Financial illiteracy hampering Americans' ability to plan for retirement

by Jim Sloan

A new study is out showing that financial illiteracy is "widespread" among older Americans, with only a third of those surveyed able to answer three fairly simple questions about interest rates, inflation and investments.

The study by two economic researchers for the National Bureau of Economic Research also found that fewer than a third of the 1,269 older American adults surveyed had tried to come up with a retirement plan, and of those who tried, only about two-thirds succeeded.

Most important, however, was the study's conclusion that financial understanding and knowledge are closely related to planning. People who keep track of their checking account spending and their savings account balances are more likely to have adequate retirement savings accounts.

The 3 key questions

The researchers used three questions to gauge the level of understanding of survey participants.

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

  1. More than $102
  2. Exactly $102
  3. Less than $102
  4. Don't know

2. Imagine that the interest rates on your savings account was 1 percent per year and inflation was 2 percent per year. With the money in this savings account, after a year, would you be able to buy…

  1. More than you can today
  2. Exactly the same
  3. Less than you can today
  4. Don't know

3. Do you think that the following statement is true or false, or you don't know? "Buying a single company stock usually provides a safer return than a stock mutual fund."

Answers: a, c, false. How did you measure up?

What the answers revealed

Only two-thirds got the first answer correct, but three-quarters understood the second question about inflation. On the investments question, only half of the respondents understood that holding a single company stock is typically riskier than holding a stock mutual fund.

The researchers found that those with greater financial knowledge were more likely to have attended a retirement seminar. They also found that financial illiteracy is particularly low among women and minorities and the lesser educated.

A call for greater financial education

The analysis is a clarion call for more financial education. The authors noted that the "financially savvy" are more likely to take formal educational steps to bolster their retirement savings accounts, such as using retirement calculators, going to seminars and consulting with financial experts. Those who had the best savings rates and did plan for their retirement were less likely to have gained their financial knowledge from family members, co-workers or friends.

The study comes on the heels of an Employee Benefit Research Institute (EBRI) report showing that workers' confidence in having enough money in their investments and savings accounts to live comfortably in retirement continues to drop.

The percentage of workers who say they are not at all confident they have enough in their investments climbed to 27 percent, up from 22 percent in 2010 and 10 percent in 2007. Only 13 percent said they are very confident they have saved enough.

Middle-income boomers forced to rethink retirement

by Jim Sloan

Baby Boomers are tightening their belts and maintaining their savings rates as a result of the financial collapse three years ago that battered their retirement savings accounts, diminished their real estate investments and made them rethink the type and duration of their impending retirement.

A new study from the Bankers Life and Casualty Company painted a pretty bleak picture of U.S. residents between the ages of 47 and 65 who earn between $25,000 and $75,000. For instance, nearly 70 percent have experienced a decline in their retirement savings account since 2008, 21 percent have not seen any recovery in their investments, and 14 percent have no retirement savings account at all.

But they are a plucky bunch, this group of 78 million people born between 1946 and 1964. Nearly all of those who participate in some kind of employer-sponsored retirement savings account either maintained or increased their savings rates even as many of the employers cut back or eliminated their own contributions.

The shift to individual responsibility

In recent decades, the responsibility for retirement has been shifting from employers and institutions to individuals. Pensions have declined and the 401(k) savings account and other individual saving mechanisms and investments have taken their place.

The big test for how this shift is working is the baby boomer generation, whose oldest members turn 65 this year and whose aging members will increase the nation's over-65 population from 14 percent to 21 percent in the coming years.

Their numbers will test the capacity of Social Security and Medicare, but also go a long way to determining what retirement will "look like" for a generation that has had to save up for its own golden years. While retirement for previous generations involved slowing down, moving to a retirement community or being cared for by family, this study found that baby boomers expect something different, including:

  • A more active lifestyle: More than half are looking forward to retirement, but one if four are uncertain.
  • Work: Three out of four of the 500 respondents in the study expect to work in retirement and most for financial reasons.
  • Concern about money: Whether it's interest rates, cd rates or money market rates, nearly three-fourths say their financial situation--not their age--will determine when they retire.

Falling behind on savings and investments

The study also found that many boomers feel they haven't saved enough for retirement, for instance:

  • Two-thirds feel they are behind their savings rates.
  • Half are not confident they've put enough in their money market accounts, retirement accounts, certificate of deposit or other investments for a comfortable retirement.
  • More than half have less than $100,000 in their retirement investments; one fifth have less than $10,000.
  • More than three-quarters are concerned about health-care expenses, inflation and long lives gobbling up their retirement savings.

The impact of the economy

In addition to the nearly 70 percent who saw their retirement investments decline in value, many say they've had to recalculate their retirement date, with 80 percent putting it off for an average of five years.

In addition, more than half have cut back on discretionary spending--such as dining out--and 43 percent have reduced their credit card debit. Two-thirds are trying to reduce their health-care costs by delaying treatment or moving to a cheaper health care plan.

Creative ways to ensure a comfortable retirement

by Jim Sloan

The commonly accepted rule is that you need at least a million dollars in your savings accounts or investments before you can retire comfortably and protect your principal with 4 percent annual withdrawals.

But is that necessarily true? Probably not; people are enjoying comfortable retirements with a lot less in the way of retirement savings accounts and investments.

In fact, the kind of lofty retirement advice that says you need a million in your savings accounts or money market account has probably done more to discourage people than it has to inspire them to save more. Some of us see $1 million and figure we might as well just give up and work for the rest of our lives.

Exceptions to the investments rule

According to TIME magazine's Moneyland website, the $1 million/4 percent rule is based on some pretty faulty assumptions.

One faulty assumption is that your only income will come from savings accounts and investments, such as stocks, a certificate of deposit or a money market account.

The truth is that you'll probably still be able to draw funds from Social Security, particularly if you're already retired or close to it. If you've been working all your life and paying into Social Security, this could be a nice monthly benefit, particularly if you wait until you're 70 before you start taking money.

Staying on the job

It's also true that you may decide to continue working, at least part time. Many businesses are allowing flexible work schedules and better retirement planning in an effort to keep older workers. Although the jobless rate for workers 55 and older climbed recently, the 6.8 percent unemployment rate for seniors is still far below the national average. If you're valued and jobs are available, why not keep working?

Other income-generating moves

The financial planners advocating the 4 percent rule may also not be taking into consideration other moves you can make to ensure a safe income during retirement, such as owning a home.

Although home prices have plummeted in recent years--wiping out equity that many of us expected to retire on--the poor home-buying market has created a stronger rental market in some areas. What that means is that you might consider renting out your big home when you outgrow it rather than selling it when prices are depressed. Rent payments that exceed your remaining home payments are a great way to increase your income while letting someone else pay off your mortgage.

Another option would be to start a small business now, before you retire, that you can easily keep going after retirement. You may not be looking at something that requires a lot of heavy lifting, but there are opportunities for "passive investments" such as mini storages that might fit the bill.

Whatever you do, it's important to have a specific plan. According to CBS' Moneywatch.com, this requires:

  • You decide at what age you and your spouse will start collecting Social Security. Most advisors recommend waiting until you're 70.
  • You determine how to consolidate your investments, including your savings accounts, IRAs, 401(k) and pensions, to generate retirement income.
  • How much income you'll need if you decide to keep working.

Ultimately, you'll have to manage your payouts--that original 4 percent number--and make adjustments as you need to. If your investments aren't performing like you'd hoped in retirement, you may have to withdraw less. On the other hand, a strong stock market could give you enough to take that long vacation you always dreamed about.

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Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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