Remember the good old days, when workers retired with a gold watch and a pension? They’re long gone, of course.
Only 15% of private sector workers now participate in a traditional defined-benefit pension plan (three out of every four government workers do), according to the Pension Rights Center. And yet nearly two out of every three Americans polled earlier this year think a traditional pension plan does a better job of ensuring retirement security than do defined-contribution plans like 401(k) plans or IRAs.
I mean who would rather try to pick winning stocks, outguess Wall Street and the Federal Reserve, and keep up with changing tax laws for the “freedom” of managing their own retirement? Only actors in TV ads for brokerage firms, that’s who. The rest of us would rather get that nice monthly retirement check in our bank accounts and let the professionals handle everything else.
Unfortunately, that train left the station a long time ago. But even in the jerry-built U.S. retirement system, there are some simple ways to set up that steady stream of income pensions used to provide.
“What people have to understand is that if a company isn’t providing a retirement plan for them, they can create their own through their investments,” says Gary B. Garland, a New York- and New Jersey-based attorney who specializes in retirement and estate planning.
The first place to look is the only part of the retirement system that still provides pension-like income for almost all Americans: Social Security. Financed by a payroll tax on workers and employers, Social Security is the ultimate annuity. Its average monthly benefit per person in 2019 is $1,461, or just over $17,500 annually.
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Most Americans rely on Social Security to cover at least half their income, though it was designed to replace only 40% of what people previously earned. The best way to maximize your benefits is to work longer. Fewer than 4% of Americans wait until they’re 70 to start collecting, and most claim early, although each year you delay adds 8% to the payout you’ll get. Even by waiting for your full retirement age (66 or 67, depending on when you were born), you can raise benefits nicely while continuing to stash away money in your workplace or personal retirement savings plan.
Beyond Social Security, there are several ways to create a pension-like income stream for yourself.
Again, the first one the federal government does for you, albeit indirectly. Yes, you can use that big (or not so big) pot of money in your IRA or company 401(k) any way you want once you turn 59½ (although you will pay income taxes on any money you withdraw). But you should think of it not as a big lump sum to tap into when you need cash, but as a source of funding for your personal pension.
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Here’s where the government comes in. The year after you turn 70½, you must withdraw a certain percentage of all your traditional retirement plan assets every year. It’s called the required minimum distribution, or RMD.
The IRS offers a table with a life expectancy factor by which you divide your total balance of all traditional IRAs and 401(k) accounts—including SEP IRAs and solo 401(k) plans—as of the previous Dec. 31. At age 70, it’s 27.4 years and at 80 it’s 18.7 years. Notice how as you age, the denominator shrinks, which means the percentage of your traditional retirement funds you must withdraw rises. (It starts off at 3.6% or so, but you can withdraw more, if you’d like, and pay taxes on it for the privilege.) That’s because the IRS wants to get back as much of the money you accumulated tax-free over all those years as it can.
But here’s the good part—you can use the government’s requirements to help you build your personal pension. Let’s say you’ve turned 70½ and plan to take a withdrawal this year. As of Dec. 31, 2018, your traditional retirement plans were worth $328,800 and you had a Roth IRA worth $70,000. That was a trick question, folks—don’t count the Roth!
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So, divide $328,800 by 27.4 and you’ll get $12,000. You can take out the money any time between Jan. 2 and Dec. 31. If you make monthly withdrawals (from any non-Roth plan you want), you’ll get $1,000 a month in addition to your Social Security payout. That’s also a market-neutral withdrawal strategy, like dollar- cost averaging in reverse, Garland points out.
So, those are the first two pieces of your personal pension. If you want more income, you can buy fixed annuities, so-called longevity insurance or managed-payout mutual funds or take out a reverse mortgage to generate more cash each month. We’ll talk about those strategies in depth in future columns.
So, yes, you can still have a pension—if you build it yourself.
You’re on your own getting that gold watch, too.
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