Table of Contents
Praise
Title Page
Copyright Page
Dedication
Foreword
Preface
THE BOGLEHEADS
THE COMING RETIREMENT BOOM OR BUST
ABOUT THIS BOOK
CHAPTER REVIEWS
Acknowledgements
PART I - THE BASICS
CHAPTER ONE - The Retirement Planning Process
INTRODUCTION
LIFE IN RETIREMENT AND YOUR RETIREMENT WELL-BEING
WHEN TO BEGIN THE RETIREMENT PLANNING PROCESS
THE TIME VALUE OF MONEY AND OTHER IMPORTANT CONCEPTS
CALCULATING YOUR NUMBER
LIFESTYLE IMPACT ON SETTING A RETIREMENT DATE
LIFESTYLE CONSIDERATION: THE COST OF TRANSPORTATION
HOW TO CALCULATE YOUR NUMBER
A WARNING ABOUT USING SCIENCE IN FINANCIAL PLANNING
BUDGETING FOR RETIREMENT
ADDITIONAL STRATEGIES TO CLOSE AN ANNUAL INCOME GAP
CHECKING ON YOUR PROGRESS AND MAKING ADJUSTMENTS
ANNUAL AFFORDABLE SPENDING CALCULATIONS
CHECKING STRATEGIES AND TRACKING PROGRESS
LIFE’S UNKNOWNS AND THEIR IMPACT ON RETIREMENT PLANNING
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER TWO - Understanding Taxes
INTRODUCTION
WHY AMERICANS SHOULD UNDERSTAND U.S. TAX LAW
FEDERAL INCOME TAXES
TYPES OF INCOME FOR TAX PURPOSES
FEDERAL TAXES ON SOCIAL SECURITY INCOME
ALTERNATIVE MINIMUM TAX (AMT)
STATE TAXES
LOCAL TAXES
ADDITIONAL RESOURCES
CHAPTER SUMMARY
PART II - SAVINGS ACCOUNTS AND RETIREMENT PLANS
CHAPTER THREE - Individual Taxable Savings Accounts
INTRODUCTION
TYPES OF TAXABLE ACCOUNTS
TAX LOSS HARVESTING
MINIMIZING TAXES
NONRETIREMENT TAXABLE ACCOUNTS
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER FOUR - Individual Retirement Arrangements
INTRODUCTION
IRAS DEFINED
CONGRESS MAKES IRA LAW
SPECIFIC IRA RULES AND BENEFITS
ROTH IRA VERSUS TRADITIONAL IRA
IMPORTANT ADDITIONAL INFORMATION
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER FIVE - Defined Benefit Employer Retirement Account
INTRODUCTION
DEFINING DEFINED BENEFIT PLANS
HOW DEFINED BENEFIT PLANS WORK
TRENDS IN PRIVATE-SECTOR DEFINED BENEFIT PLANS
PUBLIC-SECTOR PLANS
KNOW YOUR PLAN
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER SIX - Defined Contribution Plans
INTRODUCTION
TYPES OF DEFINED CONTRIBUTION PLANS
OTHER DEFINED CONTRIBUTION PLANS
MANAGING YOUR ACCOUNT
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER SEVEN - Single-Premium Immediate Annuities
INTRODUCTION
SPIA BASICS
HOW ANNUITIES WORK
CHARITABLE GIFT ANNUITIES
ANNUITIZATION STRATEGIES
THE SAFETY OF SPIAs
AN IMPORTANT NOTE ABOUT INCOME FROM SPIAs
MANAGED PAYOUT FUNDS
ADDITIONAL RESOURCES
CHAPTER SUMMARY
PART III - MANAGING YOUR RETIREMENT ACCOUNTS
CHAPTER EIGHT - Basic Investing Principles
INTRODUCTION
DIVERSIFY TO REDUCE THE RISK OF A LARGE LOSS
REBALANCING
COST CONTROL
DIFFERENT STROKES FOR DIFFERENT FOLKS
COMMON INVESTING MISTAKES
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER NINE - Investing for Retirement
INTRODUCTION
INVESTMENT POLICY STATEMENT
IMPLEMENTING AND FOLLOWING YOUR PLAN
SOME WORDS ABOUT RISK
CHANGING ALLOCATIONS OVER TIME
TAXES AND YOUR INVESTMENT PLAN
NONINVESTMENT ASSETS
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER TEN - Funding Your Retirement Accounts
INTRODUCTION
PRIORITY OF ACCOUNT FUNDING ORDER
ADDITIONAL RESOURCES
CHAPTER SUMMARY
PART IV - THE RETIREMENT PAYOFF
CHAPTER ELEVEN - Understanding Social Security
INTRODUCTION
HOW MUCH WILL YOU GET FROM SOCIAL SECURITY?
YOUR ANNUAL SOCIAL SECURITY STATEMENT
HOW OTHER SOURCES OF INCOME AFFECT BENEFITS
THE TAXATION OF SOCIAL SECURITY BENEFITS
WHERE DO SOCIAL SECURITY DOLLARS GO?
SOCIAL SECURITY REFORM
MINIMUM AND MAXIMUM RETIREMENT AGES
BENEFIT CALCULATORS AVAILABLE FROM THE SSA
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER TWELVE - Withdrawal Strategies
INTRODUCTION
BUDGETING FOR RETIREMENT
LUMP SUM OR ANNUITY
INCOME FROM OUTSIDE SOURCES
TAKING WITHDRAWALS
PUTTING IT ALL TOGETHER
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER THIRTEEN - Early Retirement
INTRODUCTION
WHAT IS EARLY RETIREMENT?
