Q. I am a 45-year-old single woman with no children. I make $155,000 a year, have $165,000 in savings and $125,000 in a 401(k), and owe nothing other than my mortgage (14 years left on a $240,000 loan at 3.5 percent). What's the best way to make my dream of retiring in ten years come true?
A. My advice is to modify your dream right now. You simply don't have enough set aside in retirement savings to stop working as soon as you'd like. Let's say the $125,000 that you have in your 401(k) grows at an annualized 6 percent rate and you manage to add $15,000 a year to it—that's just 10 percent of your salary—you could save about $430,000 over the next decade. I know that sounds like a lot, but those funds might have to last you for at least 30 years. And that's not because I'm suggesting you're going to be an old-age outlier; the average life expectancy for a 55-year-old woman today is 83.
In the first year of retirement, you should plan to withdraw no more than 4 percent of your total funds. (You can adjust that sum for inflation in subsequent years, but even that rate is pretty aggressive for someone planning to retire at such a young age.) Four percent of $430,000 is $17,200. But because a withdrawal from a traditional 401(k) is taxed as ordinary income, you might net $13,000. That's less than $1,100 a month, and I doubt that's enough for you to live on, even if you're frugal. So let's say we shift half your current savings into investments on the assumption that $82,500 is an adequate amount for your emergency fund; that's still not enough money for you to retire comfortably. I know you don't like hearing that you'll need to work until 67 or 70, but better to hear it now than to realize you've made a big mistake later.
If you save diligently over the next 17 years and withdrawing 4 percent a year (adjusted annually for inflation) generates enough cash for you, you may be able to retire early—at age 62. (Use the free retirement income calculator at troweprice.com/ric to analyze your options.) Even though you will be eligible for Social Security at that time, think seriously about delaying your benefits until at least 67, when your payout could be 30 percent higher. Consider working part-time—or better yet, full-time—for a few years to supplement your income until the checks arrive.
Q: I'm a 46-year-old single woman earning $34,000 a year. Sometimes I feel so anxious about having enough to retire on that it takes away from my enjoyment of life. I have $30,000 in mutual funds and IRAs (but no pension), and no debt apart from my mortgage, which will be paid off in about eight years. I've been unemployed twice due to layoffs, so I'd like to have access to my money. Assuming I can work for quite some time, roughly how much do I need to save? I live simply but don't want to end up eating cat food.
A: While I understand your concern, I have to say that you're doing an impressive job considering your relatively modest salary. Many women making twice as much as you are saddled with debt and a huge mortgage they'll be paying down well into retirement. Give yourself credit for being so good with your money.
The best news here is that you'll finish off your mortgage in your early 50s. That means you don't need to save nearly as much as someone who anticipates having to keep making mortgage payments after she stops working.
Once you pay off the house, I want you to keep making monthly payments—to yourself. Invest that same amount in a Roth IRA. If you follow a few simple rules, you'll be able to withdraw all the money in retirement without paying a penny of tax. When you reach the annual maximum contribution for the Roth, build up an emergency cash reserve. The more you put away, the better.
Because you've been so house smart, once you turn 62 you will be eligible for a reverse mortgage: If you find your own retirement savings aren't enough, a reverse mortgage allows a lender to pay you income (in a lump sum, a monthly advance, a line of credit, or a combination of all three) based on the value of your home. There's no risk of losing the property. I hope that hearing all this will help you enjoy your life more fully today.
Q: I am a 24-year-old mother of two, and I'm getting a divorce. My salary is about $50,000 a year, and I receive no child support. I plan to return to school and will probably make only about $20,000 once I cut back my work hours. I now put 6 percent of my income into my 401(k), adding a percentage point per year. Should I keep putting money into my 401(k), despite my limited income? Or should I wait until I finish school?
A: I wish I could bottle up your spirit and share it with the world. After reading your first three sentences, I was sure you would ask how you could make it as a single parent on one income that is dropping 60 percent. But instead you're focused on building security. That tenacity tells me you can do anything you set your mind to.
But you need to be realistic. On $20,000 a year, you will already be stretched thin. So please don't shortchange basic needs to keep saving for retirement while you are in school. Look at school as a big part of your financial plan: By upgrading your skills, you give a boost to your future earning power. When you're back working full-time, you can refocus on retirement investing.
But if you seriously think you can save for retirement and support your family while you're in school, here's my strategy: As long as you have a large emergency savings fund that can cover eight months of living expenses, keep investing in a 401(k) if you get a company match. Maybe it can't be 6 percent of your salary next year (that would be $1,200 of $20,000), but even at half that, you would benefit from the company match.
If you don't have an emergency savings fund, or your employer doesn't offer a matching contribution, skip the 401(k) while in school and invest in a Roth IRA . It has no tax or penalty if you dip into your contributions to cover an emergency. Only your Roth earnings would be hit with a tax, plus a 10 percent penalty for an early withdrawal. So your Roth could do double duty: When things go well, it serves as a retirement account; in times of trouble, you can pull out your Roth contributions without tax or penalty. Any money you invest in a Roth should go into low-risk investments, such as a money market fund, CDs, or short-term Treasury bills. Once you're out of school, you can move your investments to stock exchange-traded funds or mutual funds; over the long term, stocks will help you earn inflation-beating gains. Over the short term, they are too volatile to use for a quasi-emergency fund. Good luck!
