6 Ways the Recession Will Change Retirement

Many Americans are still in denial about what it will take to enjoy their golden years.

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The Great Recession may finally be over, but the shock waves could reverberate for years—and fundamentally change the way we plan for retirement.

After most recessions of the past 75 years, the economy quickly bounced back to prerecession levels, erasing memories of hard times. This time seems different. The twin miseries of a stock market crash and a deep housing bust have eliminated $14 trillion of Americans' net worth since 2007—about $121,000 per household. That's money that millions of people had been hoping to retire on. The recent rebound in the stock market has eased some of the pain, but the decline in home values is likely to continue into next year, to be followed by an indefinite plateau. Some analysts think it could take a decade for homes to reclaim the peak values of 2006—and 20 years in California and Florida.

[See 4 problems that could sink America.]

The unemployment rate, meanwhile, is likely to rise above 10 percent in 2010, with jobs remaining scarce for years. Real household incomes, after inflation, have been flat for a decade, with little chance for a boost as long as there's slack in the job market. Economic strains are forcing millions of Americans to revise their plans for the future, especially retirement. Here are some of the biggest adjustments we're going to have to make:

Stop gambling with retirement funds. There's a big difference between saving and investing, and until last year, the distinction was fuzzy. Many Americans thought they were in fact saving for retirement, by spending money on their homes, which theoretically raised their value, or putting cash into a stock or bond portfolio. As millions have now learned, those were very risky investments that didn't always protect the principal.

When the stock market bottomed out in March of this year, it had lost 13 years' worth of gains; even with the recent market rally, stocks are barely back to 2004 levels. By the time the epic housing bust winds down, probably next year, Moody's Economy.com estimates that home values will have fallen 43 percent from the peak levels of 2006.

[See why a housing rebound could take 20 years.]

Some people have indeed managed to finance a rich retirement on earnings from stocks and real estate. But they enjoyed a remarkable lucky streak that's not likely to repeat itself anytime soon. For the most part, stocks were kind to investors in the '80s and '90s, with the S&P 500 rising 234 percent from 1980 to 1990 and 308 percent from 1990 to 2000. But those gains were far out of sync with historical growth rates, and so far this decade we've seen the payback (which economists call a "reversion to the mean"), with the S&P 500 down about 28 percent so far this decade. "You can't invest your way to retirement," says economist Gary Shilling. "You've got to save your way to retirement." That means setting aside a higher portion of overall income every month and keeping it safe, through investments that either protect the principal or allow a time horizon long enough to earn back the losses from crashes like those we've seen over the past several years. Planning on free money, in other words, is a bad strategy.

Spend less. Americans are taking Shilling's advice and saving more of their disposable income, reversing a 25-year consumption binge that left Americans deeply in debt. But a real turnaround in spending habits will take years and require more fortitude than many probably realize. Between 1960 and 1985, the savings rate ranged between 6 and 10 percent of personal income, with a peak of about 14 percent in 1975. But as consumer spending became a bigger part of the economy, so did the borrowing used to finance houses, cars, vacations, clothes, and everyday items. After 1985, the savings rate began to drift toward zero, and it actually became negative for a while in 2005.

[See why you're going to save more, like it or not.]

It has now risen to about 6 percent, and Shilling predicts the savings rate will rise to about 10 percent over the next decade. That's prudent economic behavior, but the catch is that greater saving will cut into consumer spending, which has been the biggest source of economic growth in recent years. A long-term slowdown in consumer spending will probably stunt the economy and perpetuate other problems, like high unemployment. And, oh yeah, Americans will have to prove they're serious about living thriftier, going without every new gadget and paying off their credit card balances.

Accept reality. For all the signs that Americans have started to adjust, many are still in denial about the lifestyle changes they'll have to make if they ever want to retire. Research by consulting firm McKinsey & Co. shows that the typical American has so little set aside for retirement that meeting basic needs will be a struggle. Worries about retirement have spiked, according to McKinsey surveys, but the average expected retirement age, 64, hasn't changed since 2007. And the proportion hoping to finance retirement through home equity has actually increased, even though home values have plunged. Does not compute.

Stay put. As people get closer to retirement age, they start to crunch the numbers required to move to that bucolic college town or Southwestern golf-course community. And these days, it may not be worth the cost, or even possible. The housing bust and financial meltdown have upended the rules for buying and selling homes and relocating. Many retirement-age people own their homes outright or have just a few years left on their mortgage, so they may think that the housing bust doesn't apply to them. But their home may still end up worth a lot less than it was only a few years ago, and with banks extremely stingy on loans, buyers could be scarce.

[See 10 cities facing another real-estate bust and 10 cities primed for recovery.]

The home you want to buy may have fallen in value, too, but many imminent retirees have taken a big hit on their retirement portfolios, and cash is scarce all around. Retiring in place might be the best strategy. You can always consider a retirement move in a few years, once the markets have stabilized and banks have loosened up.

Leave less behind. John Bogle, founder of the Vanguard mutual fund firm, says that as retirees try to make the numbers add up, they work their way down an "inverse priority pyramid": the progressively painful list of things they can live without. The proverbial daily latte and other unnecessary expenses usually go first. Many will discard some of their more cherished hopes, like a home near the beach. Then come uncomfortable kitchen-table discussions over that legacy for the kids and grandkids. "A lot of parents want to leave a nice little nest egg for their children," says Bogle. "That's nice but not essential. I don't believe anybody should live in privation so they can leave something to their children." Break it to your kids gently.

[Read Bogle's advice on how to invest smarter after the recession.]

Work longer. Early retirement isn't as fashionable as it used to be, mainly because many Americans will simply have no choice but to keep working, perhaps for 10 or even 15 years longer than they expected. Economists, at least, are cheerful about the prospect. "More people are going to postpone retirement, and I think that's going to be great," says Mauro Guillén of the University of Pennsylvania's Wharton School. The hoary idea that older workers must retire to make way for younger ones has been discredited, he says, and there are plenty of jobs with skill requirements and seasonal or flexible hours that are ideal for older employees.

Besides, a full lifetime of work can be healthful for individuals and socially productive. "Maybe we need more people who like to work and don't count down every day till retirement," muses Bogle, who is 80 and recently published his seventh book, Enough: True Measures of Money, Business, and Life. "Work is good. You're accomplishing something. Isn't that the point of a good life?" Millions of baby boomers are about to find out.