They say nothing in life is constant, and perhaps nowhere is that more apparent than in retirement planning. A century ago, Social Security didn’t exist and pensions were just becoming popular in the private sector. Half a century ago, there was no Medicare. Retirement accounts like the 401(k) and IRA weren’t invented until the 1970s with the passing of the Employee Retirement Income Security Act of 1974, more commonly known as ERISA.
Over the past century, retirement planning has gone from very uncommon to a primary goal of most working Americans’ financial lives. But how you plan to provide for this time in life is vastly different from how it was done a century or even a quarter-century ago.
What Retirement Planning Used to Be
In your parents’ or grandparents’ time, retirement planning was much simpler. You worked for one employer throughout your life, and during that time, your employer often put aside money into a pension for your retirement. The employer was responsible for investing those funds on your behalf and then paying you an income stream in retirement. Between that pension and Social Security, most retirees had retirement prepared for them.
As defined-benefit pension plans faded into the background, retirement planning began to shift to become the employee’s responsibility. Employers no longer offered a plan that provided an income benefit, but rather offered plans where they had the option to match a portion of an employee’s contributions into the plan, known as defined-contribution plans.
The value of defined-contribution plans depends on the value of contributions made and the performance of the investments in the plan. Employees take on a lot more responsibility with these types of plans. Employees are often responsible to take initiative to enroll in these plans, they need to decide how much to contribute, how to invest, when to make changes and ultimately decide how this account fits into their overall retirement picture.
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What Retirement Planning Looks Like Today
Today, retirement planning is a far more intricate and challenging process. Americans are living longer and with fewer sources of reliable income now that pensions are far less common.
At the same time, many people enter retirement with only one source of planned income: Social Security. And Social Security is not designed to replace your entire income. Social Security replaces around 40 percent of most retirees’ pre-retirement earnings, yet, in our experience at Scarborough Capital Management, retirees generally need 80 to 90 percent of their pre-retirement salary to live comfortably in retirement.
All of this points to the need to save more, but according to the U.S. Bureau of Labor Statistics, only 55 percent of adults participate in their workplace plan (and even those who do, often struggle to keep up with the demands of a 30-plus year retirement). The median balance in 401(k) plans in 2019 for participants age 65 and older was just over $58,000. Again, in our experience at Scarborough Capital Management, many of today’s retirees need far more saved for their retirement.
In response to the precarious state of Americans retirement preparedness, Congress passed the SECURE Act in 2019 to increase access to tax-advantaged accounts and help prevent retirees from outliving their assets. While COVID-19 and the subsequent CARES Act may have received the most press in 2020, the SECURE Act could be the most impactful change to retirement planning in recent history.
The SECURE Act brought about many changes to retirement planning. Many of these changes improved the accessibility of retirement plans for small business and part-time employees, meaning more Americans have access to the tax benefits of qualified retirement accounts.
The Act also pushes back the Required Minimum Distribution (RMD) age (when you must begin taking withdrawals from certain qualified retirement plans like an IRA) from age 70-½ to 72. This means retirees have 18 extra months to keep their pre-tax retirement savings in their accounts.
While retirement planning has changed drastically, there are 3 key elements of retirement planning that will never change: Saving, spending and investing.
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Saving
Saving is a key element (and the first step) of a sound financial plan.
Saving is the process of putting money aside for an emergency or future use, and allows you to reach your short-term goals, like buying a house or staying afloat if you were to lose your job. The money you save should be easily accessible when needed.
Without your savings, the money you would need in these circumstances would likely be paid for with credit or from prematurely drawing from your investments. Both options have a big impact on the money earmarked for your Golden Years.
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Spending
The flip side of saving is spending. Anything you spend can’t be saved. Instilling good spending habits early on can help you in the present as well as in the future.
One of the biggest costs in retirement is often healthcare. Studies show that a healthy 65-year-old couple retiring in 2019 will need close to $390,000 to cover healthcare expenses, including Medicare Parts B and D. An essential component of any modern retirement plan is how you’ll cover these costs in retirement.
Medicare doesn’t kick in until age 65, leaving many early retirees with a major expense and few resources for paying it. Around one-third of early retirees claim Social Security at age 62. These funds are sometimes used to cover these expenses before these retirees have access to Medicare, but this comes at the cost of lower overall Social Security benefits. You don’t receive your full benefit unless you wait until at least your full retirement age – between age 66 and 67 for most retirees. The longer you can delay taking Social Security until age 70, the higher your benefit payments will be. If you retire before you have access to Medicare, where will you get coverage?
An alternative is to save even more before retirement. A Health Savings Account (HSA), which allows savers to use distributions to pay for qualified healthcare costs in retirement without paying federal or state income taxes, can be particularly beneficial, if you have access to one.
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Investing
Investing is the third essential element of any retirement plan, and one that has become even more important for modern retirees. Longer retirements mean retirees’ savings need to last for more years. For this to be possible, it’s important to manage your assets with growth in mind.
Having an appropriate mix of growth and income investments is critical for today’s retirees. Before retirement, in what is called your accumulation years, you may have a more aggressive investment strategy geared toward growth. Then, as you near retirement, you may want to adopt an increasingly conservative strategy to preserve the gains you’ve made. Make sure to talk with your financial advisor about your risk tolerance and asset allocation to make sure your portfolio coincides with your goals.
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Putting it All Together
Ultimately, retirement planning is about bringing all of these core elements together: Saving, spending, and investing. Retirement planning is the process of defining your retirement goals and then bringing each of these elements together to work in harmony toward achieving those goals. By planning your savings while managing your expenses and then utilizing an appropriate mix of investments for your goals, you can work toward securing the retirement of your dreams. But doing so requires careful preparation and knowledge.
This is why many savers lean on a financial advisor who specializes in retirement planning to help guide them along the way. At Scarborough Capital Management, our team of financial advisors understands the intricacies of retirement planning for the modern day. They help clients stay abreast of changing legislation and take advantage of every retirement planning opportunity available.
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If you’re ready for professional help in planning for your future, contact us. Your retirement is far too important to leave up to chance.
