By David Howard, Financial Advisor at Simasko Financial
The times are certainly changing, and not for the better.
For previous generations, retirement was simpler. Graduate from high school and college, secure a job, work up the corporate ladder for 20-30 years and then retire, with a sizable pension and Social Security income, allowing the nest egg saved up from employment to be passed down to their heirs, mainly intact.
To previous generations, having income in retirement was virtually a guarantee. Moving forward, retirees cannot make the same assumption. When Social Security was established in 1935, it was designed for individuals to pay into the system more than they would ultimately receive in retirement. For newborns in 1930, the life expectancy was 58 for men and 62 for women, respectively. With a retirement age of 65, those who lived to see retirement weren’t expected to receive benefits for very long.
Eighty years later, life expectancies have increased to 76 for men and 81 for women, an increase of nearly two decades for each sex. People are living longer with each passing decade, yet the retirement age has remained unchanged. Entitlements is now the largest portion of the federal budget, totaling 5 trillion each year, with Social Security accounting for 1 trillion. The looming federal debt of nearly 20 trillion conjoined with future political policies will inevitably cause the destruction of the entitlement system, unless the current structure is completely changed. There are only two counters to this epidemic that can be controlled by retirees; how long they work and how well they save for retirement.
The first and less enjoyable solution to retirement planning is to accept that we must work much longer than prior generations in order to achieve our goals. This can be done in several ways; by staying longer at a career-long employer into our seventies, starting up a side business or a full-time business in the twilights of our careers, or even continuing to work part-time after we retire. We all will inevitably work well into our seventies before we have ample retirement savings.
The second and more difficult solution is to take retirement into our own hands. Starting from the very beginning of our careers, we all should be saving as much as we can and as often as we can. Roth IRAs might be the single most underused investment vehicles that have the largest opportunity from a career-long perspective. They allow after-tax dollars to be invested and grow tax-free, without a required minimum distribution once an investor turns 70 ½. These are essential to be maximized in the early years of a career for two reasons; a reduction of taxable income from a traditional IRA is not necessary (most people won’t drop a tax bracket from doing so), and there is a phase-out for Roth IRAs. Once investors reach a certain level of income each year, they can no longer take advantage of these investment vehicles, leaving only corporate plans and after tax accounts available to fund retirement.
Many investors have a difficult time deciding between investment accounts, and which ones should take priority when they only have so much they can afford to contribute in a given year. Most people make the common mistake assuming that corporate plans, like 401k’s, are always more beneficial than individual IRA’s. Although they certainly can be, depending on the company that is offering one, most fall short of what individual retirement accounts can offer. The most important factor in deciding between the two is the employer match. Free money is always nice, but the majority of 401k plans only match for a small amount compared to the annual limit you may contribute each year. Therefore, investors should contribute to 401k plans up to the match, then max out individual retirement accounts, with any remaining investment going towards after tax accounts.
Equally important to funding investment accounts is how they are invested and managed. Far too many corporate plans offer a limited selection on what can be invested, with an even lesser amount of guidance provided to employees who are selecting what they will hold and maintain for 20-30 years. This reoccurrence may leave the majority of corporate plans in shambles if a retiree ends up entering retirement during a recession or downturn in the economy.
Because of this, developing a relationship with a financial professional early in a career is becoming essential to securing a desirable retirement, for individuals just starting their careers, all the way to those who are preparing to complete theirs. Financial managers can provide the attentiveness and expertise retirement portfolios require and allow investors the opportunity to focus on their careers.