I’m in my mid 20’s, but I spend much of my time with people in their 50’s and 60’s. These clients are nearing retirement–the point in life where one would like to either cease working, or dedicate substantially less time to work-related activities. The challenge is sustaining an income stream which is sufficient to lead the same lifestyle established during prime working years. I have many answers as to how workers nearing retirement can supplement their savings or find insurance-related products which can mitigate the risk of outliving one’s assets. What I’d like to focus more on is why 90% of the questions I get related to retirement and creating long-term income streams stem from people in their 50’s and 60’s- just the demographic which should be well prepared for these nearing issues. The people who should really start paying attention to their longer-term financial well being are those in their 40’s, 30’s and younger–those who face plenty of issues of their own.
One of the looming issues facing the younger generation is the social security system. This is one of those taxes which you can’t write off, negotiate, or choose not to pay. It often shows up on a pay stub as FICA tax. FICA stands for the “Federal Insurance Contribution Act.” The government has made the decision that as a resident of the United States, 12.4% of your gross income (capped at $87,900 worth of earnings) will be paid into the Social Security Trust Fund. The logic here is that, as a nation, we’re a bit too irresponsible to properly plan for our retirements. The government will tax us during prime earnings years and then provide us with some guaranteed benefit when we’re old enough to qualify for it. From a glance, it seems like a forced savings plan, not a bad idea assuming all the money we pay in comes back to us in later years. Let’s take a look at how the system holds up to its theoretical purpose.
The Social Security Act was passed in 1935 by Franklin Delano Roosevelt as a reaction to the Great Depression. Following the crash of 1929, the United States grappled with a 25% unemployment rate and a 70% drop in stock prices. The Social Security Act was quickly passed with 16 people contributing for every 1 person receiving benefits. The system was very liquid and the government invested all the proceeds in safe Treasury paper to ensure that the funds would be available for later generations. Gradually, the population both increased in size and aged. By the 1980’s there were about half as many workers contributing to the Social Security system for each person receiving benefits. A lot of this had to do with the heavy Baby Boomer popular moving through the workforce at the same time. The result is that now there are about 3 contributors for every 1 person receiving benefits. If the system remains the same, a 27% decrease in benefits will be necessary to maintain liquidity by 2042. Those over age 40 probably don’t have much to worry about in terms of decreased benefits, but workers in their 20’s and 30’s will, without question, be affected by these demographic changes.
The solution to the Social Security problem is complicated by a number of factors, the greatest being that we truly cannot predict with the degree of accuracy we need the demographic statistics which would allow us to pinpoint a solution. How can we anticipate a world war or a depression? We can’t, so we do our best job to set up a flexible system that will evolve with the population. Some people have suggested raising Social Security taxes above 12.4% to create liquidity for the system. Other have suggested raising the maximum level of earnings which social security tax can be applied to. Currently, the 12.4% only applies to your first $87,900 worth of income. Increasing that number to $160,000 would create hundreds of millions of dollars for the system. It would also be a direct tax on the upper-middle class, presumably people who are employers and an integral part of keeping the economy floating. We have to carefully consider the ways we raise taxes so that the impact doesn’t trickle down to other areas of the economy. The one solution which is easy to understand but extremely complicated at the same time is privatizing the social security system so that the money we contribute each year is earmarked for us. Why should all the Social Security money go into a collective account controlled by the Federal Government? Are they really more fiscally responsible than us as individuals? Think about the size of the budget deficit in the United States when pondering that question. Granted, if individuals were in charge of managing their own Social Security funds we’d likely have a problem on our hands. What if John Doe decided to invest his savings all in shares of risky stock? Well, that could be a good or a bad decision, but certainly too risky for an account labeled “social security.” Perhaps the investment choices could be simplified as conservative, moderate, and aggressive. This way, there wouldn’t be too many investment choices, but still an opportunity to participate in the markets over the long term. This would have proved a very positive decision if the baby boomers were investing in the markets since the 1960’s. All of these ideas are currently being thrown around in Congress and debated by opposite ends of the political spectrum. We’ll likely see the issue heat up as the next presidential election approaches.
The logical extension of a discussion on decreased government benefits and the needs for us to take on more personal responsibility in planning for our retirement is how we can save more through qualified retirement plans which are available to us. The most common qualified retirement plans which are available to individuals are 401(k) plans, 403(b) plans, and IRA’s. When I refer to a “qualified retirement plan,” that includes any savings vehicle in which we can save money on a pre-tax basis (not getting taxed on those contributions) and the money continues to grow tax-deferred until withdrawals are taken. Generally we can’t take withdrawals from qualified plans prior to age 59 ½ without getting hit with a penalty. The reason for that is the government understands certain people will pull the money out when they don’t absolutely need it unless a penalty is put into place. The government offers these incentive savings plans in the first place to encourage people, through tax benefits, to participate in individual and corporate savings plans. In fact, the government estimates that for a person currently 40 years old, Social Security, combined with qualified retirement plans such as 401k’s and IRA’s will still only account for 60% of the income needed for a comfortable retirement. The extra money is usually found through personal savings, part-time employment during retirement, or a more substantial decrease in lifestyle during eldest years. Obviously each person has their own situation with factors specific to just them.
To return to my original point, the planning aspect of retirement is easiest for those in their 20’s and 30’s. The process becomes increasingly difficult and involves more sacrifice as we approach our 50’s and 60’s. The power of compounded savings (reinvesting interest rather than spending it) has a tremendous benefit to those who can afford to do so. And the truth is most of us can’t afford not to. If you treat saving like a bill and never miss a month, you will reach your savings targets earlier than you ever thought possible. This applies to both retirement savings and other long-term spending goals. Thanks for reading and feel free to contact me with any further questions about this article or any aspect of the financial planning process.
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Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.
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