Rolling Your Own Pension – Why You Need to Take Control of Your 401(k)
By: Curt Stowers
Where Did Pensions Go?
A generation ago, many— if not most—people had jobs that came with a pension after working +/- thirty years with a company. These pensions, when combined with Social Security, provided economic security in retirement. For most, pensions are now long gone.
In my opinion, there are two main reasons why pensions have faded away.
The Cost of a Pension
First, and I believe the biggest driver, there is the economic reality that pensions are a cost. Companies are constantly evaluating if that cost is delivering value to their customers. Many companies have concluded that this benefit is not required to deliver equivalent value in the marketplace. I am not defending the practice of eliminating pensions. I am simply observing that economics are perhaps the largest driver for the reduction in the number of companies offering pension plans.
Fewer Long-term Relationships between People and Companies
That is because of the second reason—people’s tendency NOT to remain with a single company. In days gone by, a large number of people started and ended their career with a single employer. Pensions were “part of the deal.” However, over time, it has become less and less likely that individuals will spend their entire career with a single company.
Now some will argue that this is a “chicken and egg” relationship—no pension, means no one stays VERSUS no one stays, so no pension. I’m not going to take a side on this debate. I’m simply observing that the lack of long-term relationships between employees and employers has led to a reduction in the prevalence of pensions.
Rolling Your Own (Pension)
Hopefully you will excuse me having a little fun with the “roll your own” metaphor. Those who know me know I abhor cigarettes and have never even though about touching illegal substances. Still, the metaphor works in this case.
With pensions gone,
it is incumbent upon individuals
to take responsibility for their financial future.
With pensions gone, it is incumbent upon individuals to take responsibility for their financial future. Key to this is putting in place a plan to provide income in retirement. Perhaps the most effective, and most commonly available tool to support this endeavor is the 401(k) plan. These plans were started back in 1978 when a new section was added to the Internal Revenue Code.
Since that time, they have grown massively and now house close to $4.0 TRILLION dollars in assets according to the research I did prior to writing this post. That is a lot of dollars! For the remainder of this article, I am going to assume the reader has access to a 401(k) or some sort of similar investment alternative.
Defer Now and Draw Later
Traditional 401(k) plans allow individuals to defer income from taxes now and draw it later in retirement. I’m going to avoid getting into the pre-tax (traditional) and after-tax (Roth) 401(k) discussion here. In either case, the key is that you are DEFERRING part of your income now so that you can DRAW on that income later.
- In essence, you are “funding your own pension,” just as companies used to do on your behalf.
Again, I’m NOT arguing on the morality of companies stepping away from funding pensions, I’m simply stating that if companies are no longer doing so, you need to pick up the responsibility to protect your financial future.
How Much to Save and How to Invest
A disclaimer is in order here—unless I’m your advisor you should NOT take my advice/follow my guidance. What follows are some thoughts and ideas for you to review and discuss with your advisor.
When it comes to how much to save, that’s a very tricky question. It involves looking at your current spending, your current tax rates, your planned rates of return, the time to retirement, and the time you have in retirement. How’s that for a non-answer?
As a rule of thumb,
I have found that saving 20%
of your income is a good [amount].
However, as a rule of thumb, I have found that saving 20% of your income is a good number to target. Here’s how I got to that:
- Start with 100% of your income
- Take 8% off for social security and Medicare.
- It’s actually 7.625%, but I like round numbers.
- Take 24% off for taxes
- You may pay more or less, but this is a reasonable number for many.
- Take 28% off for your mortgage
- That is what banks approve you for/what many decide to do.
- The assumption being in retirement you won’t have to pay this/you will have retired your mortgage.
These three “deductions” leave you with 40% of your gross pay—OUCH!!! I’m arguing that you should put HALF of this aside for retirement and live off of the other half. In other words, for every year you work, you want to fund one year of retirement.
For every year you work
you want to fund one year of retirement.
Again, there are no “guarantees” that this will work for you, but if pressed, I encourage people to start with saving 20% of their income based on this “earn one year, save one year” concept.
That brings us to the issue of how to invest and what returns to expect from your portfolio. Again, unless I am your advisor, don’t rely on me for support in this area!
As a rule, I guide people to implement a diversified (across asset classes), non-active (think index funds or factor-based funds), low-cost portfolio vis-à-vis mutual funds. People will suggest all sorts of numbers for expected returns. Long term, the S&P 500 index has shown around an 8% return. There is NO GUARANTEE YOU CAN OR WILL GET THIS RETURN.
However, if you implement a well-thought-out, diversified Investment Policy Strategy, there is an outstanding chance that you will EXCEED the rate of increase in inflation. This brings us BACK to the “earn one, save one” idea:
- If you’re saving the same amount you’re spending AND you can outpace inflation, you are essentially “funding” a year of retirement for each year you work.
So What Do You Do Now?
This brings us to our call to action:
- Take the time this weekend to review your current 401(k) plan and make adjustments if necessary to ensure you are on track towards building a nest egg for retirement income.
Most plans have tools available. If you’re not familiar with how to perform such an analysis, reach out to someone you know at work, a friend, a family member, or a professional advisor.
You are responsible for your financial well-being. Don’t delay in getting started today!
Would You Like More Support?
- Do you have a well-defined Investment Policy Strategy that is used to drive your investments in support of a comprehensive financial plan?
- If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner while focusing on your desired outcomes?
If so, feel free to send us an email or give us a call. We’d love to have the opportunity to help you find a bit more peace of mind when it comes to investing.
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