The ‘three-legged stool of retirement’ is a term dating back more than sixty years, and is used to describe the most typical sources of retirement income. Those sources are Social Security, employer sponsored pensions, and personal savings.
Times have changed and none of these legs have the kind of strength needed to support the retirement needs of a nation. All three are facing serious financial shortfalls that will devastate the retirement plans of a significant percentage of the population.
Perhaps the time has come for the old stool to get a new leg…
Retirement is the Biggest Expense of Your Life
Ask ten people what retirement means to them, and you will likely get ten different answers. If your dream is an activity filled retirement and/or one of travel, you will require a lot more money than someone who wants nothing more than a quiet cottage with a garden. From the age one chooses to leave the workforce, what they have accumulated in savings, what benefits they may be entitled to, etc, there are hundreds of potential financial outcomes that will determine if their idea of a dream retirement can be a reality.
The new retirement realities are:
⦁ You may live past the age of 100
⦁ Most people have not saved enough for retirement
⦁ Most people will have to keep working in some way
⦁ Your expenses may not go down, but your income will
⦁ Medical costs may double or triple
⦁ The dollar may lose value (could you afford a $20 loaf of bread?)
⦁ Government programs may be drastically cut
⦁ The government is paying for retirement social assistance programs with money they don’t have, by robbing (taxing) John Jr. to pay for John Sr.
⦁ You are your own retirement boss
Retirement planning can be very complex with hundreds of various combinations of different plans, options, and scenarios. Consult a professional if necessary, but it is always a good idea to understand the basics so you know what you are getting into. This module is an introduction to retirement funding and covers only the basic material that the average person may find helpful.
Introduction to Retirement Plans
Employer Sponsored Pension Plans
A lot of people are counting on their workplace pensions to make up the majority of their retirement funding. The most common employer sponsored pensions will fall into one of the following two categories.
Defined Benefit Pension Plan
⦁ A defined benefit means you know exactly what your pension amount will be at retirement
⦁ The benefit is based on a formula such as: 2% x average earnings in the last 5 years x years of service (maximum 35)
⦁ The benefit is not based on investment returns, so you are not at the mercy of poor management, investment choices, or market timing
⦁ Employee and employer make contributions
⦁ Employer is responsible for any shortfalls needed to pay employee pension for life
⦁ Employers are moving away from defined benefit pension plans because of astronomical costs
⦁ A benefit might be calculated using the following formula: Pension = 2% x average yearly earnings in the last 5 years x years of service (to a maximum of 35)
⦁ Dana worked for the government for 30 years when she decided to retire at age 60. During the last 5 years, her annual salary averaged $60,000 a year.
⦁ Her yearly pension would be: 2% x $60,000 x 30 years = $36,000 ($3,000 per month)
⦁ If she waited to retire at age 60, her pension would be: 2% x $60,000* x 35 years = $42,000 ($3,500 per month)
⦁ *This figure may be higher if her salary increases in the last 5 years of working
Defined Contribution Pension Plan
⦁ Contributions are ‘defined’, because both the employee and employer know exactly how much they will contribute each year
⦁ Contributions are based on a percentage of your earnings
⦁ Employers often match the employees contributions
⦁ Pension plans that involve profit sharing or stock ownership are included in this category
⦁ The risk – You don’t know what your pension will be at retirement because it depends on the investment performance of the contributions.
Retirement Savings Plans
Employers may also provide employees various other options in order to save for retirement. See the links below:
Retirement Savings Plans – United States
Money Purchase Plan • 403(b) – Tax Sheltered Annuity Plans • SARSEP – Salary Reduction Simplified Pension Plan • Payroll Deduction IRA • Employee Stock Ownership Plan • Profit-sharing Plan • Governmental Plans • 457(b) – Deferred Compensation Plan • 409A – Nonqualified Deferred Compensation Plan Retirement Savings Plans – Canada
Retirement Savings Plans – Canada
Planning For Retirement
Your Retirement & The High Cost of Procrastination
“One third of adults in the United States have no retirement savings at all, and according to Bankrate.com, the figure is even worse for people age 18 to 29 (millennials) with 69% having nothing saved. This is very troublesome as it is this age group who is expected to feel the biggest impact from both the lack of employer pensions as well as Social Security shortfalls. Since the 401(k) is voluntary, it is included in with personal savings. It has done very little to ease the impending retirement crisis, with the average amount saved a meager $18,433 (CNBC – March, 2015). The program is underutilized and a lack of financial literacy results in the majority of people making the wrong investment choices.” Will Bitcoin Be the Leg That Stabilizes a Failing Retirement System?
The chart below shows the financial consequences to your retirement when you put off starting to save. Anna, Bob, and Carol each save $2,500 a year for 20 years. They each earn interest of 7% compounded annually on their investment. The only difference is the age at which they start.
Starts saving at age 25
Anna stops saving at age 45 after contributing $50,000
Bob starts saving at age 35
By the time Bob starts at age 35, Anna has a $39,459 head start
By the time he reaches age 45, Anna is ahead by $70,204
Bob stops saving at age 55 after contributing $50, 000
At age 55, Anna is now $106,060 ahead of Bob
At age 65, Anna is ahead of Bob by $194,988
Bob would have to increase his yearly contribution to $5262 to match Anna’s final savings total
Carol delays saving for retirement and this procrastination is going to cost her
Carol starts saving at age 45
As Carol makes her first contribution of $2,500, Anna has already saved $109,663
At age 55, Anna is now $176,264 ahead of Carol
Carol stops saving at age 65 after contributing $50,000
At age 65, Anna is ahead of Carol by $294,110
Carol would have to increase her yearly contribution to $9674 to match Anna’s final savings total