A Tottering Stool

The Three-Legged Stool – a financial phrase that describes the most common sources of retirement income for many individual investors.

You’re familiar with the three-legged stool, aren’t you? It’s an unsteady device often employed to reach seldom-used items stored on the pantry’s top shelf. It’s likewise a fading metaphor used by older investors to describe the primary components of a well-rounded retirement plan. In times quickly waning, the plan consisted of an employer-sponsored pension plan (commonly called a Defined Benefit Plan¹), supplemented by personal savings and Social Security. In that largely bygone era, an approach lacking any of these primary components raised the fear of dog food consumption in one’s future.

This week's blog focuses on the rapidly transitioning “employee pension plan” leg of the Three-Legged Stool – a financial phrase that describes the most common sources of retirement income for many individual investors. When I suggest in my blogs that investing should be simple, I’m not just discussing social security, or an employee plan you might be participating in at work. Rather, I’m focusing on the individual’s personal savings effort that, today, is having to replace those rapidly disappearing employer-sponsored Defined Benefit Plans or DBPs (commonly known as pension plans). In short, with the steady disappearance of company pension plans, the management of retirement packages is becoming YOU, the individual investor’s responsibility.

Things are always evolving. That old three-legged stool looks increasingly different in today’s financial world. Those Defined Benefit Plans (DBP) once offered by many employers are becoming relatively scarce. A DBP is a type of pension plan whereby an employer/sponsor promises a specified pension payment (or lump-sum or combination thereof) on retirement that is predetermined by formula based on an employee's earning history, tenure of service and age, rather than depending directly on individual investment returns).

I’ve read that only about 20% of America’s Fortune 500 companies offer some variety of DBPs to new employees when, barely a generation ago, that number was closer to two-thirds. More and more companies have replaced DBPs with what are called Defined Contribution Plans or DCPs, popular examples being 401(k) and 403(b) plans. A DCP is a plan whereby the employer, employee or both make contributions on a regular basis. Benefits are credited to an employee’s account (resulting from those contributions) plus investment earnings on the money in the account. The primary difference between a DCP and a DBP is that with a DCP, the employee is not guaranteed a certain amount of money in retirement. The employee makes his or her own investment choices and assumes all of the risks involved.

In short, the old DBP leg is morphing into and becoming part of the personal savings leg, dropping into the individual saver’s lap a much greater responsibility for accumulating and managing an even larger portion of retirement savings.

In today’s world, many generous employers contribute funds to their workers' retirement by matching a portion of what employees contribute to their 401(k) or 403(b) plans, within specified limits. Top limits of 3-6% are not unusual, but remember, it’s FREE MONEY. Consider this employer match, this free money, as today’s partial pension replacement – a much smaller leg of your three-legged stool with the caveat that it exists only when YOU contribute dollars to be matched.

Next, let’s address the increasingly “iffy” Social Security retirement program leg of the stool. The financial media is filled with all sorts of projections and opinions about whether this important component of your retirement stool has a leg to stand on (poor attempt at humor). According to recent 2019 Social Security and Medicare Boards of Trustees projections, without legislative changes, the Social Security Retirement Trust Fund is projected to deplete by 2035, at which point retirees will receive only about 75% of their scheduled benefits. On a brighter note, the Disability Trust Fund will not deplete until 2052, a 20-year improvement over last year’s forecast due to continuing significant declines in disabled-worker applications and lower-than-expected disability-incidence rates.

No, Social Security benefits will not completely disappear in the projected 2034-35 time-frame, but without political intervention, beneficiaries will face an immediate across-the-board 21% benefit cut that will grow over time to 26% by 2090. Why, you ask, would any benefits be available? Payroll taxes paid by younger workers after 2034 and trust fund interest will be enough to fund about 79% of scheduled benefits, but at an ever-declining rate. So, without a major political fix – reduced benefits, increased retirement ages for full benefits, higher earnings limits subject to tax, etc. – you should anticipate an increasingly spindly Social Security leg to your stool after 2035. To add to your somber mood, on the healthcare side of things, the 2019 report also mentioned that Medicare’s hospital insurance fund would deplete in 2026.

So, there you have it, folks – why it’s becoming increasingly important that YOU, personally, save as much as you can during pre-retirement. That personal savings leg is fast becoming the strength of today’s three-legged stool. But a greater onus is now on you. Are you saving enough to meet your retirement goals as 2035 approaches? The legs of your personal stool absolutely must include a strong DCP leg (your personal savings), supported by two increasingly wobbly legs: Social Security and those employer (FREE MONEY) contributions to your 401(k) that may or may not be there when you need them.

I would be remiss, of course, if I didn’t mention the increasing presence of “geezers” like myself in the post-retirement workforce. Does that mean our stools have sprouted yet another leg in today’s world? Well, yes and no. People have worked full or part-time beyond retirement age in the past. But with more baby boomers reaching retirement age lacking adequate funds to live comfortably – some, of course, just want to keep working – this older segment of the work force seems to be expanding, thus, this fourth appendage. And then, there is state and local aid going to lower income retirees, but that’s another story. In short, we do whatever is necessary to avoid those dog food dinners, or to avoid moving in with one of the kids… or a grouchy nephew (an inside story).

So how do we beef up those personal savings? Keep reading my blogs and I’ll present some simple options.