Retirement is one of those areas that individuals put off. Many people think education funding, vacation planning, and other immediate expenses should come first and retirement can be tackled or started tomorrow. Does that sound like you?
So why do you put it off? Is it too scary or the payoff is not immediate enough? Why do the majority of Americans have to save and plan for ourselves? Let’s explore this topic a little more…
During the 1940’s, the US workforce were mostly laborers. Whether the job was to build aircraft or automobiles, or weave textiles, most employees devoted their entire worklife to one company. In return for such loyalty, companies voluntarily decided to provide retirees with guaranteed income during their retirement. What does this sound like? Yes, a pension!
What is a pension? This is a definition provided by Wikipedia: “A pension is a fund into which a sum of money is added during an employee’s employment years, and from which payments are drawn to support the person’s retirement from work in the form of periodic payments.“
Doesn’t this sound great? A guaranteed source of income when you don’t work anymore? The catch, of course, was that employees needed to devote 30 years to the same company–and employers had to honor that loyalty by establishing pension plans. Times have changed the retirement landscape.
According to CNN Money, only 4% of employers provide defined-benefit plans, once the most common (and reliable) type of pension. And even when pensions are available, average tenures at companies make it unlikely many of us will receive one. The combined generations, Gen X and Millenials, spend an average of 4.5 years per job today. So even many US workers who are traditional employees are in a situation comparable to us as entrepreneurs: responsible for much of our own retirement savings. The good news is, this new landscape means that there are many options out there for independent savers.
This history lesson comes back full circle to our discussion on retirement and saving yourself! Understanding how to build true wealth takes time. The younger you are, the more time your money can grow and withstand the volatility of the primary financial instrument available, the US Equity Markets.
The good news is, the math of savings might be more in your favor than you think. Let’s provide a concrete example, let’s say, you went out to eat out daily. It costs you $25/day. If you were to save $10 out of that $25, put it into a place that pays 8% annually, for the next 30 years. How much would you have by changing this one habit? Would it shock you that this amount would have grown to almost $500,000? Does this convince you by sheer math, that a small change can create BIG impact?
Like everything else in life, discipline is key. There is no “Get rich quick scheme” or “You can’t lose” scenarios. Saving for retirement is like living healthy-it’s a matter of a lot of small decisions. If you have made the decision to work out every day, you know that means just doing it, no matter the weather or how busy you are. Saving for your future requires that level of focus and discipline too. How can you achieve this? First and foremost, set your intention. It’s easier to resist the temptation to grab that pizza when your intention is solid.
What about Social Security? Can I depend on that guaranteed source of income? Yes and No… every corporate US worker pays into Social Security. It needs a little more explanation of how the system works in order to get that ‘Ah-Ha’ moment. You (meaning the US worker) pay into the system now for the people who are retiring now. Did you catch that? Now is the key word. The US government is not saving what you pay into the system for you. You pay now to support the people who need the income now. This is known as a Pay-As-You-Go plan.
In previous decades, the US had 40 workers supporting 1 retiree. Today, we have 3 workers supporting 1 retiree. All the people in the Baby Boomer generation will be retiring in the next 20 years. That’s 87 million people. With that impending group, Social Security is estimated to be illiquid by year 2034. You as a paying participant now may get far less in the future than what you paid in, according to reports from the AARP.
Traditionally, the pillars of retirement consisted of 3 parts: savings, pension, Social Security. With the pension practically eliminated for corporate employees and reports that Social Security may be reduced when Generation X and Millennials retire, who do you have to depend on? Yourself!
If you are ready to start, where and how? First things first, you have to deeply consider how your tax bracket will look in the next 20, 30, 40 years. Don’t have a crystal ball? Nobody does. (If you do find one, please share!) Here is a quick history lesson, in the 1940’s for every dollar you made, you kept 6 cents. That is not a typo! Why? World War II… Our government needed to fund the war, so how did they? Through us! Historically tax rates rise or fall with the US government debt burden. Where are we today? Check this out! It’s pretty scary.
All income falls into 3 tax buckets, Tax Now, Tax Deferred (Later), Tax Advantaged. Your favorite uncle, Uncle Sam, will always have his hand in your cookie jar. Let’s provide an example to this concept. You put your money into the bank, you get a 1099-INT every year, you pay Tax Now (every year end). If you are employed by someone else or self-employed and you put income into a retirement account, 401(k), SEP IRA, this money is considered Tax Deferred. You do not pay any taxes now but must pay tax on every cent earned at your future age of 59 ½ to 70 ½. Tax advantaged accounts consist of 529, Roth IRA, 7702. You pay tax now but never have to worry about paying taxes on this money ever again.
Whichever bucket you choose, there are always pros and cons. Uncle Sam has limitations on how much you can put into the latter two buckets. You must weigh each option appropriately. Many believe that they will pay less taxes in retirement, that may be true but all that money will be at the mercy of that then tax laws. Why not diversify your tax situation to the latter two buckets as much as possible?!
The investment order of operations (yes, there actually is one) is as follows: 1. Take the free money (any matching funds from employers or professional associations, for instance!) 2. Tax Advantaged, 3. Tax Deferred, 4. Tax Now.
Remember: no one is more interested in your financial future than you!
I would love to hear your thoughts or comments. Or if you have a financial topic that you would love some feedback or discussion, please reach out.
Will Gee is a financial wellness expert based here at Impact Hub. He organizes workshops to help individuals learn about financial wellness. His upcoming events include Becoming Financially Healthy for 2019 on January 10: https://www.meetup.com/Power-of-Investing-Learn-to-Invest/events/257743062/