Five Steps Toward Fixing Your Retirement Plan

A new report casts considerable doubt on how well many Americans will fare in retirement: Those born between 1966 and 1975, the so-called Gen-Xers, will be the worst off regarding their retirement plan, able to replace only half their working income. Older savers will do better, but only just.

What happened? One way to look at the problem is through a policy lens. As companies abandoned pension plans during the 1970s and onward, Americans were slowly pushed to fend for themselves in retirement. We replaced that system with the largely voluntary 401(k) and IRA-based retirement plan.

Experts often speak of retirement plans as “defined benefit” or “defined contribution.” The difference can seem subtle, but it’s quite stark. Pension plans promise an outcome (the benefit) and then work to provide it. Private, individual savings plans promise an opportunity (contributions today with tax breaks and company matches) while not guaranteeing the result.

One can easily debate the relative merits of either retirement plan path, but the point is largely moot. It’s extremely unlikely that corporations will voluntarily resume the long-term financial risk of running pension plans. They dumped pensions for a reason.

What’s left for working Americans who expect to retire is a real retirement plan puzzler. How can an individual replicate the predictability and solidity of a pension-style plan sized down to one? Is it even possible?

The retirement plan fix

The answer is yes, but it takes a fundamental reimagining of the purpose of saving and retirement. Here are the five basic retirement plan steps:

1. Pay yourself first. If you don’t save money, you won’t have money. Budget experts suggest doing a breakdown of where you spend every dime, but the simplest budget method by far is to remove a significant percentage of your pay in advance (double digits, at least) and deposit it into an account you cannot easily access. You can’t spend money you don’t have. Safely deducting savings ahead of your check is exactly what a 401(k) does quite well.

2. Take every tax break you can. The ancillary benefit of a 401(k) is that someone else — your employer working with the IRS — automates the pre-tax deduction process for you and keeps all the records intact. That’s a major load of paperwork that you as an employee almost certainly wouldn’t take on. Your taxes are lower today, and the benefit is easily portable as you change jobs, which of course you will.

3. Estimate your real retirement plan needs. This can be the tricky part. Caught between generations that depended on private pensions and government retirement plans, most people seem to believe that “someone else” will take care of the problem of paying their bills once they cease working. Yes, you probably will get something out of Social Security, but the idea that it will be enough to support your lifestyle is plainly an illusion. You have to have enough money set aside to finance, at minimum, 70% of your highest paycheck. Most young people won’t make it, Pew found.

4.  Stop hoping the market will save the day. Once savers begin to accept that they are not on track, that’s when interest in the markets and investing tends to take root. The problem is, real pension planners never hope to “make a killing” on a stock. They have a legal responsibility to assume the worst and plan conservatively. That doesn’t mean holding cash or being 100% bonds for decades (which brings its own risk). It does mean seeking a reasonable return for the risk assumed and dialing down that risk as you near retirement.

5. Think like a pension manager. Do you know if you’re on track to retire on time and with ample income to sustain your lifestyle over decades in retirement? A pension manager knows exactly how well or how poorly his or her retirement plan is working. You should have enough information to feel the same level of confidence, information the government is working to require of 401(k) plan providers.

It’s possible to save enough and retire on time with a reasonably safe income — mathematically. What’s missing is the will to take charge of one’s own financial future, a lesson the Gen-Xers will unfortunately have learned very late in the game, if the current retirement plan data holds true.