Money Matters
Retirement
by
Randall Bingham

Two of the three legs of a secure retirement, the Federal Social Security System, and employer sponsored plans, usually done in conjunction with the state retirement system where you live, are defined benefit plans. This means that no matter what your expenses are, the plan will not pay any more than the stated or planned benefit. Social Security gets a lot of press about not being able to continue its current benefit package due to the changing demographics of our society.

Thomas Nugent, chief investment officer for PlanMember Securities managed funds, had this to say about Social Security in his 2004 3rd Quarter report following the re-election of President Bush

“First, most Americans think that the Social Security Trust Fund is some government savings account that holds assets that can be used to fund their retirement. Nothing could be further than the truth. The only savings in the Fund is debt issued by the federal government to be used only in the Trust Fund. The Fund cannot hold any other assets. To fund future payments, the government will have to “refinance” this debt just like it finances the federal budget today. Since the Social Security System is really a pay as you go system, why not just drop the razzle dazzle and make the System a general budget item. The concerns about getting future Social Security checks are also unfounded. The federal government has the power to write as many checks to Social Security recipients as necessary. There are no constraints on the federal government’s ability to write these checks. If the government” writes too many checks, the result could be inflation, not insolvency, but we know that Social Security payments are indexed to inflation so what is the problem?”

The current Social Security benefit for a worker just now retiring who had been earning $40-60,000 during the last 5 years is about $1,000 a month, or roughly 25% of the wage it is replacing. The benefit is not exactly wage based, but for the purposes of this article, we will assume that 20-25% of your wage were to be replaced with Social Security. The state retirement systems I am familiar with have a defined benefit of between 50% to 67% of the highest average wage paid during the time frame the employee was covered. Continued health care coverage is a major portion of the benefit, but the expense of health care is subtracted from the pension benefit.

If you add the two benefits together, you will come up with a range of 70% to 90% potential income replacement. Isn’t this enough income? Not unless you plan on having a thirty year, stay at home, water the flowers and grow a garden retirement. If you plan to travel more, eat out more, play golf every week, indulge yourself with equipment and tools for the hobby you only dreamed about during the time you raised a family, then you will need to consider those life style adjustments. Using the 120% estimated income needed as a reference, if there are not outside or additional 403(b) or 401(k) savings you will end up as much as 40% short of the money you will need. To provide an inflation adjusted, 30 year benefit of $5,000 income, using today’s interest rate assumptions, it will take almost $150,000. If we used the figure of $50,000 as the target income, then in addition to Social Security and the state retirement system, a person would need to have personal retirement savings between $150,000 and $450,000 depending on the actual defined benefit to be received to reach 100% of $50,000. To reach the 120% goal, a person would need to have between $600,000 and $1,000,000 of personal retirement savings to enjoy an active retirement lifestyle. Using tax deferral to increase available assets for retirement was made easier for educators when IRS code section 403(b) was passed into law, in the late 1950’s.

The purpose of this code section was to allow a teacher, (any employee of a 501(c) (3) organization) to defer income by electing to participate in an individually owned retirement account. A few years later, the tax law was amended to allow loans from the account prior to retirement. It is the loan provision that will assist the average household to increase their rate of savings. The loan provision makes money available for major purchases that require financing and for refinancing debt at a lower cost of interest.

Above I’ve described the need to put aside large amounts of money for the future event called retirement. Many people are intimidated by the need to put aside that much money given the budget constraints they have. Let me give you an example of a common situation I encounter. A math teacher began our conversation about the need to begin saving for retirement with the statement that he had just gone over his budget and he was $25 a paycheck short of paying his bills. He saw additional income as his only option and was just beginning to work a second job in commission sales to try and make up the difference. I reviewed his budget and found he was over paying on certain debts to reduce them, he was over withholding on his income taxes, giving him large refunds and he was putting a small amount into a savings account for emergencies as well as a small amount into an IRA. I asked him to combine all those over budgeted items into a 403(b) deduction. I asked him to change his 403(b) deduction when he does make commissions to avoid the tax on that income. He has started out by saving $2000 a year into the 403(b) whereas before he was only saving about $600 a year combined into the IRA and emergency funds. As for the debt he was trying to pay down, the 403(b) account will be large enough to refinance his other debt within six months and he will be free of debt sooner with a much lower cost of interest. The lower payments on the refinanced loan from the 403(b) account will allow him to increase his savings to $4300 a year. What about his budget, you might be asking? He moved to a positive $15 per paycheck

While it is true that a retirement account that is encumbered by a loan may not earn as much as the fully invested account, the true benefit of using the loan provision for my math teacher client was in his ability to increase the rate of savings. He is moving from $600 to the ability to save $4300 and even more when he earns additional commission income. What rate of return would a person have to earn on $600 to make it grow to $2000 or $4300 in a couple of years? Obviously, if a person knows how to do that, I want to read the article. Until a person is consistently deferring $14,000 a year (the current basic IRS maximum contribution level) the rate of savings is much more of a concern than the rate of return on the investment. I’ll discuss more about the loan provision in a future article.

Randall Bingham was selected as a member of PRO Financial Group and PlanMember Securities because of his extensive knowledge and experience in tax and retirement planning matters. Licensed in Insurance, Securities and Real Estate, Randall Bingham has counseled and taught individuals and employee groups concerning personal financial matters for more than twenty years. He is an active tax practitioner and helped create Don Del Mar, Inc., a tax/financial based service business with as many as 3,000 clients in Sun City, AZ, one of the nation’s richest retirement communities. He is certified by the National Association of Mortgage Counselors and an associate loan officer with L&G Mortgagebanc. He is a recognized community leader due to volunteer work with religious and scouting activities as well a being named to the Resource Distribution Committee of United Way in Mesa AZ.