Why your 401k won't be enough to retire on...

WRITTEN BY: Gideon Drucker, CFP® AIF® ECA

Most of our clients are high earning professionals in their 30’s and 40’s.

As such, very very few of them are fortunate enough to have a pension.

If the word "pension" is new to you, or you've heard it but have no idea what it means, let me explain...

A pension, which was a staple of 20th century retirement planning, was a FANTASTIC retirement vehicle.

It provided a guaranteed monthly retirement benefit for the rest of your life.

So for example, if you worked 40 years as public school teacher, when you turned 65 and retired, you would receive a monthly paycheck equivalent to 80-90% of your 3 highest earning years…for the rest of your life.

As you might imagine, retirement planning becomes a heck of a lot easier if you have a lifetime income stream that replaces most of your working income…there’s not THAT much of an income gap that you need to fill!

But over the course of the last 40 years, this has all changed.

Most of us are tasked with funding our OWN retirement. This is essentially what the government and companies told us by creating and emphasizing the 401k Retirement Plan.

A 401k, unlike a pension, is a defined contribution plan. There is NO guaranteed income stream in retirement, there is no guaranteed interest, there is no guaranteed anything. However much money that you choose to put into your 401k each year, and however much it grows based on the investment allocation you’ve chosen, that’s how much money you will have in your 401k by the time you need to access it.

If you hit the 401k hard in your first 5 years of retirement, there very well may not be anything left for the later stages of retirement. (Again, compare this to the beauty of a pension in which you receive a monthly check of $5,000 indefinitely. Even if you live to 95 years old, that check just keeps coming.)

Well, retirement planning becomes a lot more important when we are tasked with saving for our own retirement than it was when we could just slide right from our careers into retirement with nary a change in guaranteed income. WE all need to ensure that we are adequately funding our 401k’s, Roth IRA’s, HSA’s, Taxable Investment Accounts, After-Tax 401k’s etc. because the moment that we stop working or sell our business….we may not have a dime of income coming into replace that former paycheck.

This is part of why the projected estimates for an adequate retirement nest egg for our 40 year old clients are so much more substantial than for people that are already 65 years old. If you are 65 and receiving a monthly check of $4,000 per month from your pension, and $3,000 from social security (don’t even get me started on this one….), it may only take a net worth of $1mm-2mm to fill in the income gap and for you to feel comfortable for the rest of your life.

For many of our younger, high earning clients…this won’t be even close to cutting it.

So what’s my point? The work has to start earlier.

We have to be more intentional and purposeful with our saving habits, our investment process, and our spending goals over the years.

We also have to make sure we’re not JUST saving into a 401k (or 403b, TSP, SEP IRA or other similar employer sponsored plans) because we only begin to have access to those accounts at age 59.5.

A lot of our clients have goals of becoming work life optional earlier in life. Maybe they want to move from their high paying/high stress corporate job at age 52 and then work part time/consulting until age 60 while making a substantially lower sum. Well, we are going to need a plan to distribute some of your assets prior to age 59.5 if this early “retirement” is a part of your plan and so we better have adequate investment accounts NOT held in a 401k.

Simply put, 401k’s are a wonderful and necessary savings vehicle. Most of our clients that we work with to design a Financial Life Plan® are maxing them out. But it does not help with the specific goal of early retirement because you will be penalized for taking money out if you are younger than age 59.5.

As always, please be encouraged to reach out and schedule your 15 minute Right Fit Call if you have any questions about creating your own Financial Life Plan®.