IMPORTANT AGES TO CONSIDER
MORE FACTORS TO CONSIDER
SAFE WITHDRAWAL RATE
FAMILY RELATIONSHIPS
HOW TO RETIRE EARLY
WINDFALLS, UNEMPLOYMENT, AND DISABILITY
UNRETIRING
CHANGING YOUR MIND ABOUT EARLY RETIREMENT
ADDITIONAL RESOURCES
CHAPTER SUMMARY
PART V - PROTECTING YOUR ASSETS
CHAPTER FOURTEEN - Income Replacement
INTRODUCTION
LIFE INSURANCE
PROTECTING YOUR FAMILY
INSURANCE AS A WEALTH ACCUMULATION VEHICLE
INSURANCE FOR PENSION MAXIMIZATION
INSURANCE TO PAY ESTATE SETTLEMENT COSTS
INSURANCE FOR BUSINESS NEEDS
DISABILITY INCOME INSURANCE
HOW TO SHOP FOR LIFE AND DISABILITY INSURANCE
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER FIFTEEN - Health Insurance
INTRODUCTION
MEDICAL INSURANCE
TYPES OF MEDICAL INSURANCE
EMPLOYER POLICIES
POLICIES FOR INDIVIDUALS AND THE SELF-EMPLOYED
GOVERNMENT HEALTH PLANS AND ACCOUNTS
LONG-TERM CARE INSURANCE
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER SIXTEEN - Essentials of Estate Planning
INTRODUCTION
GOALS OF ESTATE PLANNING
PROPERTY TITLING
METHODS OF PROPERTY TRANSFER AT DEATH
PROBATE
DIVORCE, MARRIAGE, AND REMARRIAGE
BENEFICIARY DESIGNATIONS
SELECTING TRUSTEES, ADMINISTRATORS, AND FIDUCIARIES
ESSENTIAL DOCUMENTS
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER SEVENTEEN - Estate and Gift Taxes
INTRODUCTION
ESTATE AND GIFT TAX LAW
BASIS RULE CHANGES IN 2010
ESTATE TAX COMPLIANCE AND TAX CALCULATION
GIFT TAXES
GENERATION-SKIPPING TRANSFER TAX
ADDITIONAL RESOURCES
CHAPTER SUMMARY
PART VI - FINDING GOOD ADVICE WHEN YOU NEED IT
CHAPTER EIGHTEEN - Seeking Help from Professionals
INTRODUCTION
ADVISERS CAN HELP
WHO SHOULD GET PROFESSIONAL ADVICE?
FINANCIAL PLANNING VERSUS MONEY MANAGEMENT
FINANCIAL PLANNING DEVELOPMENTS
COMPARISON OF FEE STRUCTURES
FINANCIAL ADVISER DESIGNATIONS
SELECTING AN ADVISER
ARE YOU HIRING A PLANNER OR A MONEY MANAGER?
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER NINETEEN - Divorce and Other Financial Disasters
INTRODUCTION
DIVIDING ASSETS IN A DIVORCE
QUALIFIED DOMESTIC RELATIONS ORDERS
DIVORCE AND SOCIAL SECURITY BENEFITS
AGREEING TO A DIVISION BEFORE MARRIAGE
REMEMBER TO CHECK DESIGNATED BENEFICIARY
FACING A FINANCIAL DISASTER
ADDITIONAL RESOURCES
CHAPTER SUMMARY
CHAPTER TWENTY - Meet the Bogleheads
INTRODUCTION
ABOUT OUR MENTOR, JACK BOGLE
WHO ARE THE BOGLEHEADS?
THE BOGLEHEADS’ ONLINE FORUMS
THE BOGLEHEADS WIKI
THE BOGLEHEAD BOOKS
BOGLEHEADS LOCAL CHAPTERS
THE BOGLEHEADS REUNIONS
OUR MISSION
APPENDIX I - Pearls of Wisdom
APPENDIX II - Recommended Reading
Glossary
About the Editors
Index
ADDITIONAL PRAISE FOR THE BOGLEHEADS’ GUIDE TO RETIREMENT PLANNING
“If you’re interested in funding your own retirement rather than some
Wall Streeter’s retirement, this is the book for you. Read it cover to cover
and you’ll end up knowing more than 90 percent of financial professionals.
Hats off to the Bogleheads for the great service they have done for
consumers with this book.”
Allan S. Roth, CFP ®, CPA, MBA,
Author of How a Second Grader Beats Wall Street
“To find true financial joy, you need to integrate sound financial principles
into your life. Retirement is an opportunity to live the life you
always dreamed of—but only for the prepared. That’s where the Bogleheads
shine. You can always count on them for straight talk, thoughtful
commonsense commentaries, and a willingness to help others. We can all
learn from their grassroots, solid approach to retirement planning that is
consistently supplemented with the powerful, rich conversations that take
place every day at www.bogleheads.org.”
Sue Stevens, President,
Stevens Wealth Management LLC and
Financial Happiness LLC
This book is dedicated to John C. Bogle.
For his wisdom, kindness, and unselfish devotion to helping individuals achieve their dreams.
All royalties from the sale of this book are being donated to: The National Constitution Center
Philadelphia, PA
Foreword
It’s hard to imagine a more fortuitous time to write a guide to retirement planning. The global financial crisis and the recession and bear market it has brought in its wake have exposed the tenuous condition of the retirement savings of millions of Americans, who would undoubtedly benefit from the sort of advice the Bogleheads dispense in this book.
