Finding Retirement Security Beyond the Pension
As we age, it’s natural to romanticize the past – first cars, first loves, and what seemed like simpler times. One common belief I’ve heard from clients is that previous generations had it easier in retirement, largely because of pensions. I remember one client in particular who was always saying how lucky his father was since he didn’t have to worry about saving for his retirement. He remembers hearing him talking about his pension. Many of the previous generations had defined benefit retirement plans, which we simply called pensions. Pension plans provide employees with guaranteed retirement income for their lifetime.
Some retirees chose not to elect the guaranteed income option and instead rolled their pensions into IRAs, investing the funds as they saw fit. Today, relatively few private companies offer pensions, though they are still common in many government and education roles. Generally, pension payouts were based on a combination of factors such as retirement age, income at retirement, and years of service. Most retirees chose the guaranteed monthly income for life, although many pensions did not include cost-of-living adjustments. Another defining characteristic of previous generations was job longevity. Employees often stayed with the same employer for 20 or 30 years, or even their entire careers, allowing them to maximize their pension benefits. Pension vesting rules also played a role, as they determined when employees earned the right to their full benefits, discouraging frequent job changes.
Today’s workers have more flexibility. Since most are not tied to their jobs because of pensions, they generally will change jobs for higher salaries. The U.S. Bureau of Labor Statistics in January 2024 stated the average number of years that workers have been with their current employer is 3.9 years, down from 4.1 years two years earlier. Today many employers offer a 401(k) plan, which is a retirement plan where contributions are defined (how much you are saving), but benefits depend on investment performance.
This has allowed employees to jump from one job to another for higher pay while taking their retirement money with them. Today, when someone leaves their job, they can always take the money they contributed to the 401(k) plan and any employer matching contributions if vested. Most 401(k) plans have a vesting schedule, which refers to the rules of earning ownership of the employers’ contributions to the plan. Some 401(k) plans offer immediate vesting, meaning you own all contributions right away.
The wistful feeling about previous generations was the comfort they had due to guaranteed monthly income covering their expenses at retirement. On gathering information for a financial plan, the subject of covering expenses would come up. By reviewing one’s banking statements, we would break down their fixed and variable expenses. Fixed expenses are those that are recurring monthly with little variation. We would then look at their Social Security projected amount to see what the shortfall would be to cover these retirement expenses. To cover the projected shortfall, we discussed taking a partial lump sum from their retirement plan to purchase a pension annuity. A pension annuity is also called a Single Premium Immediate Annuity (SPIA). This would be done by rolling over a portion of their retirement plan to purchase the desired monthly income for funding the shortfall. The SPIA can provide guaranteed lifetime income for the worker or the lives of both the worker and their spouse. By covering their fixed expenses, they also could have peace of mind like previous generations.
There were times when someone would say they are risk averse and loved the idea of placing all their retirement plan into a SPIA. I generally would not recommend this since they would be happy at first, but down the road inflation would erode their purchasing power; meaning their monthly income would not keep up with inflation. Once the fixed expenses were addressed, we would then look to cover variable expenses. These are expenses that change in amount and frequency such as groceries, dining out, travel, gas, utilities, home maintenance, etc. You know what has happened in the past several years with grocery prices escalating and, of course, energy prices increasing due to geopolitical events.
Once a portion of assets has been allocated to fund a SPIA for fixed expenses, the remaining retirement savings can be rolled into a brokerage IRA. While some may worry about “putting all their eggs in one basket,” it’s important to understand that a single IRA can still be highly diversified. Investments are typically spread across multiple asset classes—stocks, bonds, and cash—often through ETFs and mutual funds. Since their basic fixed investments were covered by the SPIA, they could take a little more risk with the balance of their portfolio. Maybe instead of a capital preservation portfolio (40% stocks, 60% bonds and cash), which is common among conservative retirees, they could increase their risk to a 50% stock portfolio.
With the stock markets at or near their all-time highs this Memorial Day, the bonds and cash in a portfolio can provide peace of mind knowing there is also enough liquidity to wait out any market correction. There is no universally accepted definition of a correction, but most consider a correction when the stock markets have fallen more than 10% but less than 20% (that would be a bear market) from a recent high.
Now that you can visualize splitting your retirement accounts to provide flexibility and income, I want to address another question that often came up discussing a client’s retirement. Approximately 50% of couples wind up divorced. You have accumulated wealth even though you had to split your retirement savings with your ex-spouse. Now you are dating again, and you may want to leave this person a little something, but you do not want your adult children to know about it. Similar to splitting your retirement plans between a brokerage account and an SPIA, you can do the same thing by creating IRAs with different beneficiaries. You can name your adult children as beneficiaries on one IRA while naming your new love as the beneficiary on another IRA. The percentages can be unequal and can also be adjusted over time.
There is no one size that fits all when planning for retirement. One thing is certain: When you are ready to retire, you will want to make sure your money will last for your lifetime. Don’t procrastinate, take the time now to make sure you have a wonderful life in retirement.
Now that you have started the process, reward yourself by heading to the beach with your favorite beverage, book, and chair.
Fred Dunbar, CLU®, ChFC®, RFC®, AIF®, is the former President of Common Cents Planning. Fred’s team may be contacted at 610-361-0865, by e-mail at info@commoncentsplanning.com or by mail at 239 Baltimore Pike, Glen Mills, PA, 19342. Investment advisory services offered through Planning Directions, Inc., d/b/a Common Cents Planning a Registered Investment Adviser. Fixed insurance products and services are separate from and unrelated to Common Cents Planning.
This commentary is meant for general informational purposes only and is not intended to be a substitute for professional financial, tax or legal advice. Investing involves risks including the potential loss of principal. Past performance is no guarantee of future results. All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.
