lost benefits, he would have to contribute the maximum amount to his 401(k) for the next 10 years. That adds up to $22,000 a year: $16,500 plus a $5,500 catch-up contribution for people 50 and older. In addition, he should open an Individual Retirement Account and sock away as much as he can. If he contributes $6,000 a year to an IRA through age 60, he can fully compensate for the loss of pension benefits.

How realistic is it for a 55-year-old to save nearly 19% of his income? It depends on his other financial obligations, says Christine Fahlund, a senior financial planner at T. Rowe Price. "Saving that much of your salary is difficult," she says. "But at that age, many people are no longer saving for college and may have paid off their mortgage."

If you can't afford to save that much, you might consider postponing retirement for four or five years to build up your savings.

Your employer trims retiree health benefits

Health insurance is often essential to retirees who aren't old enough for Medicare and can't afford or don't qualify for an individual policy. More than 40% of 55- to 64-year-olds have diagnosed pre-existing medical conditions that could cause insurers to turn them down for individual insurance. Such benefits are also important to retirees on Medicare because they often pay costs that the program doesn't cover.

Only the largest employers tend to offer retiree health coverage, and many of them have dropped or restricted access to it over the last 20 years. Between 1993 and 2001, the percentage of employers with 500 or more workers offering health benefits to early retirees fell from 46 to 29%, according to the Employee Benefit Research Institute (EBRI). Since 2001, the portion of companies offering such benefits has remained stable, but the cost to workers for coverage has increased.

More changes are coming due to recent national health-care reform. Under the new law, insurers will not be able to turn down adults with pre-existing conditions starting in 2014. Early retirees and others will be able to buy coverage through health insurance exchanges, which won't be permitted to deny coverage or charge more for it because of pre-existing conditions.

Until 2014, interim rules that took effect in July say that people who haven't been able to qualify for insurance and have gone without it for six months or longer are supposed to be able to buy coverage at rates comparable to those paid by healthy people, no matter where they live. Previously, people who couldn't buy insurance might have been able to get coverage from state high-risk pools, but only in 34 states. For details about options in your state, go to www.healthcare.gov, and click on "New Pre-Existing Condition Insurance Plan."

In addition, the federal government will give $5 billion to employer health plans that cover early retirees ages 55 to 64. That program also began in July and will continue until 2014 or whenever the money runs out. Employers must use the cash to maintain coverage for early retirees until the national exchanges are in effect.

After 2014, many employers will probably decide that their early retirees can get health insurance through the national exchanges. "It's hard to imagine that we're not going to have companies eliminating retiree health benefits, but we can't say for sure that all will do so," concludes Paul Fronstin, director of EBRI's Health Research and Education Program.

What to do if you're an early retiree

If your employer doesn't offer retiree health benefits and you call it quits before 2014, health-care reform won't help you. That's because it doesn't make sense for you to go without health insurance for six months so you can get coverage from the new national high-risk pool. Instead, you should continue your coverage under the COBRA law and use it as a bridge between your employer's group insurance and an individual policy or Medicare.

Under COBRA, firms that employ 20 workers or more must let employees continue the same group coverage for themselves and their families for up to 18 months. You'll have to pay the full premium, plus a 2% administrative fee. If you have group or COBRA coverage for at least 18 months (with no break in coverage for 63 days or more), you'll qualify for rights under HIPAA (the Health Insurance Portability and Accountability Act). That law gives you the right to buy individual health insurance that doesn't exclude or limit coverage for pre-existing conditions.

What to do if you're on Medicare

If your former employer eliminates its retiree health insurance, you can buy a Medigap policy to fill some of the holes in Medicare. If you're 65 or older, you have the right under federal law to buy a Medigap policy within 63 days of when you lose or end certain kinds of health coverage. This applies if you had group health insurance (either through your current or a previous employer) that supplemented Medicare and lost it through no fault of your own. An insurer can't deny you a policy or charge you more because of pre-existing conditions.

If you try to buy a Medigap policy when you don't specifically have the right to do so, you might still be able to get insurance but you could pay more for it depending upon your health. Keep copies of any letters, notices, and claims denials as proof that you lost your retiree health coverage.

The last stock market crash, and the ones to come

If you're still smarting from the market decline of 2008 and early 2009, you might be a threat to your own retirement. Because of the subsequent turnaround, your portfolio should have recovered or at least be on the mend. Indeed, when the Vanguard Group examined the experiences of its 401(k) investors between September 2007 and September 2009, it found that 60% of them had more money in their accounts than they did before the collapse. If your portfolio hasn't rebounded, perhaps you took too much risk when stocks were surging. Vanguard also found that from the start of the bear market in 2007 through the end of 2009, an investor with 100 percent of his portfolio in stocks lost nearly 25% of it while one with half in stocks and half in bonds lost 5%.

What you can do

First figure out where you stand. You can get a snapshot of your situation by using an online calculator, such as T. Rowe Price's Retirement Income Calculator. Next, design a savings and investing plan. Decide how much volatility you can tolerate and diversify your savings among stocks, bonds, and cash as well as among different securities in a single category, such as large- and small-company stocks.

Inflation erodes the buying power of your money

Though inflation has been subdued recently, even low rates can eat away at your nest egg over time. The buying power of $100 will be cut in half in 23 years if inflation averages just 3% annually, as it has over the past 80 years.

What you can do

The standard advice is to invest some of your retirement savings in stocks, because they've outperformed inflation in the long run. But you also need to add other inflation-sensitive investments to your postretirement portfolio. "The inflation issue doesn't go away," says Kathleen Muldoon, a certified financial planner and senior vice president at Carter Financial Management in Dallas. "It's more troublesome in retirement than when you're saving for retirement."

To hedge against inflation, Muldoon recommends that retirees continue to hold some stocks as well as invest 5 to 10% of their assets in inflation-sensitive instruments like natural resources, TIPS (Treasury Inflation-Protected Securities), and I-Bonds. If you need your portfolio to generate income, you should hold a larger position in inflation-sensitive investments. But if you get most of your retirement income from a pension and Social Security, you can devote a smaller portion of your portfolio to such securities and a larger one to growth-oriented investments.

You can invest in natural resources like agricultural products, energy, metals, timber, and water through mutual funds or exchange-traded funds. You can buy TIPS, which have maturities of 5, 10, and 30 years, from the U.S. Treasury, a bank, broker, or dealer, or through a mutual fund. I-Bonds are also sold by the Treasury, as well as at banks and credit unions.

If the consumer price index goes up, TIPS grow in value and provide more income. Their interest rate is fixed, but their principal amount gradually rises with inflation so that interest payments also go up. TIPS pay interest semiannually and return the principal amount at maturity. If a bond's adjusted principal amount is greater than its face value, you'll get the greater amount. Unless you paid more for a TIP than its initial face value, you'll never get less than its initial face value at maturity.

I-Bonds offer a fixed rate of return set at the time of their purchase, plus a variable semiannual inflation rate. They earn interest for up to 30 years, but you can redeem them after 12 months if you pay a penalty equal to three month's interest. There's no penalty if you hold the bond for at least five years. Interest on both I-Bonds and TIPS is exempt from state and local income taxes.

Finally, if you can, consider waiting to start collecting Social Security. Since it's indexed to inflation, you'll build up your monthly benefit if you postpone collecting checks. You'll reach your maximum benefit when you turn 70.

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