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What's Your Retirement Financial Fitness Level?

Originally submitted:  April 19, 2013

A Delaware Voice Submission

Vincent A. Schiavi, CFP®, CPA/PFS

It should come as no surprise that recent studies have found that the number of Americans unprepared for retirement is growing at an alarming rate. While high unemployment and stagnant incomes have contributed significantly, most of the blame can be found right in the mirror. Too many of us are just not disciplined enough to postpone consumption and save accordingly.

A generation ago, significant reliance was placed on employer funded pension benefits to support American workers in retirement. Add a little savings and Social Security to the pension benefit and a retiree could look forward to reasonable financial security. Sadly, pensions have slowly but steadily been abandoned by most private employers. Reliance has shifted to savings plans, like 401(k)s and Individual Retirement Accounts (IRAs), that were designed to supplement, not replace, the traditional defined pension benefit.

When an employer offers a pension plan, there is an obligation to fund the benefit by making periodic contributions to the plan’s investment account. Plan assets are required to be invested in a prudent, diversified manner, designed to grow and meet the promise of a lifetime of monthly pension benefits.

The shifting of a paternal approach to providing worker retirement security to worker self- reliance is what drew me to the profession of objective financial planning thirty years ago. Unfortunately for many Americans, when the retirement security “ball” is passed from the employer to the employees, the ball is being dropped.

When actuaries review pension plans, they will compare estimated future pension benefit obligations to the funds accumulated in the pension’s investment account to meet those obligations. Plans in good shape are considered fully funded; plans in trouble are considered to have an underfunded obligation.

The same approach can be taken by individuals. First, one should estimate how much annual spending will be needed in retirement. Then subtract expected Social Security and any possible pensions. The result is an obligation you will have to fund through your own savings.

Let’s look at a simplified example. Suppose you estimate your current annual living expenses, including any taxes, to be $50,000 a year. This excludes any savings and debt payments you determine, or hope, will not be necessary in retirement. You expect Social Security to be $20,000 a year, and that you will not be fortunate enough to vest in any employer provided pension benefit. That leaves you with the need to fund $30,000 of annual spending in retirement. In this basic example, in order to fund an annual inflation-adjusted withdrawal from your investments of $30,000 a year, studies have shown that an initial withdrawal rate of 4%, subsequently adjusted for inflation, could enable a diversified portfolio to last about thirty years.

So how much would you need in investments to generate the additional $30,000 in retirement cash needs? Let’s do the math. Take the cash need of $30,000 and divide it by the expected withdrawal rate of 4%. The result is a beginning retirement investment balance need of $750,000.

Of course, an income need of $50,000 today will not buy the same basket of goods and services tomorrow because of inflation. If we assume an inflation rate that averages 3% over the next twenty working years of a 45 year old today, he or she will need $90,300 that first year in retirement ($50,000 times a factor of 1.0320 ). If we further assume that the expected Social Security benefit will rise at a rate of 2% to $30,000 a year, the lump sum needed to supplement that will be roughly $1.5 million. ($90,300-$30,000, or $60,300, divided by .04).  

Are you on track to fully fund your retirement cash needs, or is your personal retirement “pension” underfunded and in need of urgent action? I know these saving amounts can seem unreachable, but the answer should not be to throw up one’s hands and do nothing. Doing that only shifts the burden of your financial security to younger family members or social services. If you have not done so already, make funding your retirement as important as any other spending want or need. Make financial fitness as important as your physical fitness. Financial peace of mind is the reward to those who plan responsibly.