When it comes to retirement planning, one size does not fit all.
You cannot take a cookie cutter approach and expect the results to fit your individual needs. There are so many variables that can have an impact on a person’s particular situation. In addition, there are many complexities today that we were not aware of or did not exist years ago.
As recently as 1985, retirees relied on Social Security for 65% of their retirement income. That number is now down to 27%, putting more of the responsibility on the shoulders of retirees.
Some of those are changes in the type of pension plan most often utilized as well as the overall availability of plans, an increase in longevity, increased costs for healthcare, an increase in the number of people (especially young people) changing jobs and the declining dependency on Social Security.
Types of qualified plans
Qualified plans are still the best vehicle for accumulating retirement funds because of the tax deductibility of contributions and the fact that employers often contribute to the plans. There are two general types of qualified retirement plans: defined benefit plans and defined contribution plans.
Defined benefit plans provide retirement income based on a formula that takes into consideration your age at retirement, your final average income over a period of years and your years of service. Most, if not all, of the plan’s contributions are made by the employer. Since it is based on a pre-determined formula, the benefit is easy to estimate.
For small, closely held businesses, where the principals are usually older and have significantly higher incomes, a defined benefit plan can be a great approach for the business owners.
Defined contribution plans, also known as money purchase plans, provide a benefit based on the value of the funds as well as the individual’s age at retirement. The most common example of these plans is a 401(k). Unless the funds are in a fixed interest account, market fluctuations will impact the retirement payout. These plans are usually funded either partially or entirely by employees. Profit Sharing Plans, IRA’s and Roth IRA’s are also types of defined contribution plans.
For employees who stay with one company, defined benefit plans often offer a better option since more of the funding comes from the employer and the benefit is more predictable. The trend, however, is toward defined contribution plans since the year to year cost can be better controlled by the employer. As of 2018, 58% of full-time employees had access to defined contribution plans only, 16% both defined contribution and defined benefit plans and only 3% defined benefit only. This means that less than 80% of full-time workers have pension plans available and less than 20% participate in defined benefit plans.
Factors That Go Into Planning
People are living longer and so have a legitimate fear of running out of money. The life expectancy of a 65 year old has increased by over 20% since 1990, thus requiring greater contributions during the earning years. There are (at least) two ways this can be addressed. Build up an account that will, at least initially, generate enough income so you do not have to dip into principal. An alternate approach is to plan on using annuities that can provide lifetime income, no matter how long you live.
The first approach requires you to accumulate a bigger retirement nest egg. However, it also provides a hedge against inflation since you can ultimately start drawing down some of the principal.
Annuities need less funding but most do not address the issue of inflation. Also, if you choose the annuity approach, you may need to consider a payout option that includes your spouse/significant other since a standard annuity payment ends upon the annuitant’s death. There are some annuities that offer increasing payments but that may require receiving lower payments in earlier years.
With people living longer and families more spread out, there is a greater likelihood that someone will need some sort of long-term care. According to the Centers for Medicare and Medicaid Services, about 60% of people over 65 will require some type of long-term care services during their lifetime. More than 40% will need care in a nursing home for some period of time.
Longevity also increases the risk of dementia, making someone more susceptible to scams or money mismanagement, so that needs to be included in the planning process. It makes sense to turn over partial or full control of your funds to a trusted family member at some point to avoid this.
Most people will lose their health insurance coverage when they retire. With the cost of insurance growing at a much greater rate than inflation, this needs to be considered when projecting income needs. In addition to paying for parts B and D of Medicare, a Medicare Supplement plan and prescription drug plan are also important.
Based on an estimate by Fidelity, an average couple retiring today will need $280,000 to cover healthcare and medical costs in retirement. For single retirees the estimate is $150,000 for women and $135,000 for men.
It is an increasingly common practice for people to change employers as a means of improving their compensation and having better career opportunities, especially when they are young and relatively new to the business world. Often little or no consideration is given to the effect the move may have on future retirement benefits. This is a big shift from a time when a person would typically spend years with the same company and would retire with a reasonable benefit.
Although any pension contributions made by an employee are his or hers to transfer or rollover, the majority of pension plans have a vesting schedule that limits the amount of company contributions that are available. In the case of a 401(k) plan, when an employer matches employee contributions, some or all of those funds may revert back to the employer if the employee is not 100% vested.
There are many who feel that Social Security will not be available when they retire. Although that is an extreme position, the likelihood is that in the future Social Security will look different than it is today.
Changes in demographics are having a negative impact on the Social Security Trust Fund with a smaller workforce having to support an increasing number of retirees. Increasing life expectancy adds to this problem. Projections say that the Trust Fund will be insolvent sometime between 2033 and early 2040’s. After that time, income will cover about 77% of scheduled payments. Though this is clearly not ideal, it is not as dire as the predictions that say there will be no Social Security in the future.
Financial/retirement planning has a lot of moving parts and needs to be continually tweaked during the accumulation period. You need take advantage of tax qualified investment vehicles if available, especially when employer funding is involved. Where employer contributions are dependent on those of employees, as in many 401(k) plans that have matching contributions, employees should be sure they receive the maximum matching payments.
Bob Ehnert is the owner of the Ehnert Agency, a full-service life and health insurance agency that specializes in retirement planning, life insurance planning and retirement and estate planning.