How About Some Retirement Planning ABC's?
By Matthew D. Hutcheson, an independent fiduciary and a nationally recognized authority on qualified plans and fiduciary responsibility. He is a Certified Pension Consultant and an Accredited Investment Fiduciary Auditor™. He may be contacted at matt@erisa-fiduciary.com.
I, like most Americans, love my 401k plan. I enjoy watching it grow and evolve. I enjoy learning about investments and more specifically, the 401k investments available to me. However, with all of the attention that 401k plans receive in the media I fear that many participants may be getting the wrong message about what factors are most important to them at the time, or at a minimum too much information that may be overwhelming.
For example, I recently sat in on an “investment education” meeting. The meeting was intended to give participants the knowledge they needed to make their own investment decisions. However, after one hour it was clear that participants were a little more educated and a lot more confused and overwhelmed. These were highly intelligent people. Since that meeting I have frequently pondered about how these highly educated people could be struggling with their understanding of investments. Also Fiduciaries can sometimes be fooled into thinking everyone “gets it” by focusing in on the knowledgeable few who are often outspoken during these meetings. These knowledgeable few ask quality questions and seem to have a solid grasp of the issues at hand. They may also enjoy trading over the Internet and might do quite well. Notwithstanding the few who “get it”, there remains an overwhelming majority who are left struggling to grasp how the information applies to them. The danger of this is that many of those who do not understand end up asking their friends, “what funds are you going to choose?” They then blindly follow hoping their friend know what they are doing.
Laying a solid retirement planning foundation
I believe that before we throw participants in the deep lake of investment knowledge, let’s first teach them to swim and give them a life jacket as well. In other words, let’s start with the fundamentals – or the ABC’s of retirement planning. Only when participants understand these ABC’s will investment education take on true personal meaning.
A. Know your ages. How old are you now? How old will you be when you want to retire? How old will you be when you can be expected to die? Understanding the significance of these three ages is extremely important. Choosing an investment strategy before understanding these dates is a mistake, a true “cart before the horse” scenario.
The first date range you need to define is between right now and your desired retirement age. The second is from your retirement age until your expected age of death. For example, if an average retirement age is 65, but you want to retire at age 60, not only will you need five additional years of income from your retirement plans, you will also have shorted yourself five years of normal income from employment. This gets even more complicated when you find out you have a tendency to live longer than you may have expected. What if you live 1, 5 or 10 years longer than you thought you would. Take this short quiz to see how long you can expect to live. Now granted, there are many different opinions about the proper way to determine life expectancy, from drawing from pure statistical data to taking many other quizzes with literally dozens of other variables, but I like this particular life expectancy quiz. Doesn’t it make sense that if you are expected to live to age 85, and your best friend is expected to live to age 75, that you will need more money at retirement than your friend will? (All other factors being equal). Therefore, understanding your ages is absolutely critical. If you invest in the same funds as your friends, you may find yourself in real trouble when it comes to time to retire.
B. Know your needs. Do you know how much money you will need at retirement? This depends on several variables, but it is fair to say that most people will need at least 80% of what they earned prior to retirement. However, in all reality you will want 100% of your pre-retirement income. Who wants less money when they retire? The level of income you will need will increase as inflation increases, so you will need to plan on having enough to ensure inflation does not erode your retirement nest egg. If you made $35,000 the year you retired, you will in all likelihood need $36,050 the next year, $37,131 the year after that and so on. This is due to inflation. (3% used in this example).
C. Know how to satisfy your needs. 99% of all Americans will receive their retirement income from three sources.
- Social Security
- Company Sponsored retirement plan such as a 401k, Pension etc., and
- Personal savings and investments.
The average retiree will 10 to 15 times their pre-retirement income in savings and investments to insure they will have enough money to last until they die. Again, if you make $35,000 in the year you retire, and if you expect to receive $15,000 per year from Social Security, you will need a minimum of two to three hundred thousand dollars in 401k/pension and personal savings to ensure long-term retirement security. Here’s how this is calculated:
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Pre-retirement income:
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$35,000
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Less Social Security:
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($15,000)
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Minimum Annual Income needed:
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$20,000
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(Range of assets needed $20,000 x 10 = $200,000 to $20,000 x 15 = $300,000)
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Of course these are simply guidelines. Again, whether you will, for example, need $200,000 vs. $300,000 or some other number altogether is dependent upon how long you will live, how early you retire and what types of financial demands you may have at that time. (I.e. if you need $60,000 to live on, you will need somewhere in the range of $600,000 to $900,000 in assets.) Don’t forget your retirement assets need to continue to grow after you retire.
With the perspective of these ABC’s, a participant is now prepared to be “educated” about investments. The relationship between risk, return, time horizons and other terminologies can now take mental form. With meaningful – personalized knowledge, a participant can proactively analyze which funds will get them where they want to be. They can then say with confidence, “if I want to retire two years early, I will need to earn another 2.75% each year for the next 15 years to ensure I have enough money”. Or, “Because I will most likely live longer than I originally thought, my annual investment return needs to be closer to 15% than 12% as I previously thought”, and then be able to make it so.
Sometimes, even with an understanding of the basics, it is really helpful to see how all of these factors affect each other. There are software programs that do a great job of helping participants understand the interplay between all of these variables. The software I like the best is Retirement Planner 2000™ by Torrid Technologies, Inc. It is extremely simple to use. It calculates everything, including estimated Social Security payments, and displays the information in both spreadsheet and colorful graphical formats.
As a Fiduciary advisor, I strongly recommend to my clients that their participants be taught the Retirement ABC’s first by using many types of tools, including printed materials, the Internet, and retirement planning software. Once this foundation is laid, the participants will be prepared to understand the investment education they receive, and they will be able to put it to practical use.
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To get a copy of the Retirement Planner 2000™ go to www.torrid-tech.com and download it for $25. You may also request a copy by sending me an email with mailing instructions to mdh@consultant.com. A diskette will be mailed the next day with an invoice for $25 enclosed.
Need More Information?
Matt would be glad to discuss this issue with you further. You may email him at
matt@erisa-fiduiary.com.
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