If you are like most American’s, you may feel a bit behind in your retirement savings or just sense a general lack of preparedness for this next stage of life. This might feel more urgent if you are less than 10 years away from entering your Golden Years. Before you know it, that day will be here. Get on the road to financial health, by following these 3 quick tips.
Take Personal Responsibility for Your Three-Legged Retirement Stool – I remember an old three-legged stool in my Dad’s workshop as a child. He used to sit on it while examining the brakes on the old Fords we spent time restoring. Sitting next to him I learned a lot as I served as an effective runner for needed tools. My Dad had a wise motto that I have never forgotten. He would often say, “The best place to find a helping hand is at the end of your own arm.” He’s lived his life that way and I’ve benefited from his rugged individualistic nature always trumpeting the virtues of self-reliance. My Dad’s wisdom will be applied here as you learn about the YOYO retirement you are saddled. Read on to learn about what YOYO means.
In the historical world of financial preparedness, the concept of a three-legged stool represents a similar self-reliant theme. For decades, many financial professionals used the concept of a three-legged stool to describe the three most common sources of retirement income:
- Social Security
- Employer’s Retirement or Pension Plan
- Personal Savings
One does not have to dig too deeply to recognize the shakiness of these three legs for many prospective retirees. Based on the June 2013 annual Trustee’s Report, the Social Security trust fund will be exhausted by 2033. After 2033, income will cover just 77% of scheduled payments. Everyone knows our Social Security system needs help, but politicians do not have the courage to take it on and so they keep kicking the problem down the road.
What about the second leg? Since 1979, significant changes have occurred in the types of employment-based retirement plans. In short, Defined Benefit (DB) plans in the private sector have declined while Defined Contribution (DC) plans have soared. Consider recent statistics from the Employee Benefit Research Institute (ebri.org). Their research notes that among 2011 private-sector workers who have a retirement plan, 69% of them participated in a DC plan and only 7% had a DB pension plan. Contrast this from 1979 where only 17% engaged in a DC plan and a whopping 62% had a DB plan. In short, DB plans have all but disappeared while DC plans, like 401k’s, have skyrocketed. News Flash: These plans are not the same!
But, who bears the risk of accumulation and distribution for an employee’s retirement income under a DB plan, the employer or the employee? Answer: The employer. Conversely, who bears the same risks for an employee’s retirement income under a DC plan? Answer: The employee.
Clearly, there has been a major transfer of risk and responsibility for an individual’s retirement from the employer to the employee. That’s likely you! Much of this transfer has occurred with little employee education. Many 401k defined contribution plans started with healthy matching incentives only to slowly decline over the years.
Personal savings is the third leg. This leg was only supposed to be needed if the other two legs faltered. But now with struggling Social Security benefits and fewer DB Plans to go around, personal savings is an important third leg. Personal savings could include Individual Retirement Accounts (IRAs) in all their shapes and sizes, as well as non-qualified investments accounts, etc… Current reports also suggest that Americans are not saving enough outside of any employer-sponsored plans.
What does all this mean? It means you are pursuing a YOYO retirement. What does YOYO stand for? It means, “You’re On Your Own!” This is especially true if you are in the private sector since pensions are still prevalent in public institutions. If you feel behind in your retirement preparedness you must take personal responsibility, put on your learning cap, find a financial professional you can trust and begin moving forward today. The answer to your retirement woes is you, so let’s get going! Your economic future depends on it!
Clean Up Your Financial Junk Drawer – If you are like most you probably have a junk drawer in the kitchen. A junk drawer often represents a collection of items with no apparent order or purpose. It contains stuff we think we might need, but can’t seem to throw away. It can even represent open projects we have been putting off like that old handle that fell off the bathroom cabinet years ago.
Junk drawers could include a dead flashlight, old cell phones, broken or old TV remotes, a small extension cord, various power supplies for who knows what devices, some random tools and maybe an indiscriminate screw or fastener. And of course, every time you open it up, you vow that someday you are going to, “clean that thing out!”
So, what does it have to do with pre-retirement? Most people have a financial junk drawer. It has characteristics like its cousin, the kitchen junk drawer. This drawer tends to be full of random financial products acquired over the years with no apparent purpose or correlation. It might represent a range of various financial accounts, policies and documents that are inherently important, but just not organized or coordinated in any meaningful way. Random IRA’s or 401k’s from previous jobs or various insurance policies that overlap or don’t make sense. It could even represent a bloated savings account earning point-nothing at the bank. Check out the list of deductions on your paycheck and you may find some junk drawer items.
The basic by-product of a financial junk drawer is a lack of efficiency and organization. But, maybe more importantly is a lack of mental clarity and control over one’s financial life. When you decide to clean it out you will likely find misdirected or idle resources. This could result from either an account or policy you didn’t know existed (I have seen this happen many times), expenses you can eliminate (needless EFT’s hitting your checking account), fees you can reduce (Yahoo!) or assets that can be put to work more productively. All of this results in more wealth building. Note: If companion assets are positioned properly, they can lead to significantly more income in retirement. See the next step on Retirement Income Streams.
Over the years, I have helped many clients gain clarity over their financial lives. Learn more about organizing your financial junk drawer. Click here. Work with a financial professional who has the heart of a teacher to help you clean up this mess. As you work to get organized and put meaningful financial strategies in place, you will feel an increased sense of financial peace and completion.
