Fixing the 3-legged retirement income stool for tomorrows seniors

By Kirsten L. Falk

For years, the conventional wisdom about retirement income was that it could be compared to a 3-legged stool: the first leg was a pension or employer-sponsored retirement program; the second leg was Social Security benefits; and the third leg was the individuals personal savings.

Because the United States has one of the lowest personal savings rates in the world, planners in the past have focused on warning those approaching retirement of the danger of a 2-legged “retirement income” stooli.e., entering retirement without having the third leg of personal savings.

In the current political and economic environment where politicians are planning sweeping changes to the second leg, even to the point of declaring that there is no trust fund for Social Security, seniors may find that if they are to have a 3-legged stool, they may have to provide 2 of the legs themselves.

In all probability, future retirees will continue to receive Social Security benefits of some sort. In fact, many of the proposed plans would not affect the benefits of those who are already retired or are currently 55 or older.

However, for those under 55, there is increased likelihood that benefits will be reduced. That is very bad news as a large number of currently retired Americans derive a significant percentage of their income from Social Security payments. Because so many of those who have not yet retired have inadequate personal savings, a reduction in Social Security benefits would be devastating.

With such a bleak outlook for future retirees, is there any way to prevent a scenario that has seniors flipping burgers at a fast food restaurant when theyre 80 years old? Is there anything that advisors can do to help their clients construct a more stable retirement income stool?

The answer is emphatically “yes.” It truly is never too late to improve the prospects for a clients future retirement.

If the amount of the clients current accumulated retirement savings is not substantial, that future may not include cruises around the world or a second home in Aspen. However, anything that advisors can do to help clients maximize current savings will result in a more comfortable retirement.

Perhaps the first thing advisors can focus on is the clients current spending habits. Many people will protest that they cant afford to save more because they dont have anything left after paying the bills.

Although it may be true that some people have nothing left to save, in most cases, clients have expenses that they could reduce to earmark more for savings.

For instance: Are they currently paying for services they dont really use like premium cable TV channels or a flat monthly fee for unlimited long distance on a traditional phone line? Many people sign up for such services, only to find themselves watching very little on the premium channels or using their free cell phone long distance minutes instead of the traditional phone service.

Dropping the premium cable TV channels could save $10 to $20 a month, while dropping flat fee long distance could save another $20 or so. Thats a potential maximum savings of almost $500 a year without sacrificing a thing.

A few other savings could be realized by using free services, such as getting best-selling books or movies from the library, instead of buying or renting them. Not purchasing one hardback book a month would save roughly $250 a year, while not renting one movie a week would save another $250 or so.

With just these few simple changes, an advisor can help a client find $1,000 to save for retirement.

Once clients start examining their spending habits, with the advisors help, they will be amazed at all the ways to save money without too much of a sacrifice. Chances are that looking at all of their expenses will yield additional savings on expenses that can be turned in to retirement savings.

Now that they have found the money to save, where should the advisor advise them to put it? Keeping in mind that the goal is to help the client construct a stable retirement income stool, the focus will be on helping the client shore up the personal savings leg and the Social Security leg.

The most cost effective way to strengthen the personal savings leg is through maximizing contributions to tax-deferred retirement programs such as the employers 401(k) plan.

For example, assume that the client has “found” an extra $2,000 in annual savings by examining his/her expenses. If the client then puts that amount put into a 401(k), this would result in an annual before-tax deposit of $2,400 for someone who pays 20% in federal and state income tax. Over the course of 10 years, the total contribution would be $24,000; if your client earns a modest 5% annual return, the sum total at the end of 10 years would be $31,696. Without dramatically affecting current lifestyle, the client will have strengthened the third leg of the retirement stool.

As for that second leg, Social Security, today it might be safer to think of that leg of the stool as a combination of Social Security and additional personal savings.

But, since Social Security payments traditionally have been a guaranteed monthly income with periodic cost of living increases, the best way to strengthen that leg with personal savings may be to add another guaranteed monthly income payment purchased with personal savings. In other words, the advisor may want to advise clients to contribute to a deferred annuity. This is particularly true if they have saved the maximum amount that they can in before-tax dollars.

Although savings put in to an annuity would be after-tax dollars, the annuitys earnings would be tax-deferred.

This second leg could end up being the most important leg, because it would consist of predictable income that clients can depend upon to meet basic needs during retirement.

For that reason, the advisor would want to help the client estimate what the minimum income need will be in order to determine the amount of personal savings needed to supplement the projected Social Security income.

If a client is unable to save an additional amount for this leg of the stool, the retirement plan might call for converting part of the tax-deferred savings to an immediate annuity upon retirement. Because the purpose for this would be to create a stable retirement income stream, the best type of immediate annuity might be a fixed or equity indexed annuity.

In a sense, clients will be creating their own “trust” by strengthening the second leg of their retirement stool.

No matter what changes are made to Social Security, by helping clients find ways to save a little more now for a lot more in the future, the advisor will have helped them to construct a more stable 3-legged retirement stool.

Kristen Falk, FLMI, AAPA, ACS, AIAA, AIRC, ARA, is a senior writer with LOMA in Atlanta, Ga., and currently writes online courses for LOMAs E-Learning Web site. Her e-mail address is falk@loma.org.


Reproduced from National Underwriter Edition, April 15, 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.