Retirement Income: 5 Steps to Fill the Gaps

It's never too late to start planning your retirement security. Here's a one-size-fits-all strategy that will help secure an adequate stream of income in your later years.

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With the giant baby boom generation entering traditional retirement years largely under-saved, the issue of how to secure adequate income for these years has been thrust under a national, if not global, spotlight. Thankfully, this is a fixable problem.

In a new study, Fidelity Investments and Strategic Advisers found that 38% of current retirees do not have enough income to cover their fixed monthly costs and that working Americans can expect a 28% income drop after they retire. That’s a sizable hole to plug and it’s made deeper by some false illusions.

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For example, 66% of workers plan to work past their normal retirement age in order to make ends meet. But in reality only 12% will. Joblessness is part of the issue. But so is poor health. In fact, while just 34% of today’s workers expect to be in fair or poor health at retirement age, the reality is that 43% will experience significant decline, according to the study.

These findings underscore the yawning need for more retirement security, and according to Fidelity the fix is much the same for every age group—though the earlier you start the more certain the results. In a nutshell, here are five steps to adequate retirement income, regardless of age:

  • Adjust asset allocation One in five are invested too conservatively for their age. Rule of thumb: subtract your age from 110. That is the percentage you should have in stocks.
  • Boost savings The average amount saved last year was $3,500. But most folks are not fully benefiting from their tax-advantaged savings plans by maxing out or merely saving enough to capture an entire employer match.
  • Adjust your retirement date The average planned retirement age is 65. Delaying by a couple of years and continuing to work part-time can be a game changer.
  • Buy an annuity Just 17% of retirees are using an annuity to create a guaranteed lifetime income stream. This is an essential product to guard against outliving your resources.
  • Tap into home equity In the survey, 72% said they owned a home and 32% had no mortgage. Smart downsizing will unlock some of this equity.

How do these steps fill the gaps? Let’s look at a typical Generation X worker (aged 34 to 47). On average, in retirement this worker anticipates needing $4,900 of monthly income (in today’s dollars). Yet looking at this worker’s assets and savings rate, the study found likely monthly income would be just $3,200 (through Social Security, pensions and savings withdrawals). That leaves a gap of $1,700 a month.

This worker can close the gap through the steps above. Here’s how it works:

Start with asset allocation. Most of Gen X is way too conservative with just 50% invested in stocks. At 37, exposure should be 73%. Greater growth potential over the next 30 years translates into another $350 of monthly income in retirement. Savings? The typical Gen Xer is socking away 5% of pre-tax earnings in a tax-favored account. By increasing that rate one percentage point each year until the rate reaches 10%, and then maintaining it, the worker adds $550 of monthly income.

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A Gen Xer would further boost retirement income by working full-time past retirement age to age 69 ($500 a month) and then part-time to age 76 ($200 a month). Annuitizing 40% of assets at age 67 would add another $150 of monthly retirement income. Downsizing the house at age 67 and setting aside 25% of the sale proceeds would boost monthly income by another $250.

Voila! This worker more than fills the gap, creating an additional $2,250 in monthly retirement income. Of course, all these numbers are hypothetical. Meanwhile, Fidelity assumed an 8.35% compound growth rate, which has not been the recent experience.

The challenge is slightly easier for Gen Y (21 to 33) and tougher for boomers (48 to 66) because of the length of time each has before retiring. Then again, boomers have more assets to work with. For specifics, look at the full study. But the point remains: Acting now will make a big difference later on.