A good retirement plan should have three components

By Jack Bobo

The current debate on Social Security should have at least one beneficial effect. Hopefully those who are following the discussions, particularly lawmakers, will develop a better understanding of what the system is and how it works. In my years in Washington I was struck by how few people on Capitol Hill and elsewhere had a firm grasp of what was happening. The best remedies come when there is full knowledge and politics are set aside. That may be too much to hope for, however.

One important element to the discussions that should be of paramount interest to the public is not receiving the attention that is needed. I refer to the fact that Social Security is not now and never has been a retirement plan in and by itself. Alone it does not provide security but rather a base upon which true security may be built. In the past the program was intended to replace 32% of covered wages. The last number I have seen showed the replacement ratio currently at about 40%. Given todays longer life expectancy, that is not adequate for anyone and even mild inflation would soon make life even more difficult. Even pension supplements may be inadequate to maintain a healthy and interesting lifestyle.

More needs to be said about what we used to call the “three-legged stool” concept of providing for retirement. Simply stated, a good retirement plan should have three components: Social Security, employer plans and private savings. Any shortage of one leg of the stool must be compensated for by the other two. But for sure, its hard to sit on a one-legged stool.

The leg that I would like to address here is private savings. Despite the creation of IRAs of various types, as a country, we remain one of the lowest, if not the lowest, in savings rate among industrialized nations. Some studies have shown that IRAs did not create new net savings; rather they just shifted money from taxed accounts to tax-favored accounts. Moreover, tax incentives have more appeal to high-bracket taxpayers and that is not where the current problems lie. Median income for IRA holders is $62,500, whereas for non-IRA owners it is $35,000. IRA holders also have significantly greater additional assets. But even IRAs are losing popularity, with 25% less new money flowing into them compared to the mid-1980s. True, 401(k)s have taken up some of the slack, but again, primarily with high-wage earners. It will take more than tax savings to solve the problem.

President Bush has proposed the creation of “Lifetime Savings Accounts” to boost the individual savings rate. Given the ease with which savings can be withdrawn prior to retirement, the idea has been described by some as a tax-free checking account.” That is not likely to lengthen the critical leg of our three-legged stool.

The first sales track that I learned when I was new in the business dealt with the vulnerability of savings accounts that were accessible when temptation arose. We described the typical savings plans as “roller coasters”an apt description since statistics at the time showed that very few accounts sustained long-term growth. I believe this is still true, for most people have been far more aggressive in acquiring debt than savings. Banks, which should be champions of thrift, have played an important role in this. The promotion of credit cards, easy credit and encouraging people to experience the good life by cashing in on the equity in their home, either through a home equity loan or by refinancing their existing mortgage, have reached epidemic proportions. All typical examples of spend first and save last.

Offerings from the stock market too often appeal to the “strike it rich” mentality. There is nothing wrong with that if your house is otherwise in order and you can afford the associated risks. Ben Franklin, the exemplar of the value of savings, said it best: “He that waits upon fortune is never sure of a dinner.”

For most people, retirement is a future event and the most important part of money for future delivery is “will it be there.” The second most important thing is “how much.” Guarantees are very importantjust ask the folks who used to work at the Studebaker Corporation, whose retirement plan evaporated when the company went broke.

I believe now and always have believed that the double duty dollars of cash value life should be the most important component of the individual savings leg of our stool. There are, of course, tax advantages to life insurance, but that is not the main reason it persists and works well as long-term savings. It meets the criteria that there is value if you live, die or quit, three possible scenarios. There are dollars for emergency wherein you can be your own banker. There are strong incentives if you continue long term and forfeitures if you dont, both of which inject an element of discipline.

Our track record is good, we have kept our promises, but somehow lately we have gotten off the track. Getting back on track will not save Social Securitybut it will strengthen our leg of the stool.


Reproduced from National Underwriter Edition, April 8, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.