Retirement and a Stool!

by Krantcents · 23 comments

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What does retirement have to do with a stool?  The three legged stool describes a retirement strategy of Social Security, pension and personal savings.  This strategy is dated since very few employers offer pensions.  What changed?  Most employers replaced pensions with 401k plans where employees contribute on a pretax basis to an annual limit.  These funds grow on a tax deferred basis until withdrawal.

There is a huge difference between a defined benefit plan (pension) and a 401K plan.  First, you probably do not work for a company that provides a pension.  If you did, you did not work there long enough to have significant benefits.  Most employees do not spend their entire career with one company.  The concept of a fixed sum paid to you in retirement is over!  How can you have a comfortable retirement?

401K Plan – first leg

If you are just starting out, you can choose a career that offers a pension or take your future in your hands.  Most people in their twenties do not think about retirement and do not contribute to a 401K or savings in general.  Saving or contributing to a 401K is not required, but maybe it should be.  Many employers will match your contributions to encourage participation.  If you miss out on your twenties, you lost a whole decade and you only have three more to catch up.

Some companies have started automatic enrollment to make retirement savings mandatory.  If your company has automatic enrollment, it is increasing participation!  You are automatically enrolled unless you elect to opt out.  You can change the percentage of contribution or have no contribution.  Automatic enrollment cut the number of employees who normally would not participate in half.  This is one way to encourage higher participation.

This is good way to make sure you have a sizable nest egg in retirement.  A 401K is the first leg of my 3 legged stool for retirement!  A 401K and their other incarnations including IRAs are important resources for retirement income.  After a forty (40) year career, you should have one (1) million dollars in your 401K.  If you withdraw just 3 or 4%, you can replace $30-40,000 of income.  For some, this is a comfortable retirement.  Automatic enrollment may be the answer to increase employee participation.

Rental Income – 2nd leg

The second leg of my retirement stool is rental income.  If you own a home, you probably owned more than one over your lifetime.  If you never sold each home and rented it out you would have rental income to support you in retirement.  If you had two (2) homes rented out for a total of $2,000 a month without a mortgage, you probably will net $1,500 a month.  Therefore you could replace $18,000 of income per year.  My numbers are approximate, but rental income is a good way to replace income in retirement.

You may not want to become a landlord or be one in retirement.  You can invest in rental property without actually owning the properties.  There are real estate investment trusts in the stock market that may be substituted for rental properties.  I owned income property (apartment buildings and a shopping center) and I think it is a great way to build assets and earn income.  Saving and investing is the first step to providing choices in retirement.  So it is up to you!  Rental income is a great second leg in the 3 legged stool retirement strategies.

Social Security – 3rd leg

Normally Social Security would be your third leg, but changes are coming.  They may raise the retirement age to match the higher mortality of retirees or change benefits for younger workers.  Whatever the changes you can no longer depend on Social Security, if you are under fifty-five (55) years old.  What should you do?  I think Social Security will be there, but expect some changes.  The median Social Security payment was approximately $15,000 in 2010.

Other sources of income – 4th, 5th & 6th leg

Dividends, interest, royalties, are just a few additional sources of income.  Some choose to delay retirement and continue working or work part time.  Many self employed people work well past the traditional retirement age because they enjoy what they are doing.  They cut back on their hours, but continue their business.  Still others sell their business and buy immediate annuities to provide income.

Final thoughts

Planning for retirement should start early.  Retirement is one of the most important events in your life.  Using my suggestions you can have a comfortable retirement on $63-73,000 ($30-40K IRA withdrawal, $18K rental income & $15 k SS) a year in retirement income.  Of course, these are approximate numbers and you should plan your own retirement.  These figures do not include any additional income such as dividends, interest royalties or part time employment.  How do you want to live in retirement?

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{ 20 comments }

Glen @ Monster Piggy Bank November 15, 2012 at 2:14 am

My wife and I are looking into getting a rental property in the next few months as we can both see the advantages having the extra rental income will provide.

Plus, because I live in Australia, the government pretty much subsides it in your tax return if you are negatively geared :)

Krantcents November 15, 2012 at 7:30 am

Rental property is great for income, but you still need to buy it at a good price. Secondly, check out the property for deferred maintenance and repairs. Lastly, do all the front end work to make sure you have a good tenant.

AverageJoe November 15, 2012 at 8:55 am

I love “the stool.” Such a great analogy for multiple streams of income. As you suggested, I too love REITs for people who don’t like rentals. My personal goal with the rental income leg of my “stool” is to get the mortgage paid off on my rental unit before I completely retire. That way, I’ll have a solid income stream that currently is going to a bank.

