Oct 16, 2020 4 min read

Americans are more responsible for their own retirement than ever before. Most will not get defined benefit pensions unless they work for a government agency or a very large company.

Yet, according to a recent Department of Labor report, only 40% have even calculated how much they need to save for retirement. It is very important to not run out of money then because the average American spends 20 years in retirement.

In the late 1980s, the 401(k) plan became the unintended retirement plan. When 401(k)s first became part of tax law, the intended purpose was for an executive to receive deferred compensation in them. Ted Berna, who is considered the father of these plans, discovered that they could serve a broader base. They became a substitute for defined benefit pensions. This was needed because of international competition.

Workers would defer some of their income into these plans, and the growth would increase income tax-free until the money was removed from the plan. Often, a company would offer some match to increase participation. All investment risk was borne by the employee instead of the company.

It is alarming, but the Labor study found that in 2018, almost 30% of private industry workers with access to a 401(k) plan or something similar did not participate. Many were leaving free money on the table. If Social Security is your only income during retirement, you are going to be living a limited lifestyle during these years.

The Secure Act made some changes to help in this area. Instead of opting into a plan, the employee must now opt out if he or she does not want to participate. Opting out would not be a good idea for most people. You should have a target of saving 10% of your income. You may start at 5% and work your way up over time.

It is important to start saving early. Let’s look at two examples. One man started saving for retirement at 28. He saved $500 every month until he retired at age 65. Assuming he earned 7% annual compounding, he would have a balance of $962,024 when he turns 65 years old. He would have contributed $222,000.

A woman began saving $500 a month at age 22 and earned the same return as the man above. Because she started six years younger, her total contribution was $258,000. This is $36,000 more. But her balance at 65 would be $1,486,659 – or $524,635 more! Maybe this is why Albert Einstein called compound interest the Eighth Wonder of the World.

There are employees of a major steel company in the area deciding whether or not to take a buyout of their pensions. Because interest rates are so low, actuarial calculations offer what seems like a large lump-sum payment amount.

But is it a good deal to take the offer? Let’s use the rule of 4%. People often ask financial advisers what percentage of their savings they could spend every year and probably not run out of money. In 1994, William Bergen and Morningstar co-authored a report that a 65-year-old couple could spend 4% a year. This means to receive $30,000 per year, you would need a balance of $750,000. Most people do not have that much in their 401(k).

It is important to note, however, that in 2013, Morningstar revisited the rule and said you should take out only 2.8% each year. It made this change because of increased market volatility, low interest rate environment and a more conservative investment mix. Under the new guidelines, you would need $1,071,429 to safely withdraw $30,000 per year.

Remember, while it is likely you could do this, it is not guaranteed like a defined benefit pension.

Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.