Perhaps the most important concept of retirement planning at one time was the “three-legged stool” of retirement planning. The three legs were:
- Defined Benefit Pension
- Social Security Benefits
- Private Savings
For many years, the theory was that while you shouldn’t necessarily rely on any one of those “legs” alone to secure you a comfortable retirement, taken together these three "legs" were going to make you financially comfortable.
Retirement Planning Then vs. Retirement Planning Now
Many things have changed since the financial planner community began advocating this retirement planning “stool.” The decline of defined benefit pensions has been widely reported. So too has the potential demise of Social Security. Sensationalist journalism aside, it’s safe to say that there will be changes made to the Social Security system and that, for most people, the benefit payments won’t be more generous than they’re currently expecting.
Demographic and Lifestyle Changes Affect Retirement Planning
Life expectancies continue to rise. Early retirements are more frequent, often due to health concerns and layoffs as opposed to dream buy-out packages or lottery winnings. Taken together, these changes mean you’re likely to have a shorter working career and will need to sustain yourself for more years in retirement than members of your parents’ generation.
Therefore, it’s important that you recognize the implications of the changing nature of retirement. Here are four areas of retirement planning to consider:
- Defined Benefit Pensions
- Social Security
- Savings Rate
- Roth IRAs
Defined Benefit Pensions and Retirement Planning
If you are fortunate enough to have a defined benefit pension, treat it like the gold it is. Do what you can to maximize that benefit, be it by working extra hours during your final years prior to retirement (upon which salary your pension benefit is often calculated) or even by working additional years, as another key component of many pension benefit formulas is length of service. You’ll always be grateful for a larger monthly benefit check.
Retirement Planning and Social Security
Although defined benefit pensions continue to deteriorate for private sector workers, nearly everyone qualifies for a Social Security benefit - a defined benefit pension plan itself. Furthermore, this defined monthly benefit is indexed for inflation, meaning that your monthly payment rises over the many years you might spend in retirement.
Now more than ever, managing your Social Security benefit is critical. Take the time to understand the implications of an early retirement. Evaluate whether you can avoid taking your benefit before your normal retirement age and the permanent benefit reduction that comes with it. Coordinate benefits with your spouse to maximize the combined potential payout based on each of your earnings and marital history.
Save. A Lot.
More than anything else, the changes to retirement lead to greater individual responsibility. That means saving more money and doing so in the most intelligent way possible. Here is where qualified retirement plans like regular IRAs, 401(k) plans, and 403(b) plans are so critical. Self-employed individuals should evaluate their ability to increase SEP-IRA contributions as well.
Max Out Your Roth IRA
Given the importance of saving, one retirement planning vehicle stands above the rest: the Roth IRA. Its tax-free nature is an extraordinarily powerful incentive and enabler once you reach your golden years. Take maximum advantage of the Roth IRA and you can create a sizable account balance you to tap in retirement as you wish – tax-free.