Krantcents November 15, 2012 at 9:24 am

Excellent goal, but you may want the write off. The tax code favors mortgages for now. You could refinance and buy another rental.

JW @ AllThingsFinance November 15, 2012 at 12:08 pm

I’ve found that a lot of foreign companies still offer pensions. My mother works for the largest private pharmaceutical company in Germany and they offer a pension plus 100% 401k matching. That’s incredible to me. As you said though, pensions are nearly impossible to find in the US these days.

Krantcents November 15, 2012 at 12:50 pm

Germany treats their employees very well. It may be one reason there economy is booming. In some ways, I wish we would model our industries after them.

John@MoneyPrinciple November 15, 2012 at 3:05 pm

We have been looking at these issues recently as we should have regular cash flow to invest shortly. But I would counsel against starting things too early – the young should invest in education, skills, living and finding what they really want to do with their lives. The time for investing is a little later…

Certainly they have some things right in Germany – technical education and a national investment strategy to name two – but don’t forget that as part of the Eurozone, their factories are full because the currency is, from a German perspective, substantially undervalued. This is much the same as the Chinese who link their currency to the dollar. Both currencies are in my opinion at least 25% below a competitive rate.

Krantcents November 15, 2012 at 4:08 pm

Some may say that the U.S. dollar is undervalued too. I think it helps our exports and it moving our economy too. I suggest that young people invest when they begin their first (career) job after college or some other post secondary training.

John@MoneyPrinciple November 17, 2012 at 3:01 pm

The opposite in fact. Since the yuan and dollar are ‘linked’ by China controlling the exchange rate for its currency (not that there is anything the US can do about that) and China, the corollary of an undervalued yuan is an overvalued dollar. Essentially think of the two economies as one,

When China eventually makes its currency floating, which it will have to because of demand from its domestic economy and to avoid yuan inflation, the yuan will rise and the dollar will fall – along with most other currencies. Much the same with Germany if it divorces from the southern European states by either group leaving the Euro. A German currency would appreciate just as a Greek currency would devalue.

So we have the worlds two major manufacturers managing to depress their currencies, which is partly why the factories are full in Germany and China. Problems will occur if demand stops then they have large fixed liabilities in wages, machinery and overheads but so far both countries have been doing OK.

Krantcents November 17, 2012 at 4:08 pm

Perhaps the the actions of Congress in the next couple of months will offset some of those issues. It would be really great for the U.S. to start getting stronger economically and return to a leadership role.

RichUncle EL November 16, 2012 at 8:14 am

I think this is a great post. I wanted to say that Reit’s are as you mentioned in addition to many financial media outlets as well, a substitute for rental property, I tend to disagree because if you have a 401K and IRA those are tied to the ups and downs of the markets just like Reits. But rental property does not have this disadvantage and if the stock markets crash your rental will remain the same.

Krantcents November 16, 2012 at 8:48 am

You are right to some extent. You will always have much more control over a property you own, however REITs do not react to the stock market volatility unless it has some underlying problem.

Barbara Friedberg November 17, 2012 at 9:43 pm

The homes I wish we had held on to were our condo and home in San Diego bought quite awhile ago. Although long distance rental management is fraught with stressors.

Krantcents November 18, 2012 at 9:43 am

rental property is best when it is local. You can “drop” by and check up on it. A management company would be my last choice.

Elizabeth @ Broke Professionals November 18, 2012 at 3:32 pm

My husband has a pension AND an employer-sponsored 401(k); we are VERY lucky.

Krantcents November 19, 2012 at 9:17 am

That’s great! It is is a nice perk!

Untemplater November 19, 2012 at 10:11 pm

I’m so glad I have a 401k. The employer matching makes such a big difference and it keeps me disciplined with putting money aside each paycheck. I like your tip about adding more and more legs. Diversifying income is one of my current goals for retirement.

Krantcents November 20, 2012 at 12:37 pm

Multiple streams of income is my mantra for retirement! Retirement can be as long as your career and I want a hedge against the unknown.

My Own Advisor November 24, 2012 at 5:02 am

Nice post.

For my retirement plan, I have one more pillar, so I have a table really :)

#1 would be income from Canadian government plans. #2 would be my pension plan from work. #3 would be my self-directed registered savings (RRSP = 401k). #4 would be my passive dividend income.

Multiple income streams for retirement is definitely where it is at…totally agree with you :)

Mark

Krantcents November 24, 2012 at 8:13 am

Table or stool, there are a lot of legs! That way, you are not dependent on any “one” source.

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