By Michael Lynch
11 LET’S ADD A PENSION
The employer-provided pension—monthly income from a company for which you no longer work—is a hoary part of the American past that never really existed for most of us. In 1970, at pensions’ peak, just under one in two American workers worked for an employer with the traditional retirement plan. (“A Timeline of the Evolution of Retirement in the United States,” Workplace Flexibility 2010, Georgetown University Law Center, 2010, scholarship.law.georgetown.edu/legal/50.) Today, the number stands at one in five in the private sector. (Monique Morrissey, “Private-Sector Pension Coverage Fell by Half over Two Decades,” Working Economic Blog, Economic Policy Institute, January 11, 2013, https://www.epi.org/blog/private-sector-pension-coverage-decline/.)
Let’s meet two of them now, Tony and Toni. Tony was wrapping up a long career mousing around. He started at the Walt Disney Company, hired right out of high school in the good old days when talent and on-the-job learning and performance meant more than a college degree. Toni worked first as a secretary and later as an administrative assistant for the local electric company. They grew up on the same street and married soon after high school. They were already grandparents and looking forward to retirement at age sixty-five. Toni wanted to start a free childcare center for her grandchildren. Tony planned to do whatever he wanted, which would likely include fishing in the Gulf of Mexico. They figured they needed roughly $9,000 in their pocket each month to live right.
TWO PLUS THREE EQUALS FIVE
Toni arrived at my office concerned that they were not ready for retirement. Because of the financial and other demands of raising and educating five children, she felt they were a little short in saving for retirement. When I asked Tony about the five children, he explained, “We had two boys, so we figured [the] third time would be the charm for a daughter. Well, we were blessed with triplets, so we got two daughters and another son.”
They were proud of getting five children through college without any student loans. “A college degree today is the equivalent of a high school diploma when Tony and I got started,” Toni explained. “I wanted to get them ready to chase their dreams.”
As a result, they had many years when there wasn’t enough money for all of life’s necessities and the important extras such as vacations, prom dresses, and retirement savings. Their combined retirement funds amounted to an impressive $400,000. Toni’s friend Mary told her that a couple needed at least $1 million to retire, and Toni was worried she wasn’t even halfway there.
At our initial meeting, I asked many questions, the sort one doesn’t discuss with friends like Mary, and I was convinced they were ready to retire and move on to their next adventure. I discovered that not only did they have $54,000 in Social Security coming to them (Tony’s benefit was $2,500 a month and Toni’s $2,000), but they also had an equivalent sum in corporate pensions. At a 4 percent withdrawal rate, these pensions alone were equivalent to $1,350,000!
ASSETS PULLING LIGHT DUTY
The next time we met, I’d had a chance to crunch the numbers, and they looked good. With a target of $9,000 a month spendable, they needed just $10,000 a month in taxable income. They were in a sweet spot of the current tax code. Of the $10,000, their guaranteed income supplied $9,000, or 90 percent. They needed just $1,000 a month from their investments. This amounted to only 3 percent of their now impressive $400,000 pile. In retirement planning, size matters, but it’s size relative to the need.
By now, you can probably design Tony and Toni’s plan. Still, a little more background is needed to do it right. I discovered that they considered themselves conservative investors and didn’t really like the downs but had always managed to sit tight and hang tough when the market got ugly. It was hardly surprising that they wanted to leave an inheritance for their children if possible.
They had plenty of income for today and could afford to go very conservative at this point. They were leaning in this direction, having again heard that it was important to go into bonds when retirement was imminent.
I explained that this may be riskier than investing more moderately. Today, they didn’t need all their investments for income, given their fantastic pensions and solid Social Security. They faced the twin risks of a long life and inflation. Their pensions were not indexed for inflation. If inflation returned to just 3 percent, their pensions would be cut in half (in real value) when they reached eighty-nine. The job of their investments was twofold: they would top off their income need today and replace what inflation stole from their pensions in the future.
Given their conservatism, we placed $50,000 in an account containing fully liquid US government-backed investments. This provided five years of income insurance and left $350,000 to be invested in an equity-dominated (70 percent) managed portfolio. From this, they would withdraw $1,000 monthly, with 10 percent going to the IRS and $900 free and clear to spend. Given that 90 percent of their starting income was already guaranteed, Tony and Toni did not need the benefits of an annuity. Their risk was inflation, and they benefited from the potential for growth of a pure investment solution.
If they’d been extremely conservative, they could have used a deferred annuity like Bill and Sue did. A deposit of $250,000 would have closed their income gap, and 100 percent of their needs would have been met with guaranteed income. That would have left $150,000 to replace the value of their income as inflation erodes it.
“That sounds like a belt and suspenders approach,” noted Tony when I explained it.
“I was thinking an umbrella, raincoat, and hat approach,” added Toni. We had a chuckle, and they explained they were fine with one layer of protection. “I guess we don’t need $1 million,” said a visibly relieved Toni. They had a simple, understandable plan and were ready to retire.
The above article originally appeared as a chapter in It's All About The Income and is reprinted with permission from the author Michael Lynch. No parts of this article may be reproduced without correct attribution to the author of this book.