My Dad sat on an old three-legged stool in his workshop while examining the brakes on several old Fords we restored and enjoyed working in the 60’s and 70’s. As a child, I spent many years being his “tool runner.” These are fond memories. As I grew up I acquired a fond hobby of working on old classic cars. Looking back, in addition to this great love, many words of wisdom were gleaned as I kneeled next to my Dad on that old three-legged stool.
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, an employer’s retirement or pension plan and personal savings.
If you are a private sector American worker hovering in the 40-60 age category, how confident are you in your prospects for a “happily ever after” retirement?
One does not have to dig too deeply to recognize the shakiness of the proverbial three-legged stool for many prospective retirees today. Even if you feel you have accumulated a significant nest egg of over $1,000,000, I think you will be surprised and the shakiness of your own stool.
First, do your own research regarding Social Security. 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. Our Social Security system needs help, but few politicians have had the courage to take it on and so they keep kicking any potential fixes down the retirement road.
Second, since 1979, significant changes have occurred in the types of employment-based retirement plans. In short, Defined Benefit Pension Plans in the private sector have all but evaporated while Defined Contribution Plans like 401k’s have soared. News Flash! These plans are not the same! Our popular 401k Plans from the early 1980’s lack the essential element of actuarial science, meaning there are no lifetime income guarantees with these pre-tax plans. These plans are simply a pot of accumulated pre-tax dollars you are left to position for retirement income hoping it will not run out.
Over that last 30-40 years, there has been a major transfer of risk and responsibility for an individual’s retirement from the employer to the employee. I call it a YOYO Retirement. You are On Your Own! Unfortunately, much of this transfer has occurred with little to no employee education regarding how to take a large pre-tax asset and convert it to income. Ask yourself, how much prospective retirement income help you gotten received from your Human Resource Department on charting an effective course with your 401k, 403b, 457, etc…? Better yet, how much schooling has your existing financial advisor provided in terms of navigating this transition? That’s what I thought!
Third, is personal savings. This leg was only supposed to be needed if the other two legs faltered. Beyond employer retirement plans, there is an alphabet soup of Individual Retirement Accounts (IRAs) and/or other non-qualified, after tax investments one can engage, but many Americans are not taking sufficient advantage of such plans or opportunities.
US News & World Report, March 19, 2013, found that “28% of Americans say they have less than $1,000 saved for retirement.” The 2013 Retirement Confidence Survey by the Employee Benefit Research Institute found that “60% of workers report they have saved less than $25,000 for retirement (excluding the value of their home and pension plans).”
Understandably, many pre-retirees feel an unsettling angst when contemplating any hopes for retirement recognizing their own three-legged stool might be unsteady.
But wait, you are different and have practiced the art of delayed gratification. Congratulations! You have accumulated a sizable retirement account outside your employer defined contribution plan. You may be shocked how little it might yield in withdrawal rate income if you expectedly leave it in the market as a hedge against inflation. The best research today suggests a retiree should not take more than 3.5% from his or her portfolio each year. Some research suggests a mere 2.8%! Otherwise, there is a strong probability you may run out of money. In short, the old 4% Rule is dead. Simply look at the 1980’s 10 year US Treasury Rates versus today. We are certainly living in a historic low-interest rate environment with increased global market volatility. Still not convinced? Google, “Say Good-bye to the 4% Rule” and read a range of impressive, independent articles on the subject. Also, try out the Retirement Nest Egg Calculator on the Vangard.com Website.
An approximate 3.5% income rule creates another pre-retiree challenge as it will be very difficult to accumulate sufficient assets to enjoy a “happily ever after” retirement. For example, a $1,000,000 nest egg will only yield a paltry $35,000 of annual retirement income! This income is woefully short of most expectations.
This all results from the issue of withdrawal rate risk which attempts to solve the problem of the sequencing of returns in a fluctuating interest rate environment. More on that in another article.
Even if you have $500,000 saved, this will only generate about $1,500 per month given the lower withdrawal rules. Add Social Security to this and you will still be forced to live on a fraction of what you are used to earning. And what about extended life expectancy and the threat of inflation? Most pre-retirees are not aware of this reality, which is why you must develop a more robust retirement income planning strategy!
Fortunately, there are proven strategies that can combat withdrawal rate risk, mitigate return sequencing problems and restore actuarial science to a pre-retiree’s retirement game plan. If pre-retirees take immediate action, they can dramatically change the financial trajectory of their retirement income. For example, increase retirement income by 30-50% without saving any more money and without taking on additional risk.
What is my next step? I always tell my clients, “Don’t do anything you don’t understand!” So, education through financial assessment is next.
As noted, the first step is an assessment. Second, learn how to execute more efficient retirement income strategies. This is why I developed the “Retirement Income Wellness Check Up” to accompany client meetings and educational workshops. It’s a great starting point to help pre-retirees get centered on what matters most with respect to generating significantly more retirement income from the nest egg they have accumulated in pre-retirement.
The check-up asks participants 10 important retirement income questions. Workshop attendees respond privately with a 1, 2, or 3 on their individual check sheets. When answering each question, 1 means the attendee is “absolutely confident”, 2 means “somewhat confident” and 3 means “not very confident.” At our events, sufficient time is spent discussing and educating on the importance of each retirement preparedness question.
At the end, attendees add up their scores to determine if their prospective “retirement income is healthy” (Score: 10), “need a doctor” (Score: 11-20) or if their retirement income “needs to be rushed to the emergency room” (Score: 21-30). The levity generates chuckles, which are powerful motivators to move forward with what matters most.
Test your level of preparedness by answering the questions below:
- Social Security Timing – Based on when you plan to take Social Security benefits, are you confident you will receive the most income available?
- Withdrawal Rate Risk – Do you know the correct percentage to withdraw from your assets each year to ensure you don’t run out of money? Do you know how to significantly increase this rate without taking on more risk?
- Fluctuating Interest Rates / Sequencing of Returns – Do you have a strategy to combat the threat of fluctuating interest rates and sequencing of returns?
- Assets Only Retirement – Since an “assets only” retirement often falls short of income expectations; do you have a strategy to sufficiently close the retirement income gap?
- Actuarial Science – Do you have a strategy to take advantage of actuarial science?
- Secure Guaranteed Lifetime Income – Do you have a guaranteed flow of income that cannot be outlived? Meaning, do you have a portion of your income dedicated to routine household expenses that are positioned as guaranteed lifetime income.
- Combat Survivorship Risk – Are you positioned to replace lost income when a spouse passes?
- Enhance Personal Legacy – Have you thought about and/or provided for your personal legacy?
- Buffer to Volatility – If assets are to remain at risk in retirement, do you have a formal strategy to buffer market volatility? This concept of a non-market correlated, tax-advantaged, liquid, inflation-protected asset to buffer retirement income in a down market can significantly increase retirement income.
- Current Financial Relationships – When you think about the financial relationships in your life, are you confident they can guide you appropriately? Will they, not only get you down the retirement mountain without running out of money but do they have the experience to identify the other pre-and post-retirement risks and help you develop the strategies necessary for financial peace?
Add up your score! Do you need a doctor?
Being an active learner in one’s financial life is essential for success. Abdication is not an option! Yes, the three-legged retirement income stool has changed dramatically, but there are answers to increasing one’s retirement income, often without saving any more money. Do you know these strategies?
Take ownership of your financial future today! Taking the Retirement Income Wellness Check-Up is a great start. Doing so will give you a more credible claim on financial peace.