On the other hand, it’s also hard to imagine a time when investors might be more reluctant to read anything that has to do with investing. Their nest eggs often depleted and sometimes shattered, and dreams of retirement delayed if not deferred—largely due to the recklessness of a select group of Wall Street experts who seemed unable to measure the risks on the balance sheets of the firms they ran—one could hardly blame an investor who says “the heck with it all,” writing off the financial markets as a rigged game, one in which their capital is used, first and foremost, to enrich the insiders.
But the fact that such a reaction is understandable doesn’t make it correct. For better or worse, most Americans today who want to enhance the modest retirement income distributed through our Social Security system have been given the responsibility of funding and managing their own retirement accounts, charged with investing their way to a secure financial future. The current economic crisis will not absolve us of that responsibility, even as it makes it more difficult. Invest we must.
But that by no means implies that investors should continue blithely along the path they’d been on. As the current bear market has made plain, too many Americans were ill-prepared to shoulder the responsibility that had been placed upon them. Even worse, our mutual fund industry was equally incapable of providing the assistance our nation of amateur investors needed. The conflicts of interest mutual fund managers face—seeking to maximize their own earnings, which reduce, dollar for dollar, the returns earned by their mutual fund investors—proved too great a temptation for them to resolve in favor of their fund investors.
So what is an investor to do? First and foremost, seek wisdom. “Wisdom excelleth folly as far as light excelleth darkness.” I used those words from Ecclesiastes some 15 years ago, in the epilogue of my first book, Bogle on Mutual Funds, as a way of introducing my Twelve Pillars of Wisdom, which I described as “lamps to guide you on your search for a sensible, productive investment program.”
Reviewing them recently, I was struck by how well they have stood the test of time. I’ll let you judge for yourself:
1. Investing is not nearly as difficult as it looks. Successful investing involves doing just a few things right and avoiding serious mistakes.
2. When all else fails, fall back on simplicity. There may be a handful of alternatives that prove to be better than simply buying and holding a portfolio balanced equally between a total stock market index fund and a total bond market index fund over the long term, but the number of alternatives that will prove to be worse is infinite.
3. Time marches on. The majesty of compounding returns is remarkable. Over 25 years, an 8 percent annual return grows a $10,000 investment by $58,500. But the tyranny of compounding costs is remarkably destructive. Annual costs of 2.5 percent would reduce that return to 5.5 percent and slice your portfolio’s long-term growth by more than half, to $28,100.1
4. Nothing ventured, nothing gained. Yes, the stock market is volatile. Yes, its future returns are unknown. But eschewing the stock market incurs its own risks. Our recognition of that and our faith in the resiliency of American capitalism compel the majority of American investors to allocate at least some portion of their nest egg to stocks in an effort to reach their long-term goals.
5. Diversify, diversify, diversify. While it’s impossible to eliminate all of the risk associated with investing, risk can be greatly reduced by diversifying broadly within each asset class (ideally, using a low-cost total market index fund) and then constructing a well-balanced portfolio that owns an appropriate mix of stocks and bonds.
6. The eternal triangle. Risk, return, and cost are the three sides of the eternal triangle of investing, inextricably linked to the long-term growth of your portfolio.
7. The powerful magnetism of the mean. Investment superstars come and go, the vast majority proving to be comets who briefly illuminate the firmament with spectacular performance, only to see their returns deteriorate, returning to, and then lagging, the average returns of their peers and the market.
8. Don’t overestimate your ability to pick superior equity mutual funds, nor underestimate your ability to pick superior bond and money market funds. In equity funds, past returns tell us nothing about what the future holds. Performance comes and goes, and yesterday’s leaders are likely to be tomorrow’s laggards. The top-performing bond and money market funds, on the other hand, are typically populated by the lowest-cost alternatives. In these areas, investors can choose the low-cost leaders with a reasonable amount of confidence in their favorable prospects for continued success.
9. You may have a stable principal value or a stable income stream, but you may not have both. Intelligent investing involves choices, compromises, and trade-offs, perfectly illustrated by the choice between a 90-day Treasury bill’s fixed value and volatile income stream, on one hand, and a long-term Treasury bond fund’s volatile market value and relatively stable income stream on the other.
10. Beware of fighting the last war. Too many investors—individuals and institutions alike—become infatuated with the recent past and find themselves eternally (and futilely) reacting to what has happened in the financial markets instead of building a portfolio that can withstand whatever the future holds, recognizing that particular cycles and trends never last forever.
11. You rarely, if ever, know something the market does not. The financial markets reflect the hopes, the fears, even the greed of all investors everywhere. It is nearly always unwise to act on insights you think are your own but are in fact shared by millions of others.
12. Think long term. The daily volatility of the market is often “a tale told by an idiot, full of sound and fury, signifying nothing.” The wise investor tunes out this noise and patiently focuses on the long term while staying the course.
Of course, these 12 pillars are more than just an epilogue to a 15-year-old book. They represent the foundation on which I built The Vanguard Group. From its inception in 1974, I strove to make Vanguard a firm that emphasized the simple over the complex, the enduring over the ephemeral, and the low-cost over the costly, represented most clearly by the broad market index fund, which guarantees its investors nothing more (and nothing less) than their fair share of whatever returns our financial markets provide.
And as pleased as I am that, 35 years later, history has shown the merit in such an approach to investing, I’m even more pleased with how broadly it’s been embraced by millions of investors, none more so than the group that calls themselves the Bogleheads.
