By Kristina Russo | American Express Credit Intel Freelance Contributor
5 Min Read | July 31, 2020 in Money
How we invest for retirement has changed, with a greater emphasis on personal savings.
Modern retirement plans often include some level of continuing employment, which supplements your income and takes pressure off your nest egg.
Ultimately, experts recommend you aim for cumulative savings of 10x the salary you earn in your final year of work before retiring.
More retirement investment options have emerged to assist our saving.
The three-legged stool metaphor for retirement savings has undergone a transformation during our lifetime. Each leg, formerly thought of as pension plan, personal savings, and Social Security, has become a bit wobbly, leaving many to wonder how they should invest for retirement in the 2020s.
That transformation is an important reason why investing for retirement may feel overwhelming at first – even though it can be relatively straightforward. Here, I discuss how retirement investment strategy has evolved in recent years, to give you a solid context to begin forming a retirement plan that works for you.
Pensions: Back in the day, employers sponsored defined benefit plans, or pensions, for their employees. These pensions provided retirement payments in set amounts to employees, usually based on criteria like salary level and length of service. Participants did not contribute to and could not access the funds until retirement. All the funding and investment risks were on the sponsor and determined by complex actuarial calculations. This kind of pension plan has become uncommon – only about 1 in 4 civilian workers have access to defined benefit plans in 2019.1
Social Security: Retirement benefits are paid by the federal government and available for people beginning at age 62 who have worked for at least 10 years. Payments are determined by your salary levels and the age you start collecting benefits – you’ll receive more per month the longer you wait before collecting benefits, up to 70. Originally meant to help supplement retiree income, the long-term viability of this program has come into question. Some experts predict Social Security will need to raise the retirement age or reduce benefits to avoid becoming insolvent over the next 20 years.2
Personal savings: This always has been a part of the three-legged retirement stool. Whether in the form of savings accounts, CDs, stocks, bonds, or a coffee can, personal savings is the most controllable leg. According to one study, however, only 5% of current retirees are funding their retirement through personal savings.3
A key part of the three-legged stool metaphor is that, like a stool, you have multiple income streams to support your retirement plan, which helps to balance out risks. Many believe that the “legs” of our future retirement plans, Social Security benefits aside, likely will include defined contribution plans, personal savings, and income from a side hustle.
Defined Contribution Plans: These largely have replaced the pension plans of years ago. Over 60% of civilian workers have access to defined contribution plans.4 These plans allow an employee to contribute part of their earnings into investments, which hopefully increase over time, providing a retirement nest egg. Examples of defined contribution plans include 401(k), 403(b), 457, Employee Stock Ownership Plans, and profit-sharing plans.5
Upon retiring with a defined contribution plan, you receive your entire account – all the contributions and investment gains and losses – rather than a set monthly payment like in a pension plan. Some defined contribution plans have tax benefits. Some include employer-contributed funds or company stock. Many plans have contribution limits, and most require participants to direct their own investments. By law, every retirement plan must have a written Plan Document describing how it works, and most also provide an easy-to-read “cliff notes” version of that document called a Summary Plan Description. Understanding your plan, or any investment vehicle for that matter, is the second most important rule of saving for retirement – after starting to save as early as possible.
Personal Retirement Savings Investment Options: There are more investment options for personal retirement savings than ever before, a good thing since personal savings are expected to become the largest part of future retirement plans. These accounts, which vary in terms of tax advantages, contribution limits, and withdrawal policies include:
For detailed descriptions of each of these retirement savings options, read “Explaining 6 Key Types of Retirement Plans.”
Keep working: This may sound surprising, but continuing to work after retirement is a growing trend that is expected to become a core part of the retirement stool, especially for millennials. The number of Americans working post-retirement has doubled over the last 25 years to 20%.6 Enabled by improved health and increased education, they are supplementing their retirement plans and increasing their average annual income by more than 60%.7 Because future retirees will also be more tech-savvy, expect them to remain in the workforce even longer, making the retirement age of 65 a thing of the past. Earnings from the extra working years will likely be an important part of retirement plans.
When it comes to how much you’ll need to save for retirement, it can be helpful to break it down by age.8 From age:
How you make retirement investments has changed over time. The components of tomorrow’s retirement plans will likely differ from those of previous generations: they’re expected to rely more heavily on personal savings in defined contribution plans such as a 401(k) and other savings vehicles like IRAs. But the number one rule of how to save for retirement never changes: start saving early!
1 “The Latest Numbers Civilian Workers Compensation,” U.S. Bureau of Labor Statistics
2 “The Three-Legged Stool of Retirement Planning,” The Balance
3 “Retirees Live a 20th Century Retirement in the 21st Century,” Wells Fargo
4 “The Latest Numbers Civilian Workers Compensation,” U.S. Bureau of Labor Statistics
5 “Types of Retirement Plans,” U.S. Department of Labor
6 “Older Americans in the Workforce,” United Income
9 “Weekly and hourly earnings data from the Current Population Survey,” Bureau of Labor Statistics