The traditional three-legged retirement stool – consisting of pensions, personal savings and Social Security benefits – is looking wobblier than ever.
Defined benefit pension plans, which have been disappearing for some time, are now on the verge of extinction. Just 8 percent of private employers offered pension plans in 2017, according to the U.S. Bureau of Labor Statistics. Employers have largely shifted to defined contribution plans that place the retirement savings responsibility on employees, and for 69.5 percent of these companies, a 401(k) is the plan of choice, according to Callan's 2017 Defined Contributions Trends Survey.
The long-term outlook for Social Security threatens yet another one of the stool's legs. The Social Security Board of Trustees projects that by 2035, the program will only be able to pay out 75 percent of scheduled benefits to retirees. Those already close to retirement may not have to contend with lower benefits, but rising prices could still erode their purchasing power.
"The lack of a pension, coupled with Social Security not keeping up with inflation, will leave many baby boomers worrying that they may outlive their assets," says Bill Van Sant, senior vice president and managing director at Univest Wealth Management in Souderton, Pennsylvania.
For everyone else, the retirement stool is looking more like a pedestal, with the leg for pensions chopped off and the one for Social Security coming up short. For those younger than baby boomers, personal savings will need to be the strongest leg to meet income needs in retirement.
Unfortunately, for many savers, personal savings often end up being the weakest link, says Keith Ellis Jr., investment advisor representative and co-founder of SHP Financial in Plymouth, Massachusetts. "Many people are unaware or have incorrectly estimated how much money they'll need to live comfortably in retirement." The result is that savers face more pressure than ever to shore up their retirement savings stool.
Do the math. Retirement is a numbers game, and if the pension leg of your stool is represented by a goose egg, the other two legs had better compensate. This is where understanding your projected Social Security benefits, retirement income and savings needs becomes paramount.
In 2018, the maximum Social Security benefit for someone retiring at full retirement age is $2,788 per month. If your retirement is decades away, that figure may be higher, but don't assume it will be enough to compensate for the lack of a pension. Inflation, for example, could take a large bite out of your benefits. Financial research organization LIMRA estimates that a 2 percent inflation rate could result in a $73,000 shortfall over a 20-year retirement.
Although deferring Social Security until age 70 could yield a larger benefit amount, personal savings should still be the main priority. Calculating your target savings number is a critical step. "Not knowing how much you need is like preparing to jump out of an airplane unsure if your parachute will fail," says Barry Bigelow, lead advisor for Great Waters Financial in Duluth, Minnesota.
If your target number is much higher than what your current savings rate can keep pace with, even when Social Security is included, there are two remedies: increasing your savings rate and reducing expenses. It's also important to understand how the various pieces of your plan fit together, such as "how spending affects withdrawal needs, which in turn affects taxes," Bigelow says.
Realize your tax-advantaged savings potential. In the absence of a pension, tax-advantaged plans may become the cornerstone of your retirement strategy. To get the most out of them, you'll need to maximize your savings rate, minimize fees and choose risk-appropriate investments.
Bigelow says savers often get the balance between risk and taxation wrong. "Tax-advantaged accounts like Roth IRAs should, in most cases, be your highest level of risk in your portfolio," he says. The reason? Higher risk often translates into higher returns, and with a Roth IRA, distributions of gains would be tax-free in retirement.
Holding the same investments in both taxable and tax-advantaged accounts is also a mistake. "Taxable accounts need to be invested in a way that accounts for unforeseen taxable transactions," such as the reinvestment of dividends and interest, Bigelow says.
Chasing recent performance is another error retirement savers can't afford. "If you're investing based on last year's returns, you're investing in the past, not the future," says Mark Cross-Powers, regional manager for New Hampshire at People's United Wealth Management. At the same time, it's important to choose investments that correspond to your risk tolerance and investment horizon. "Asset allocation and diversification work, and as smart as you or your advisor is, nobody can tell with absolutely certainty what's going to happen."
Nick Strain, senior wealth advisor at Halbert Hargrove in Long Beach, California, says savers should broaden their horizons beyond a company plan. That means having liquid savings you can access for medical expenses or emergencies. "Remember, you're trying to create an efficient cash flow strategy in which you can control the tax burden as much as possible throughout your retirement."
Add a new leg to your stool. Diversifying your income streams can strengthen your retirement plan. Adding dividend-paying stocks or a rental property to your portfolio, for instance, can generate consistent income for retirement. An annuity that provides lifetime income is another option.
If you're considering an annuity, understand the different types, Ellis says. With immediate annuities, for example, your income payments begin right away. Deferred annuities, on the other hand, begin paying out at a future date. Annuity returns also can vary. A fixed annuity offers a conservative guaranteed rate of return, whereas a variable annuity's returns fluctuate with the market.
Van Sant says annuities can solve specific income needs, but investors should be aware of surrender periods, contract charges, limitations and investment risk. Like any other investment, weigh the advantages and disadvantages before considering an annuity to shore up your retirement stool.