I met my first Boglehead on February 3, 1999. I had flown to Miami to deliver a speech, and Taylor Larimore, the group’s unofficial leader, invited me to join a group of his compatriots for dinner at his home that evening. Taylor and his friends proved to be as wonderful a group of people as I had ever met—intelligent, thoughtful, trustworthy, and eager to help others—in short, good human beings. We all had so much fun that our gathering quickly became an annual event. We’ve held our reunions in cities all over the country, and each one has been larger than its predecessor. Bogleheads 8 is scheduled for Dallas, Texas, in September 2009.
This group of like-minded investors represents the promise of our electronic age, which combines a seemingly endless amount of information with an unprecedented ease of communication. Harnessing both, the Bogleheads band together to help and encourage all comers to sort through the noise in the pursuit of their financial goals. Collectively, the group provides a vast gold mine of wisdom and experience waiting to be explored.
The Bogleheads’ Guide to Retirement Planning is a true gem from that gold mine, a book whose advice is firmly built upon those Twelve Pillars of Wisdom. Truly a group effort (no fewer than 40 Bogleheads contributed to it in some capacity), this book provides the reader with a first-rate primer on saving and investing for retirement, covering everything from opening and funding a retirement account, to investing it wisely, to drawing down your account, to estate planning—not quite cradle-to-grave coverage, but pretty close.
Importantly, these investors/writers/believers do so in a way that even the most novice investor will be able to follow. I’m admittedly not the most impartial judge of their work—heck, I’m probably the least impartial person you could find for that task—but I’m certain that our nation of investors would be far better served if more of them acted on the advice the Bogleheads dispense in this book.
I’m often asked what it’s like to have a group of people name themselves after you. It is, I readily admit, more than a little surreal, at least in the abstract. But getting to know the Bogleheads over the past 10 years or so—both in person and by following their online community—has been one of the more rewarding experiences of my long career, not because of the undeniable boost they provide my ego (though that never hurts!) but because the Bogleheads represent the fulfillment of what I have dedicated my career to building.
When I founded Vanguard all those years ago, I did so in the face of enormous skepticism. It was a brand-new organization—one operating with a then-as-now unique structure—whose success depended not on a vast marketing budget or an army of sales representatives but on faith—a faith that individual investors, one by one, would come to recognize that this then-tiny firm, doing things differently, would serve their own economic interests, and a faith that that would be sufficient to ensure our enterprise’s success.
When I chat with the Bogleheads, they almost invariably thank me for starting Vanguard. But in reality, it is I who should be thanking them. It is investors like these fine human souls who validated my leap of faith and who allowed the Vanguard experiment to flourish. And that success, such as it were, has provided me with far more acclaim than any one person deserves. It is hardly an overstatement to say that whatever success I may have enjoyed in my long career is due entirely to the fact that my faith in investors like the Bogleheads has been so well placed.
And so it is with immense pleasure that I commend The Bogleheads’ Guide to Retirement Planning to you. After reading this book, I’m confident that you’ll agree with me that the Bogleheads, this diverse collection of caring individual investors, are a remarkable group. Even better, when you learn from their collective wisdom, you’ll join the ranks of investors who are well on their way to realizing their investment goals.
JOHN C. BOGLE
Valley Forge, PA
Preface
We live in a country facing many challenges. No one can deny the importance of a strong national defense and an aggressive response to the terrorist threats that we face. No one can turn away from the importance of assuring a sound physical infrastructure when we see pictures in our newspapers of major interstate highway bridges collapsing under the load of rush hour traffic. We all agree that our secondary schools and colleges seed the future of America and they must offer a top-notch education. And we all know that without health, we cannot have wealth. Affordable health care is paramount to the long-term well-being of our citizens and an important driver of worker productivity in a competitive global marketplace.
There are many worthwhile claims on our time and money, but there is one that has major long-term economic implications if not addressed wisely and with resolve. A growing portion of America’s population will reach retirement age over the next 25 years. If we do not seriously address how those retirement income streams will be funded, we run the risk of allowing the greatest single threat to American prosperity to overtake us because of procrastination. The American people, including the younger members of our society, need clear and comprehensive guidance to deal with the challenges we all face on the issue of preparing to meet a burgeoning retirement challenge in the years ahead.
The Bogleheads’ Guide to Retirement Planning is a grassroots call to action. It encourages a broad, individual response to prepare for retirement.
The individual chapter authors are not professional writers. They are people just like you: skilled laborers, white-collar workers, teachers, entrepreneurs, small-business owners, and the like. The authors have no incentive in this not-for-profit endeavor except to make a difference—to help people who want to be helped by providing valuable information on a range of retirement planning topics. What has been written in these chapters has been learned through self-education, primarily by reading books, articles, and research and by participating on the Bogleheads.org forum. Most important, it is information gathered by the life experiences of many people. These authors are a part of a remarkable group of people who call themselves Bogleheads.
THE BOGLEHEADS
Boglehead is the name adopted by individuals who follow the business and investing beliefs of an extraordinary man, John C. Bogle, founder and former CEO of the Vanguard Group of mutual funds. Jack, as he likes to be called, is credited with being the father of index mutual funds.
In 1975, under Jack’s leadership, the newly formed Vanguard Group launched the very first publicly available index fund, the Vanguard First Investors Trust. The fund tracked the popular S&P 500 Index of mostly large U.S. common stocks. The fund was later renamed the Vanguard 500 Index Fund and eventually grew to become the largest mutual fund in history. The very low mutual fund expenses and sensible investment strategies of the Vanguard Group have allowed millions of individual investors to save billions of dollars in costs over the years, and that money saved is money earned.
