If you are like most American’s, you may feel a bit behind in your retirement savings. You may feel a general lack of preparedness for this next stage of life. If you are less than 10 years away from entering your Golden Years, a feeling of needing to catch up could even be keeping you up and night.
Before you know it, that day will be here. It's time to get going!
Get on the road to financial health by learning and addressing some important principles.
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 a 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 lived his life that way and I’ve benefited from his rugged individualistic nature always trumpeting the virtues of self-reliance.
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 - 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.
Employer Retirement or Pension Plan - 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.
Quick Test: 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.
Personal Savings - 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.
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 largely not available. 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!
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 this 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 might overlap or not 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, 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.
Over the years, we have helped many clients gain clarity over their financial lives. 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.
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. 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.
Say, you save $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 can't rely on rate of return. 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.
$30,000 is better than $10,000, but many would still say this disappointing. Most Americans are destined for this result because they are pursuing what is termed, an “Assets Only Retirement.” This means their retirement assets are largely positioned in market-based accounts like a 401k.
However, what if I told you that 5%, 6%, 7% or more 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 $60,000 or more per year in retirement. This is a central secret of catching up! Meaning the same amount of savings producing far more retirement income.
To achieve these stronger income rates and make your retirement savings more efficient, 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 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 5-7% income rate. I hope you are taking notes because I just showed you a way to significantly increase your income in retirement.
We have discussed three helpful tips today! 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 are 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.
Mark McKell is the Managing Partner of McKell Partners, a full-service wealth management practice. Its mission is to “Help individuals and families experience financial peace so they can focus their lives on what matters most." Mark is focused on providing the personalized financial services retirees and pre-retirees need to combat the risks associated with retirement.
With a BS in Accounting from Brigham Young University, Mark has worked as a financial professional since 1985 and has acquired a depth and breadth of knowledge that comes from over three decades of experience in a variety of financial arenas. Those arenas range from public accounting with Ernst & Young to positions as a corporate controller, CFO, and CEO. In 2001, he decided to devote his experience and training to helping people with their personal financial goals.
Away from work, Mark is a dedicated family man and committed to his church, country and community. He and his wife, Susan, have been married for over 35 years, and have four married children including six wonderful grandchildren.
To learn more about McKell Partners and their services, simply visit mckellpartners.com. Visit Mark’s personal blog at markmckell.com where he shares his thoughts about what matter most.