Understand Retirement Income Streams – Consider this question. “What is the underlying premise or purpose for all long-term savings?” Rephrased differently, “Why do you give up the enjoyment of your income to save?”
I have asked hundreds of people this question and the answer is typical, “for retirement” or “for the future” or “so someday I can stop working.” While these answers seem obvious on their face, they are not entirely correct. Shouldn’t the answer really be to generate an income stream in retirement? At some point, don’t you have to convert your savings to an income stream to replace your working income? Of course!
Being true, then doesn’t it make sense to understand how retirement income streams work so savings can be directed today in strategies that can provide the highest possible income at retire? I hope you just had a light bulb go on! In other words, how retirement income streams work economically define how to allocate your savings today. The sooner you get on the right path the greater positive impact you can have on the results.
Most pre-retirees and many advisors haven’t a clue how retirement income streams work and yet this is the central most critical issue of retirement planning. Assets are accumulated for tomorrow, but most lack an understanding of how to efficiently convert assets to income for retirement. Not understanding this discipline could put you at risk of running out of money later in life.
To help you better understand this concept, imagine you are a hiker planning a lengthy expedition to a high mountain peak. What is the hiking objective? Most amateurs say, “To get to the top.” However, expert hikers would never say that. They would suggest that the objective is to get back home safely. Hiking up and down a mountain can be analogous to the topics of pre-and post-retirement. On the way up the mountain, we are in the accumulation phase setting away assets for retirement. On the way down we are in the distribution phase where we convert or distribute those assets in the form of retirement income streams.
Like accomplished hikers, effective retirement planners see this up and down experience as one continuous journey. Expert hikers make sure they pack for the descent as well as the accent. The same is true when laying out an effective retirement plan. There are two rates that make up every person’s retirement journey and they are equally important. One is the accumulation rate and the other is the distribution, withdrawal or spending rate.
Understanding how retirement income streams work defines how to pack your bag in pre-retirement. Packing your bag early and correctly in pre-retirement can translate into potentially significantly more retirement income. The concept of beginning with the end in mind is illustrative here.
Remember, it’s not the size of the asset in retirement, it’s how the asset converts to income that is important. I hope you wrote that down because this is the most important concept to catching up if you find yourself behind in your retirement savings. But, what does this mean? Say, you save a $1,000,000 for retirement. You could put it in a CD once you retire and live off that income, correct? You would get a distribution rate of about 1% or $10,000 a year to live on. How do you like those results? You could put it into a fixed annuity today and get about 2%. Now, you are up to about $20,000 per year in retirement income. Still not good enough, is it!
Or, like most Americans, who leave the asset in the market, how much can you take out without running out? This is called withdrawal rate risk. Remember, some years the market is up and some years it’s down, so you must determine a safe, consistent, annual withdrawal rate so you get home safely. Back in the 80’s “The 4% Rule” was born, but that has now degraded to 3% or less. There is no room here to give you all the research. Just Google, “The 4% Rule” or “Say Good-bye to the 4% Rule.” Better yet, download the whitepaper, “Rethinking Retirement, Sustainable Withdrawal Rates for New Retirees in 2015” by Dr. Wade Pfau, Professor of Retirement Income at The American College and Wade Dokken, Co-Founder and Co-President of WealthVest Marketing.
So, how does 3% sound on your $1,000,000 retirement savings? Maybe it’s getting better at $30,000, but many would say this is still disappointing and frankly, who has the million dollars? That’s another issue. But this result is where most Americans are headed because they are pursuing what is termed, an “Assets Only Retirement,” meaning their saved assets are largely positioned in market-based accounts like a 401k. However, what if I told you that 5%, 6%, 7% or 8% withdrawal rates were possible if properly structured? What if I told you that you didn’t have to take more risk to achieve these higher rates? So, $1,000,000 could produce not $30,000, but $70,000 per year in retirement. What would you rather have? This is not a trick question.
To achieve these stronger withdrawal rates, you must understand retirement income streams and get actuarial science back in your planning. Actuarial science is the magic surrounding current pension plans. Get educated on two important financial tools or strategies that can significantly boost income rates in retirement. These are namely, a Single Premium Life Only Income Annuity paired with permanent life insurance and/or the effectiveness of deploying a non-market correlated Volatility Buffer, if assets are left in the market during retirement.
News Flash: The best planning is done on the way up the mountain, not when you are ready to summit. Procrastinate and you may be relegated to a 3% withdrawal rate. Put proper planning in place and potentially enjoy a 5-8% rate. I hope you are taking notes because I just showed you a way to potentially significantly increase your income in retirement through effective asset positioning.
Millions of Americans are behind on their retirement savings and income goals. Rodney Brooks in a USA Today article (2/13/2014) stated that Fidelity Investments, the nation’s largest 401(k) provider, noted that the average 401k balance for pre-retirees 55 and older was only $165,200. “Houston, we have a problem!” What is your 401k or retirement savings balance? Run your own numbers and the possibilities if learn retirement income streams.
There are a variety of strategies you can deploy to rescue a lack of retirement readiness or to improve the efficiency of your struggling savings account, so it produces more retirement income. We have discussed just three strategies in this writing. Taking personal responsibility for one’s three-legged retirement income stool, cleaning out your financial junk drawer and deepening your understanding of retirement income streams is essential for success. At McKell Partners, we believe that education is the key to financial freedom. Engage with us to better learn these insights. Together we can work with you on building a better road to your Golden Years.