But Vanguard is not the whole story behind Jack Bogle. He is also a model of business integrity. He stands like a pillar of ethics in a world seemingly gone mad with Ponzi schemes and multimillion-dollar golden parachutes paid to failed CEOs. Jack is a reformer. He relentlessly offers a host of practical business advice through his writings and speeches in an attempt to restore integrity in corporate America and to protect small investors’ interests. For his efforts, John C. Bogle has been granted many honors, including inclusion in Time magazine’s “world’s 100 most powerful and influential people” and Fortune magazine’s “four Giants of the 20th Century” in the investment community.
Jack Bogle has tens of thousands of followers, and many of them communicate with each other regularly. The main communication network for the Bogleheads is over the Internet on a dedicated web site, www.Bogleheads.org. Members of this free online community discuss topics ranging from mutual funds to complex investment strategies to who is the most famous guitarist of all time. On any given day, the forum hosts thousands of participants and visitors. Any person visiting Bogleheads.org may read the conversations, but you must register to participate in the discussions. That involves selecting a screen name and agreeing to follow certain ethical guidelines. Registration is free.
Bogleheads.org evolved from the Morningstar Vanguard Diehards forum established in March 1998. Taylor Larimore posted the first of his more than 24,000 forum contributions on the Morningstar site in Conversation #1. Mel Lindauer was another pioneer whose investment and business experience soon made him a forum leader. As the Morningstar forum expanded over the years, it became necessary to create a stand-alone web site that had added functionality and oversight. Thus, Bogleheads.org was born. The web site is now the largest not-for-profit investment site on the Internet.
A relatively new and exciting part of the Boglehead.org online community is the Bogleheads Wiki. It was a pioneering project by Barry Barnitz and a small group of forum members. The Wiki is an online encyclopedia of sorts that is a collection of content and Web page links designed to educate investors. The group quickly realized the valuable contribution they could make to both the forum and the greater investing community at large by creating the Bogleheads Wiki site.
Off-line, the Bogleheads have expanded to include regular local chapter gatherings and a national reunion. There are now 38 local chapters throughout the United States and Europe. Local chapter members meet periodically to discuss investing topics of interest with other members from their area. Each year, a local chapter volunteers to host the Bogleheads reunion, which Jack Bogle traditionally attends. The 2009 conference visits the Lone Star state with a meeting in Dallas/Fort Worth. Information on all these activities can be found on the web site.
Our family of Bogleheads is vast and growing, but you do not need to register to consider yourself a follower. Being a Boglehead is a state a mind, not a web site. Anyone who believes in Jack Bogle’s philosophy on good business ethics and low-cost investing principles is already a member. Chapter 20 is dedicated to the hard work and countless hours all Bogleheads have volunteered to promote this message.
THE COMING RETIREMENT BOOM OR BUST
This book addresses the enormous issue of retirement in America. Each year for the next 25 years, more people will reach retirement age but will find fewer resources for them to draw from. The senior population has grown by 50 percent since 1980, from 25 million to nearly 40 million in 2009. Retirees are living longer and are healthier. In 1985, more than a quarter of the 85-plus population lived in nursing homes. By 2008, that proportion had fallen to only 13 percent of people this age because of advances in health care and better fitness.
With so many people entering retirement over the next couple of decades and retirees living longer, where are the resources going to come from? In 1980, many people retired with a defined benefit pension paid by their employers. Today, traditional pensions paid by employers are disappearing, and personal savings and employee-funded retirement plans must make up the difference. But are we saving enough? How much is enough? This book teaches people how to come up with those answers.
Changes Coming in the Social Network
Some people still believe that Social Security and Medicare will provide adequate income and health benefits after age 65. Unless you are already well into your retirement years, it is probably a good idea to make other plans. Our social services networks are woefully underfunded and cannot deliver the level of economic welfare that many people expect.
Some prognosticators suggest that all we have to do is rearrange our economic activities to spur greater economic growth to address the shortfall in Social Security and Medicare. The reality is that economic growth becomes stifled with growing government entitlements and a smaller workforce to draw from. Unless we change the work behavior patterns of the adult population, our demographic structure will mean that labor force growth rates will drop to near zero in the 2010s. Even if we can achieve higher levels of productivity, much of this expected productivity improvement is already committed to support the higher need for services related to our aging population. Increasing costs of health services worsen the situation.
These facts cannot be dismissed, nor can a future retiree ignore the inevitable changes in benefits that are coming. It is likely that eligibility ages under Social Security and Medicare will have to be raised again. Raising the retirement age will give workers a longer time to contribute to their retirement plans and reduce the rate at which they have to contribute. In turn, it will simultaneously reduce the number of years a person is in retirement and the amount of resources needed to sustain a lifestyle that is acceptable after the work career has ended. Simply put, most people should plan to work longer.
The Saving Status of Americans
Just two or three decades ago, saving for retirement in the United States was based heavily on employer-provided defined benefit plans. Benefits after retirement were typically received through monthly or biweekly payments from lifetime income annuities. Now personal tax-advantaged accounts such as the 401(k), 403(b), IRA, and Roth IRA plans have become the primary form of saving for retirement. These private retirement accounts hold assets that are currently about four times the size of defined benefit programs.
