USA TODAY International Edition
Know when it’s time to change tack on your retirement savings plan
Situations may dictate other priorities, wiser ways to direct funds
Everyone knows you should be saving for retirement. But are there times when you shouldn’t?
Turns out, the answer is yes.
That doesn’t mean you shouldn’t build a nest egg – because you need to save and plan for life after your working years end, financial advisers say.
But it does mean there are times you might want to take a break from retirement saving to direct your money to other, more pressing needs.
So when are those times?
Do you have a lot of debt?
If you have a lot of debt, you should check your interest rates to consider whether it’s more important to use your money to pay it down or save it for retirement. If the rate on the debt is high, pay it down first.
“If a credit card’s charging you 18% interest, where would you get an 18% return ( on investments)?” said Max Jaffe, a CPA and planning counselor at TBS Retirement Planning. “You can give yourself an 18% return by paying it off.”
If you don’t pay it off, Jaffe warns the debt “will overpower you,” and fast.
To see how fast, use the Rule of 72, a quick back- of- the- envelope way of calculating when an investment, or debt in this case, will double. It works like this: Divide 72 by the interest rate number, which is 18 in this case, and you get four. That means your debt, if not paid down at all, will double in four years.
Do you have an emergency fund?
If the answer is no, you should set aside retirement savings to build one.
“With the current economy, it’s a good time to talk about that,” said Rich Guerrini, president and CEO of PNC Investment. “With the economic challenges we’ve experienced over the last 12 months and will experience over the next 12 to 24 months, the idea of layoffs is real. Without an
emergency fund, that really makes that scenario dire.”
You should aim to have at least three months of living expenses in an emergency fund, but the rule of thumb is to have six to 12 months to cover any unexpected developments.
Can your savings last 25 years?
When you start taking distributions from your retirement funds, you probably can stop saving.
If you’re looking for a number, a general rule of thumb is to divide your savings by 25, “because chances are you’ll be retired for 25 years,” Jaffe said. That amount will grow each year because of inflation, so keep that in mind. But if the amount will cover a year of expenses and inflation, “you’ll know you’re there” and can stop if you want, he said.
Are you young or poor?
A research report published last year in The Journal of Retirement argues that young people shouldn’t save for retirement. The theory hinges on the “life- cycle model,” which means people naturally tailor their spending based on where they are in life to keep their standard of living steady.
That means young people will spend the little money they earn to keep a certain standard of living, middle- aged workers who earn more will be able to keep that lifestyle and save, and older people will spend their savings to maintain their way of living.
Additionally, the report said, “lowincome workers, whose wage profiles tend to be flatter, receive high Social Security replacement rates, making optimal saving rates very low.”
The report argues that if young or low- income workers are forced to save for retirement, they could end up taking on toxic levels of debt or making tax- inefficient withdrawals from savings to meet spending needs, resulting in worse overall outcomes.
This is extremely controversial, and most financial planners will tell you that approach could be risky.
“The risk is I am 25 years old, and retirement is 40 years away,” Guerrini said. “But the time value of money and power of compounding interest, those early years, you can never make up for. The shorter the timeline drastically impacts your retirement.”