In years past, people often would stay with the same employer for 30 or 40 years and retire with a pension. Their retirement income was generally guaranteed through the pension plan, even if they had saved and invested very little on their own. Along with their Social Security benefit, this pension would provide a moderately comfortable retirement.
But pensions began to decline in the 1980s, when corporations began freezing corporate pension plans and no longer allowed new employees access. Corporations no longer wanted to carry the investment risk of funding pensions. During the past decade, many companies have phased out pensions and, through 401(k) plans, have transferred the investment risk to their employees.
Today, few people under 50 years old have pensions. They may yearn for that sense of security, but it is not an option at most employers. This has created more mobility for employees, as they no longer feel tied to a company just so they’ll be vested in a pension. In planning for retirement, however, it has become incumbent upon them to develop their own retirement “pension” by creating an income stream from their own assets. Unfortunately, left to their own planning and without a pension’s known income, investors often spend their retirement assets and end up in a tight spot in the latter years of their retirement.
The risk position of today’s typical retiree is far different from that of pensioners, who generally have had a reliable income stream no matter what happens with their own investment assets and can afford to take more investment risk with corresponding higher potential gains. Those who must depend solely on their own investments as retirement income, however, may never recover from a significant drop in assets and could face a lifetime of lower income. That’s what happened to many retirees in 2008–09.
How can retirees protect themselves from the possibility that they may run out of money? In general, they can invest in lower- risk assets. They can delay retirement, if possible, to build a bigger income cushion in the event of investment losses. Or they can build portfolios that generate significant income. This is more challenging today than in the past. With bond yields low, investors are forced to take on credit and interest rate risks to increase their income. We continue to focus on balancing sources of income to manage each of these risks.
Social security is no longer as reliable either.
For our clients in their early 50s, we project a 20 percent reduction in benefits, just in case the US government does not act to shore up the system. At one time there were more than 10 working adults for each retiree; today there are fewer than three.
The funds that are withdrawn from a worker’s pay have historically been a transfer to the previous generation as retirement income. One way to understand this is that the Social Security that is deducted from your paychecks is effectively a transfer to your retired parents.
The Social Security system is funded as long as there are enough workers to support the number of retirees. As the number of workers declines and that of retirees’ increases, the logical solutions to stabilize the program are to raise the Social Security tax, reduce the payments, or borrow money to pay the benefits. Currently, unfortunately, the government is choosing the borrowing approach. This obviously is not a sustainable way to fund benefits. All retirees, but particularly those in the future, will face declining or stagnant benefits to maintain the program.
A common question among prospective retirees is when to begin taking their Social Security benefits. An entire book could be written on that topic. We suggest that when you are approaching age 62, you should at least go to the Social Security office to review your options. Then we suggest visiting your financial planner to compare notes on what you’ve been told.
You have a lot of options, and properly handling the Social Security decision can result in a significantly higher lifetime income. We generally seek to have clients defer taking their payments until at least full retirement age, assuming they are in good health. The discounted payments you are subject to for taking Social Security at 62 are just too significant for most people.
Where will your retirement income come from? I’d love to hear from you on twitter @DougGrossCFP.
All opinions are those of Douglas Gross and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.