Self-funded retirement accounts place the responsibility for preparing for retirement squarely on the shoulders of the individual. Workers must have the discipline to save significant sums consistently for many years. And workers in many defined contribution plans must also wrestle with investing their funds. That is not an easy task, and some workers don’t want to do it. Consequently, many participants put their money in low-yielding money market accounts that have no probability of growing faster than inflation over time. In addition, at the time of retirement, the participant has sole control of the rollover assets and must determine what to invest in and when and how to withdraw assets from those accounts. These are not easy decisions for most people. Fortunately, all of these issues are discussed by the authors of this book.
We could not write a retirement planning book without addressing risk. There is investment risk any time an investor attempts to achieve returns higher than Treasury bills. During 2008, major U.S. equity indexes were sharply negative, with the S&P 500 Index losing 37 percent for the year. As the market moved lower, it translated into corresponding losses in 401(k) plans. The nonpartisan Employee Benefit Research Institute (EBRI) published an analysis of the impact of the recent financial crisis on 401(k) retirement account balances in 2008. The EBRI analysis, published in the February 2009 EBRI Issue Brief, used a database of more than 21 million participants to estimate the impact of market activity on 401(k) account balances.
Not surprisingly, how the recent financial market losses affect individual 401(k) account balances is strongly affected by the size of a participant’s account balance. Those with low account balances relative to contributions experienced minimal investment losses that were typically more than made up by new contributions. Those with less than $10,000 in account balances had an average growth of 40 percent during 2008, because contributions had a bigger impact than investment losses. However, those who had balances of $200,000 or more had an average loss of more than 25 percent because contributions made up a significantly lower portion of the account balance.
The loss in retirement savings has a profound impact on future retirement trends. It is likely to take several years before the balances of some workers reach their prerecession highs, and that includes new contributions made during the next few years. But that does not mean people should abandon their efforts; far from it. Some belt tightening may be needed, but the plan must continue. As our mentor, Jack Bogle is fond of saying, stay the course!
ABOUT THIS BOOK
There is a bull market in uncertainty in America and around the globe. So wide and deep are the issues that it is difficult to grasp all that has changed and will change in the months and years ahead. But one thing has not changed: your need to prepare. You must continue to strive for a viable retirement plan by evaluating the best ways to save, the best accounts to save in, the right amount to save, a reasonable estimate of the role government entitlements will play, how you will insure against setbacks, and how you handle a financial crisis.
This book was written for all people who are planning to retire at some time in life. We certainly encourage young people to read this book. However, we understand that most young people who enter the workforce for the first time may save for retirement but tend not to plan for retirement. Planning for retirement tends to begin around midlife, when the bones get a little creaky and the cage upstairs starts to shed a few neurons. When retirement thoughts start popping up at any age, don’t ignore them. Move those thoughts to the forefront of your thinking because you’re ready to start planning. So what should you do? How do you start? How much do you need? And who should you trust for answers?
The Bogleheads’ Guide to Retirement Planning is a great place to start building a long-term viable plan. The book covers most of the basics. However, it does not provide definitive answers to all questions. More research on your part is needed. Appendix II has a great book list compiled by Boglehead Taylor Larimore. Although Bogleheads tend to be do-it-yourself people, some issues do require the help of a professional. Trying to cut corners by doing complicated tasks yourself is not always the best course of action.
CHAPTER REVIEWS
Part I: The Basics
Chapter 1, “The Retirement Planning Process,” by Thomas L. Romens provides a great overview of things to come in the rest of the book. Tom takes you through the highlights and distinguishes the difference between saving for retirement and actually planning for it.
Chapter 2, “Understanding Taxes” by Norman S. Janoff is an important introduction to all types of taxes that can affect your retirement plan. Minimizing the impact of taxes while in retirement is critical because it maximizes your discretionary income from pensions, Social Security, and your portfolio.
Part II: Savings Accounts and Retirement Plans
Chapter 3, “Individual Taxable Savings Accounts,” by Dan Kohn explains why a taxable savings account is the most straightforward way of holding investments, though seldom the best way because you will be taxed on the income and capital gains each year.
Chapter 4, “Individual Retirement Arrangements,” by Jim Dahle shows why an individual retirement arrangement (IRA) is one of the best ways an investor can save for retirement. The advantage is that the assets in an IRA grow without being taxed each year, leaving more money to compound for your future benefit.
Chapter 5, “Defined Benefit Employer Retirement Account,” by The Finance Buff (an alias, of course). The focus of this chapter is on defined benefit plans. Funded by employers, an employee’s income benefit at retirement depends on salary and years with the employer.
Chapter 6, “Defined Contribution Plans,” by Dan Kohn covers an assortment of retirement plans, including the popular 401(k) and 403(b) plans, as well as profit-sharing arrangements and ESOPs. Dan explains the benefits and disadvantages of each plan.
Chapter 7, “Single-Premium Immediate Annuities,” by Dan Smith tackles the subject of guaranteed income streams in retirement. This interesting chapter covers all types of immediate payout annuities and includes a guide for getting the best deal.
Part III: Managing Your Retirement Accounts
Chapter 8, “Basic Investing Principles,” by Bob Davis covers exactly what the title says. The chapter includes good Boglehead principles, such as diversifying your investments to reduce the risk of a large loss, maximizing your return by minimizing expenses, and sticking with your plan.
Chapter 9, “Investing for Retirement,” by David Grabiner and Alex Frakt discusses the details of a good investment strategy while saving for retirement. This chapter focuses on creating the road map to a solid investment plan.
