The Four-Legged Retirement Stool

Here's an interesting article that says what used to be the three-legged stool of retirement (Social Security, pensions and personal savings) is now a four-legged stool of retirement (Social Security, employer retirement plans, home equity and work.) We'll start with their thoughts on Social Security:

With all of the hand-wringing over Social Security, one simple fact appears to go unrecognized. Even with absolutely no reform of the system--an outcome most believe to be implausible--Social Security is likely to pay 70% to 80% of promised benefits in perpetuity (depending on whose estimate you believe).

The notion that Social Security is disappearing as part of the American retirement landscape is simple nonsense. It makes good headlines--as when journalists reportedly cited studies of 25-year-olds who "don't believe Social Security will be there for them." But when did the opinions of 25-year-olds on retirement policy become a meaningful barometer of the future?

I'm not 25, but I am certainly one of those who's counting on nothing from Social Security. If I get something, great, that will be icing on the cake. However, I'm not putting my retirement at risk by relying on a program that may or may not exist, which may or may not change its requirements, and which pays out a pittance anyway.

And speaking of pittance, here's their next thought on what will happen to Social Security:

Although the debate on Social Security's destiny has been fractious, it seems clear where the political solution lies. On the benefits side, some type of progressive price-indexing will be introduced--which means that high-income households will see a meaningful reduction in their scheduled benefits, middle-income households may see a smaller reduction and low-income households will be unaffected. Private accounts may also be part of the solution; my guess is they'll be on an optional basis-in exchange for some tax increase needed to finance the system.

Great. Just great. All I read in this is that my benefits will be cut and I'll be paying more in taxes to the system. Just absolutely, wonderfully marvelous.

Have I mentioned lately how much I hate this program? It's a real head-banger -- paying tons of money year after year into a system that will eventually give me less and less of a return.

But I'm trying not to turn this into a rant -- let's move on. ;-)

Next they talk about "leg two," employer retirement plans (defined contribution plans -- 401k, etc.) The piece says that people are behind in saving in their 401ks and the like, but that they expect this trend to reverse as more people are covered by defined contribution plans. Their thoughts:

Most forecasts show that current workers will spend much more of their careers in account-based retirement programs, accumulating more sizable asset pools by the time they reach retirement. That's even after adjusting for all of the inevitable frictions, such as job changes and spending sprees.

Personally, this is the leg of the stool I'm banking on the most (in addition to saving in taxable accounts.) I'm counting on two things -- my own savings and investing -- to help me reach my retirement number.

Next they come to the two new legs of the stool -- home equity and work. I'm skeptical of both of these, but we'll address that as they come up. Here's what the piece has to say about home equity and how reverse mortgages can/should be used to help fund retirement:

Home equity is the largest untapped resource at the boomers' disposal. Most individuals don't access their home equity during retirement today. Some appear to free up equity by downsizing early in retirement. Others use home equity later in life--especially when they or their spouses enter nursing homes. Yet 80% of older Americans own their homes, and for the median U.S. household, 20% of its total wealth is in home equity.

Currently, the reverse mortgage market is stymied by concerns about misselling, high costs and complexity. But with additional standardization at the federal level and some private sector ingenuity, using home equity as a source of income will be a useful supplement for many boomers short of income during their retirement years.

I am not a big fan of reverse mortgages and I view them as a last resort. That said, I do like the downsizing option and I think we'll probably consider that as a way to free up equity when our kids are grown and out of the house.

Next is the last leg of the stool -- work. First, they note that many people are working longer:

More than 40% of 65- to 69-year-olds are still generating earnings from work, and it's the same for about a quarter of individuals in their early 70s, according to the Social Security Administration's 2002 Income of the Aged Chartbook. The transition from the world of work to that of retirement is increasingly gradual. For many, retirement isn't a period of permanent leisure, but a period of leisure accented by work.

In addition, they show that working longer is a big help in paying for retirement -- a concept I agree with:

Working for several more years is one way to close a retirement savings gap. Delaying retirement for such a time dramatically reduces financial risks in retirement. A longer period of work means better Social Security payouts, more savings, additional investment returns and--for the few covered by pensions--potentially greater benefits. It also means fewer years of retirement spending. (And if your employer picks up health insurance costs, that's even better!) Indeed, one of the most basic financial dangers people face at retirement is the risk of retiring too early.

Yet they recognize that not everyone who wants to work will be able to do so:

Of course, not everyone will be able to continue to work--especially those with debilitating health problems. But broadly speaking, older Americans are much healthier than they've been in the past. They're also better educated. As a result, many are more capable than their parents of remaining in the workforce for long periods of time.

I think they're right and they're wrong. They're right in saying that more people will be able to work longer (and will choose to do so.) They're wrong in that for many (maybe even most), working longer isn't practical or realistic.

Overall, here are my thoughts on the four-legged stool of retirement savings for my family:

• Social Security -- We won't count on a penny from it. If we do get it, that will be a nice addition to our already-saved-for retirement.

• Employer plans -- I'm socking away the maximum in my 401k, contribute to a SEP IRA each year, and even make non-deductible IRA contributions. (Unfortunately, I'm excluded from investing in a Roth IRA.) I also save in taxable accounts.

• Home equity -- We won't likely use a reverse mortgage, but will seriously consider downsizing our home.

• Work -- I'd love to be able to work for a non-profit for free -- for no salary at all. That's the goal I'm shooting for.

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Comments

[Mike]

I wonder how many of the 40% of 60-69 year-olds who are working had retired from a good job at the age of 62 and then discovered they didn't have enough from Social Security / pensions / savings to get by.

Perhaps if they'd waited a few years to retire and continured their good job, they'd now be comfortably retired instead of working now at a job where they spend all day asking "Do you want fries with that?" for minimum wage.

[Scott Wincklhofer]

Just a few comments on the original article (I agree with all your points).

1. They're always talking about the home equity boomers have in their houses. But what they fail to talk about is that the boomers represent a large majority of the current population. Who's gonna buy all these boomer homes so they can downsize? Sounds like a lot of lost equity to me.

2. "For many, retirement isn't a period of permanent leisure, but a period of leisure accented by work." Should be -- for many who trusted in the pension system, retirement will be short period of leisure broken up by minimum wage jobs to scrape by.

[Lord]

There is no such consensus on SS solutions. The only element on which there is broad agreement is eliminating the wage cap on contributions. This would almost entirely eliminate any funding problem, but I would recommend waiting until 2018 to commence with it.

The difficulty with savings is that with current limitations it won't be enough for those that do, and many won't anyway. It is really necessary to save outside of retirement plans to save enough.

Home equity can be part of the solution. The US population won't fall in the forseeable future, only stabilize. I would recommend depleting your other assets by 85 and only then cashing in on it.

Work is more myth than reality since only minimum wage work will be available to anyone who loses their job after 50 and those who don't lose their jobs will most likely be able to retire on schedule.

[Lord]

The number one problem with SS solutions is that they have to be better than doing nothing, and frankly, doing nothing has beat out every solution offered to date.
I would rate doing nothing as superior to the position offered.