Retirement — the word used to conjure up images of eventual leisure, travel, golf, new hobbies, or spending time with grandkids. When people get honest about their future retirement (or lack thereof), many unfortunately just worry or put off planning. For several reasons, the prospect of a “happily ever after” retirement is becoming more and more challenging.
To more effectively prepare for retirement, even higher earners ask, “How can I possibly save more, spend less and/or get a better return on my money?” These are productive questions. However, when it comes to retirement, they are not necessarily the most important questions for solving the retirement income question. Watch this video entitled, “The Retirement Income Dilemma.”
Here’s a concept you may not have considered: The problem with retirement isn’t just about the size of your nest egg. It’s about how that nest egg converts to income when you retire. Continue reading and I’ll explain.
First, in case you don’t already know, America is experiencing a retirement crisis. Consider the following as you learn this most important question pre-retirees are not asking themselves:
- According to a recent study from Fidelity Investments, “The typical US worker would face as much as a $2,100 a month shortfall during retirement if current trends continue.” (USA Today, September 8, 2012.)
- “To maintain living standards into old age we need roughly 20 times our annual income in financial wealth.” (Huff Post Business: The Looming Retirement Crisis and What To Do About It, July 24, 2012.)
- Boston College Center for Retirement Research & US Senate Committee on Health Education Labor & Pension in a work paper titled, “The Retirement Crisis and a Plan to Solve It,” July 2012, “American workers are $6.6 trillion dollars short of what they need to retire comfortably. That is enough dollars that, if lined up end to end, would stretch to the moon and back 1,000 times and still leave enough left over to pay NASA’s budget for the next eight decades.”
- To complicate things for workers in the private sector, retirement plan has continued to shift away from traditionally defined benefit pension plans to defined contribution plans, like a 401k. In short, the traditional pension plan is disappearing. “In 1980, some 39% of private-sector workers had a pension that guaranteed a steady payout during retirement. Today that number stands closer to 15%.” (Employee Benefit Research Institute 2013, Washington D.C.)
- The Los Angeles Times reported about public sector defined benefit pension plans in an article titled “Government Pensions in Cross Hairs”, April 23, 2010 noting, “Pension consultant Girard Miller told California’s Little Hoover Commission that state and local government bodies in California have $325 billion in unfunded pension liabilities, which works out to $22,000 for every single working adult in California.”
- Further, according to a report from Stanford University, “California’s three biggest pension funds are $500 billion short of meeting future retiree benefit obligations.” (Bloomberg: California Pensions $500 Billion Short of Liabilities, April 5, 2010.)
- And what about the health of Social Security? “In 1950, each retiree’s Social Security benefit was paid for by 16 US workers. In 2010, each retiree’s Social Security benefit was paid for by approximately 3.3 US workers. By 2025, it is projected that there will be approximately 2 U.S. workers for each retiree.” (www.GAO.gov: A Message From the Secretary of the Treasury.)
These are alarming facts from well-respected sources. Lower investment returns, the housing bust along with rising healthcare costs haven’t helped either. With the possibility of living 25-30 years in retirement, it is understandable why the fear of running out of money is a top concern for many pre- and post-retirees today.
If you plan to retire in the next 10-15 years, you’ve still got time. However, where should you be focusing your efforts to reach your goals? As mentioned previously, creating a larger nest egg is typically the first thing we think of. Certainly, putting more away now is wise, but that is not necessarily the most important question! There is another magic question that is not being asked by pre-retirees. This question asked and properly addressed can turn retirement anguish into true retirement bliss.
The question is,
“How and at what level of efficiency does my retirement nest egg convert to income when I retire?”
This is a question of asset utilization and efficiency rather than simply accumulating a larger asset balance. Most will find the answer to this question both enlightening and engaging. For those behind in their savings goals, they will find the answers inspiring and hopeful.
Let me explain. To illustrate, follow this example. Two pre-retirees (let’s refer to them as Jim & John) with the same amount of savings can achieve dramatically different levels of retirement income simply by how they position their assets in pre-retirement.
- Jim. Jim takes an “investment- or assets-only” approach through his 401k. In order to ensure a reasonable expectation that he will not run out of money in retirement, he can only withdraw 3-4% from his 401k each year.
- John. John, understanding how retirement income streams work, takes a more balanced approach by combining investments and actuarial science in pre-retirement. By doing this, he can potentially get 7-13% of his assets each year for retirement income. That could result in double the income in retirement!
In other words, consider the level of efficiency in your retirement plan. The latter retiree achieved dramatically more income in retirement and yet they both saved the same. How can this be and how can one position themselves this way?
Dr. Wade Pfau Ph.D., CFA, is a Professor of Retirement Income at The American College for Financial Services in Bryn Mawr, PA. He holds a doctorate in economics from Princeton University and publishes frequently in a wide variety of academic and practitioner research journals. He hosts the Retirement Researcher website and is a monthly columnist for Advisor Perspectives, a RetireMentor for MarketWatch, a contributor to Forbes, and an Expert Panelist for the Wall Street Journal. His research has been discussed in outlets including the print editions of The Economist, New York Times, Wall Street Journal, and Money Magazine.
Dr. Pfau recently published a whitepaper (5/15/2015) titled, “Optimizing Retirement Income by Combining Actuarial Science and Investments.” His research covers the aforementioned assertions and provides valuable insights for pre-retirees anxious to get more from less. I’ve made Dr. Pfau’s whitepaper available in the Learning Center of www.mckellpartners.com.
We spend a lot of time in my practice helping clients take advantage of strategies that provide higher levels of integration and efficiency. Strongly consider learning more about how to achieve higher levels of efficiency from your current plan.
Take a look at this learning video entitled, “The Retirement Income Dilemma.” The difference could mean more retirement income and an increased measure of financial peace!