Chapter 10, “Funding Your Retirement Accounts,” by David Grabiner and Ian Forsythe provides an order to funding your retirement. It is devoted to helping you make an informed decision from among the various types of accounts available to you.
Part IV: The Retirement Payoff
Chapter 11, “Understanding Social Security,” by Dick Schreitmueller is a critical chapter for everyone to read. Social Security is a primary source of income for many retirees, yet few people know as much as they should about this vast program.
Chapter 12, “Withdrawal Strategies,” by Carol Tomkovich explains that the end result of your retirement plan is to provide stable income that is high enough to maintain the lifestyle you wish to live. But how do you efficiently take money out of your various accounts? This chapter helps answer these important questions.
Chapter 13, “Early Retirement,” by Jeff McComas may sound impossible in today’s economic environment, but it is not. This chapter describes strategies to bridge the income gap between your last day of full employment and your first Social Security check.
Part V: Protecting Your Assets
Chapter 14, “Income Replacement,” by Lee E. Marshall is a critical chapter. The focus of this chapter is on life and disability insurance programs. With life’s uncertainties, protecting your future earnings from premature death or disability is a necessity.
Chapter 15, “Health Insurance,” by Lee E. Marshall is another issue that cannot be ignored in a good retirement plan. Planning for medical care provides a solid foundation for retirement.
Chapter 16, “Essentials of Estate Planning,” by Robert A. Stermer provides an overview of how you can control decisions made on your behalf when you are not able to do so. It includes life preservation directives during a critical medical problem and how your worldly possessions will be distributed after you are gone.
Chapter 17, “Estate and Gift Taxes,” by Robert A. Stermer provides insight into the complex and often changing world of distributing wealth without taxation. Planning today for sharing your wealth can save your heirs thousands of dollars in the future.
Part VI: Finding Good Advice When You Need It
Chapter 18, “Seeking Help from Professionals,” by Dale C. Maley and Lauren Vignec offers guidance on whom to trust in the finance industry. This chapter will help you understand different types of financial advisers, how they work, how they are paid, and how to choose one for the need you have.
Chapter 19, “Divorce and Other Financial Disasters,” by David Rankine is required reading. The world is not perfect; people lose jobs, good health turns bad, and more than half of marriages end in divorce. David’s enlightening chapter will assist you to find the help you need to protect your retirement plan when life’s ugly side turns your way.
Chapter 20, “Meet the Bogleheads,” by Taylor Larimore and Mel Lindauer is a special chapter about how this group helps thousands of individuals. You’ll learn a bit of the history of how the Bogleheads came to be, what happens on the Bogleheads.org forum, and how the Bogleheads organization has flourished.
Appendix I, “Pearls of Wisdom,” is a collection of thoughts and sayings that are near and dear to the hearts (and wallets) of people who participate on the Bogleheads.org forum. Some of the pearls are originals, and others are oldies but goodies.
Appendix II, “Recommended Reading,” is a selection from Taylor Larimore’s popular “Investment Gems” on the web site. Taylor has read hundreds of investment and financial planning books. These are some of his favorites.
Acknowledgments
There were many people who generously contributed their time and effort to this ambitious project. First, we thank John C. Bogle for his vision and guidance and for agreeing to write the foreword. Second, we thank Bill Falloon of John Wiley & Sons for enthusiastically supporting this book. This would not have materialized without Bill’s strong backing. Finally, we wish to thank all the Bogleheads who participated in this bold experiment. They are listed alphabatically within categories:
Boglehead Book Committee
Laura F. Dogu
Richard A. Ferri
Taylor Larimore
Mel Lindauer
Chapter Authors
Jim Dahle
Bob Davis
The Finance Buff
Ian Forsythe
Alex Frakt
David Grabiner
Norman S. Janoff
Dan Kohn
Dale C. Maley
Lee E. Marshall
Thomas L. Romens
Dick Schreitmueller
Dan Smith
Robert A. Stermer
Carol Tomkovich
Lauren Vignec
Fact Checkers and Go-To People
Ned Benz
Arleigh Clemens
Jason Good
Zack Hiwiller
Moira Keane
Paul Krafter
Shawn Larsen
Pat Marshall
Josh Meyer
Jeff McComas
David Rankine
The MN Bogleheads
Marlene Perrin
Amy Shao
Wendy Swanson
Other Contributors
Adem A. Dogu
Derin B. Dogu
Daria A. Ferri
PART I
THE BASICS
CHAPTER ONE
The Retirement Planning Process
Thomas L. Romens
INTRODUCTION
Retirement! You’ll be ready, but will you have the money to do it? Retirement planning is an exploration of alternatives that link present decisions to future implications. The objective of a retirement plan is to identify strategies that you can use to realize your financial goals—goals that will support your plan for living your postretirement years. Failure to link your retirement financing to your life plan in retirement might result in planning for the wrong future or failing to provide financially for the future you planned.
Saving for retirement and planning for it are two different topics. Young people who enter the workforce for the first time are encouraged to save for retirement, but they are not planning for retirement—at least not yet. But you are ready to plan. What should you do? How do you start? How much do you need?
The Bogleheads’ Guide to Retirement Planning explores the planning process itself, emphasizing the linkage between saving for retirement and actually planning for it. We’ll introduce some basic financial planning concepts and provide suggestions regarding how much to save for retirement and how to budget for those savings. Lifestyle choices today directly impact the ability to save for the future. As the poet Robert Burns wrote, “The best laid plans of mice and men often go awry,” it is necessary to create a dynamic plan to address the uncertain nature of everyone’s health and financial and personal future.