Q: I'm in my early 30s and have been living with my 45-year-old boyfriend for almost a decade. We own a house and have joint and individual checking accounts, Roth IRAs, a will, and power of attorney documents—everything you recommend. My concern is that my boyfriend isn't saving enough for retirement. At my urging, he started a Roth IRA but has invested less than $5,000 in it. He is anticipating a $150,000 inheritance from a relative to see him through retirement, which I don't think will be enough. I'm worried that I'll end up supporting us both.
A: Your boyfriend is being irresponsible. Anticipating an inheritance and receiving one are two different matters. Given that so many of us are living longer, combined with an increased need for care as we get older, the reality is that the money family members intend to bequeath can end up going toward their own living costs. If your boyfriend does eventually receive the inheritance, it could come when he's well into his 60s—is he prepared to wait that long? Even then, $150,000 isn't a windfall he can rely on to cover all of his retirement costs. To live off of the money, he will want to invest it conservatively in bonds to generate income and avoid eating away at the principal. I'm going to be generous and assume he'll earn 5 percent interest annually in a municipal bond (which is exempt from federal and often state income tax). At that rate, his $150,000 would generate about $625 a month. I bet that's not enough to pay for his living costs as well as all the expenses that come with enjoying one's later years (travel, going out more often, etc.).
Your partner needs to grow up rather than hope his rich relatives and conscientious girlfriend will bail him out. I get the sense that the good financial choices you've made together are the result of your planning and initiative, not his. It's okay for one person to be the leader, but both of you have to take responsibility. If he isn't up for that, you need to rethink the relationship—and all the money you put into it.
When he's ready to get serious about saving, I want your boyfriend to turbocharge his Roth IRA. The annual maximum contribution is $5,000 if you are under 50 years old and earn less than $101,000 ($159,000 for married couples); it's $6,000 a year if you're 50 or older. Pleas factcheck maximum contributions for 2012 since they change every year And tell him I said he'd better be taking advantage of any retirement accounts offered through his job, such as a 401(k). Many employers will match your contribution if you agree to have money deducted from your paycheck and invested in the account. That match is like a bonus; don't turn it down. Because your partner is getting a late start, he should put money in a regular taxable investment account and choose low-cost index funds or exchange-traded funds. Today's tough economic climate makes it more important than ever to minimize the fees you pay on your financial accounts.
Q: I have two daughters in junior high school, and not a penny saved for their college educations. How can I play catch-up quickly?
A: Even if you're starting late, the important thing is to start—but you need to take the time to plan the right way to save. Desperation can lead to rushed, unsafe investments, and the worst thing you could do for your daughters would be to put your money at risk in an attempt, as you say, to play catch-up. The expenses of college are daunting, and for many parents—especially those with more than one child—the thinking is, 'I'll never manage.' You need to get out of that mindset, because saving for college can begin with a few very simple actions.
Since you know you'll need to begin spending your savings in four to five years, be conservative. Keep your money in high-yield money market funds (you can find the ones paying the best interest rates at www.ibcdata.com), treasury notes, certificates of deposit and series EE bonds. The steps to open these accounts are quick and simple and can be completed right at your local bank, but you need to start very soon. You should also remember that as the cost of higher education increases, both the government and colleges are beginning to offer more financial aid in the form of grants, loans and work-study programs. More than half of all undergraduate students are awarded some form of financial aid, so the odds are you won't have to shoulder the financial burden on your own. The most important thing, though, is for your daughters to see you taking responsibility for your money. True education starts with messages that are passed down.
Q: In the past four years, I've paid off all my debts and saved enough for a six-month emergency fund. Should I invest some of it in the stock market? If so, what percentage? I've never had this much cash sitting in the bank before, and I don't know if it's doing what it should.
A: Paying off debt and building a six-month backup fund is a major accomplishment—good for you! (And keep it up.)
While it's fantastic that you want to make the most of this money, you should definitely not invest it in the stock market. This is your emergency savings—so you need to know it's going to be there for you the next time one inevitably arises. You just can't count on the market in the short term: Say you had $20,000 in emergency savings on January 1, 2008, and you put that money into a stock market index fund. Then, on December 31, 2008, you were laid off. You might have told yourself you'd be okay with your severance and your savings. But when you checked your account, you'd have found that its value had fallen to $12,600, since the S&P 500 stock index fund was down 37 percent.
The key with emergency savings is safety first. And second. And third.
Q: I gave a friend my life savings to put away for me. She has since been laid off and is going through some financial trouble. She has called several people asking to borrow money. I'm afraid she has tapped into my funds. How do I ask for my money back without telling her I know about her financial problems or jeopardizing our friendship?
A: The real question is, why did you give your life savings to someone else to manage? Were you trying to avoid dealing with it? If so, you have just learned one of the most important money lessons: You, and only you, should control what happens to your money. With your financial future on the line, it makes absolutely no sense to push responsibility onto somebody else. You need to find your power and take control of your life.
Even if your friend is a professional whom you hired to help manage your money, that does not mean your finances should be out of sight, out of mind. At the very least you should be receiving a quarterly statement from a legitimate third-party bank, brokerage, or mutual fund where your money is invested. Your panic tells me that hasn't been happening.
You have put your life savings at risk simply because you don't want to hurt your friend's feelings. It is time to summon the courage to be responsible for yourself and your money. There need not be any accusation or apology in your talk with your friend. Simply say you appreciate her willingness to help, but you have turned over a new leaf and are now taking responsibility for your own finances. The fact that your friend was laid off and may be in financial trouble is irrelevant. This is about you gaining control of your future—control you never should have handed off in the first place.