Do You Have Enough Legs

January 8th, 2010 by admin

I saw right away he was going to tip over. The maintenance guy was changing the light bulb outside our office entrance. His first mistake was using a chair to reach the lamp. I knew that chair had a loose leg on it. His second mistake was putting the chair on uneven ground. I told him “You don’t have a leg to stand on” and I asked if he wanted some help as I walked in. “No, I’m good to go, thanks.” I heard the crash as I entered the coffee shop. Every moron knows you need at least three legs or you will tip over. Four is better. Financial Planners talk about three legs to your retirement planning. The legs are social security benefits, pensions and tax deferred plan assets, and savings. These are the typical sources of income most of us use in planning for our retirement. But there is a problem.

Don’t Count On These Two

Some of these legs are unsteady and are becoming less and less dependable. The Social Security System is a pay-as-you-go system, with the government using general tax revenues as needed to fund social security payments. Baby boomers are about to start collecting benefits en masse in a year or so. This means the federal government will have to raise taxes, increase our already bloated deficit, or cut social security payments. My guess is the government will do all three. Social Security benefit payments are limited in amount. The maximum monthly payment is $2,185, or $26,220 a year. Many of us have earned much lower benefit amounts. So, social security benefits payments may be inadequate to support you in retirement. Social Security may not provide much “security”. Clearly, this leg of our retirement is unsteady and may become undependable. The outlook for current workers to receive the benefits promised is poor. The next leg is employer sponsored pension plans and tax advantaged private plans, such as IRAs and 401K plans. There are two types of plans, defined benefit plans and defined contribution plans. These two types are completely different and the differences are important. A defined contribution plan permits the beneficiary, you, to make contributions. 401K plans are sponsored by your employer and many employers make an annual contribution into your account, called a “match”. The assets that accumulate in these plans are yours and remain with you whether you stay with your employer or not. In the case of an IRA, you make contributions, you manage the account, and the assets you accumulate are available to pay the benefits you determine. A defined contribution plan is described a “WYSIWYG”, or What You See Is What You Get. This is not true with defined benefit plans. In a defined benefit plan, the plan sponsor, your employer, promises you a benefit of a certain amount at a certain time. The assets that accumulate to pay the promised benefits are in a Trust and remain in the sponsor’s control. The assets do not belong to the workers. There are many circumstances where the promised benefits will not be paid. For example, if the employer declares bankruptcy, the assets and benefit promises are transferred to a government guaranty entity, the Pension Benefit guaranty Corporation (PBGC). The PBGC is obligated to pay you only the maximum benefit permitted under its charter, which in many cases is about one third of the employer’s promised benefit. If the accrual under the defined benefit plan stops, your benefit payment drops drastically. The accrual stops when you take a job with another employer or when the plan sponsor terminates or “freezes” the plan. At their peak in 1984 there were 112,000 defined benefit plans. Now there are 28,800. According to the Pension Benefit Guaranty Corporation, the government entity that insures benefits, 101,000 employer defined benefit plans were terminated from 1986 to 2004. This understates the situation. More and more corporations are “freezing” their plans. IBM, Motorola, Sears, NCR and the most recent, Verizon, have “frozen” a defined benefit plan in the last several years.

Read the rest of this article and understand why you’re going to need professional portfolio management.

Mike Williams, CFA | Panhandle Portfolios, Inc