LIFE IN RETIREMENT AND YOUR RETIREMENT WELL-BEING
Retirement as we know it did not exist until the twentieth century. People worked until they could not physically work anymore. There were no pensions, no Social Security, and no Medicare. You were on your own. Most people retired to their children’s home or another relative’s home, where they lived out the rest of their days.
A new concept of retirement evolved in the 1900s. It focused on a life of rest and leisure paid for by a pension from many years of hard work in an industrial world and modest government subsidies from government-paid Social Security and Medicare. At first, retirement was expected to last only a few years. The retirement age was 65 years when Social Security was created in 1935. That was life expectancy at the time. Accordingly, many people were not expected to live long enough to collect.
Times have changed since the early 1900s; people are living longer, private pensions are diminishing, Social Security benefits are likely to be reduced in the years ahead, and Medicare coverage is becoming very costly. These changes have dramatic implications for future retirees. Baby boomers and beyond must plan retirement differently than their parents or grandparents. Perhaps retirement should be viewed as a third phase in life, potentially equal in duration to the earlier development and full-time work phases of life.
Imagine yourself in retirement for potentially 30-plus years. Where will your income come from? How will you structure this time? Undoubtedly, you will see yourself as a healthy, active person. Following good health practices today, such as watching your weight, cholesterol, and blood pressure and getting regular exercise, can increase your chances of a longer, healthier life span. Unlike earlier phases of your life, you see retirement as unburdened by the pressure to pursue an education and a career. You will want to pursue all the leisure, social, or perhaps political activities that you had no time for while working full-time. A 2004 AARP survey on baby boomers’ expectations of life in retirement found that 70 percent of the baby-boom generation expects to spend more time on a hobby or interest, 68 percent will have more time for recreation, and 51 percent expect to be involved in community service or volunteering.
Those goals are all commendable. But how do you generate the income for your living needs, given diminishing pensions and the cloudy outlook for Social Security? The big change in retirement is that you will probably not be fully retired from gainful employment. Numerous surveys have found that more than 70 percent of retirees expect to work in some capacity, and for some of them, the primary reason will be social fulfillment. Retirement certainly has the potential to be a multifaceted phase of your life.
Money is undoubtedly important, and a steady source of income is critical to a happy retirement. However, money cannot buy happiness. In her book, You Don’t Have to Be Rich: Comfort, Happiness, and Financial Security on Your Own Terms, Jean Chatzky reports that at the $50,000 income level, increases in happiness level off. Statistically, people who earn around $50,000 a year are just as happy as those earning more than $100,000 per year. Your lifestyle is your choice; simply be aware that studies show that a more expensive lifestyle does not necessarily correlate with additional happiness.
Retirement is about what you are retiring to, not what you are retiring from. In addition to your financial goals, your retirement goals should include the elements of health, social interaction, intellectual stimulation, and happiness. In their book What Color Is Your Parachute? In Retirement, Richard N. Bolles and John E. Nelson present some of the findings of Charles Morris, who attempted to define a “good life.” His characterization of “ways of life” is a purposeful synopsis of what you might aspire to retire to. Some ways of life described are (a) improvement, working for realistic solutions to specific problems; (b) service, devoting yourself to the greater good and to others; (c) enjoyment, pursuing pleasures and festivities; (d) contemplation, introspection to achieve a more rewarding inner life; and (e) action, using physical energy to accomplish things.
If you are retiring as a couple, it is very important that you agree on a common vision for the future and the strategies that are needed to reach your financial goal. Without consensus, there is the chance that you may be at cross-purposes, a potential recipe for conflict. Planning for the future involves trade-offs; you should agree on what you are willing to give up today in return for your shared vision of life tomorrow.
WHEN TO BEGIN THE RETIREMENT PLANNING PROCESS
Financial planning to support yourself in retirement should begin early in life, although planning how you will live your future life in retirement may not take place until well after you reach your mid-50s. Accumulating assets for retirement can and should begin as soon as you earn steady income, and even before. Parents who have children with earned income can set up a custodial Roth IRA and fund the account up to the extent of the child’s earnings, or the maximum allowable by law, whichever is less.
Early retirement planning should begin when you have your first full-time job. Planning at this stage involves having a savings plan so that 40 years later you will have something put away for retirement. You may not know how much to save or how long you will need to save, but saving is the beginning.
Many employers have a 401(k), 403(b), or other self-funding defined contribution retirement plan. Study the defined contribution plan options offered by your employer. Choose a broad-based low-expense mutual fund, and contribute at least enough to capture your employer’s match. Contribute more if you can—10 to 15 percent of gross income is a good target—but especially take advantage of any raises you earn to increase your contributions. If your employer does not offer a plan, or if the only investment choices are high-expense funds with no employer match, you may be better off establishing a Roth IRA at an investment firm that offers low-cost plans and a low minimum investment amount. All of these concepts are discussed in other chapters throughout this book.
Choosing the right mix of assets at the beginning of your career is not as important as getting started on retirement early and establishing good financial habits. At the beginning, it is the amount that you put into a plan that counts, rather than the return of the investment in the plan.
It is not difficult to budget for retirement savings at an early age because your spending habits have not been developed. One core strategy that works is living below your means; this strategy entails distinguishing between wants and needs and deferring gratification (minimal use of credit and avoiding revolving credit altogether). There are also psychological benefits to getting started early. Money deferred from your paycheck has an out of sight, out of mind quality, and the quarterly statements that report your fund’s growth typically offer positive reinforcement for the decisions you have made.
