Banking on Social Security and 401(k) Savings to Fund Your Retirement? Think Again…
Many retirees today are facing an unfortunate reality: Social Security benefits provide far too little income for most retirees to live comfortably in retirement. Due to outdated actuarial calculations and longer life expectancies, Social Security no longer provides the amount of funding individuals need to retire comfortably. Therefore, the burden of saving for retirement has shifted largely to workers themselves.
But unfortunately, less than half of Americans with access to a 401(k) actually participate in the Plan that is offered to them.(1) And when they do participate, the investment options in the Plan often do not provide the needed returns to finance a retirement that may last 30 years or more, even when combined with Social Security benefits.
So how can working Americans and pre-retirees make sense of this changing financial landscape and still set themselves up for the comfortable, enjoyable retirement they deserve?
Changing Attitudes In and Toward Retirement
Before getting into solutions, it’s first important to understand how the economic and social trends of the past decades have shifted the goal line, needs, and expectations for retirement. Barbara Waxman, author of The Middlescence Manifesto: Igniting the Passion of Midlife, asks her readers to consider the current trend that “roughly one-third of the United States – more than 100 million people – is over the age of 50.” She refers to this stage of our lives as middlescence.
Waxman maintains that for those in the middlescence stage, the benchmarks for achieving a comfortable life in retirement – rather than merely shifting – have disappeared entirely. The landscape itself has changed. She notes that many retirees can’t even afford to comfortably retire today. And interestingly, most retirees don’t actually prefer to leave the workforce completely. Rather, they simply don’t want to be obligated to work as they have done for decades.
In the U.S., having a successful career is highly valued and ingrained into our culture as a large part of how we identify and value ourselves. Therefore, many retirees today want to dial back their work rather than leave their careers completely.
But as retirees are grappling with these social identity changes, their financial needs to fund retirement are evolving as well. To account for longer life expectations and achieve the freedom to enjoy expensive leisure pursuits, even high-income workers are finding that their combined investments and Social Security benefits aren’t quite cutting it.
Traditional Ways to Fund Retirement: Social Security & the IRA
To understand why we need to take a little trip down history lane. In 1935, President Roosevelt signed the Social Security Act into law as a result of the Great Depression. Social Security provided adequate retirement, disability, and survivor benefits to retirees and Americans in need for nearly 40 years. However, outdated and erroneous actuarial calculations soon rendered the program insufficient to take care of Americans’ needs on its own.
In the 1970s, it became apparent to lawmakers that a retirement crisis was looming. Thus, the Employee Retirement Income Security Act (ERISA) was signed into law. With the enactment of ERISA came the Individual Retirement Account (IRA), which allowed participants to reduce their taxable income by the amount of money they contributed to their future each year (up to a certain limit).
Because companies could not sustain contributions to employee pension plans and meet shareholder return expectations, 401(k) Plans were introduced not long after IRAs. Life expectancies had increased by decades, so the government, employers, and retirees were all realizing that it’s simply not possible to finance a 30-year retirement with a 40-year career.
So that IRA and 401(k) Plans could be successful, policymakers identified 34 investment asset classes so as not to restrict individuals’ savings to the predictable erratic or low-yield behavior of stocks, bonds, money markets, and mutual funds. Other options were made available for investment, including real estate, private notes, private corporate shares, and many others.
With these asset classes, Americans have a chance to actually create personal wealth and secure the retirement they wish for and deserve.
What About My 401(k)?
So why aren’t Americans with 401(k) Plans creating the wealth they need to retire securely?
Of course, low savings rates may be partially to blame. But the most common assets individuals invest in with their 401(k) savings (e.g., stocks, bonds, mutual funds) may be responsible as well. Here’s an example to illustrate: In order to set aside a passive income of $8,333.33 a month – or $100,000 a year – in 2021, you will need to save $2,500,000. That principal will then need to earn 4% every year you’re retired.
The problem is, there are no safe haven investments (e.g., certificates of deposit, money markets, bonds) that pay anywhere near 4% returns. Rather, the interest rates on these investments might only pay about $1,500 a month ($18,000 a year). Stock dividends aren’t much better. In addition to providing relatively low returns in today’s market, stocks are inconsistent and pose a much higher risk to the principal.
Either way, retirement assets that are invested in stocks and bonds provide insufficient cash flow, which means that retirees have to start depleting the principal to fund their retirement. This problem causes retirees to reckon with highly important questions, such as:
How long will I live so I know how much I can/should cash in each year?
What will happen to me if I run out of money?
Can I still help my grandchildren pay for college or other expenses without sacrificing my own future security?
Will I still be able to leave a legacy behind for my children, grandchildren, or charities I care about?
It’s probably obvious that these questions are impossible to answer with any degree of certainty. And financial advisors everywhere caution retirees to never touch their principal. Because once you make the first sale of your assets, you’re inevitably sacrificing all future returns from those assets. This can result in retirees feeling asset-rich but income-poor, even with a $2,500,000 balance in their 401(k) account.
So, is it even possible to earn $100,000 a year in retirement without banking on a $2,500,000 principal that consistently earns 4%?
A Little-Known Solution to Fund Your Retirement: The Self-Directed IRA
The truth is, your 401(k) only offers you the investment options that are included in your Plan. These options are typically restricted to stocks, bonds, mutual funds, ETFs, and the like. But you have the freedom to invest your retirement savings in 34 asset classes – some of which may be able to provide much greater returns – with a self-directed IRA.
Take for instance David Swensen, who was the late manager of the Yale endowment. Swensen was known for developing the “Yale model” of investing, which inspired a generation of investors to move away from traditional stocks and bonds into more diversified investments such as real estate and private equity. Swensen is credited with producing some of the highest consistent investment returns with a 20-year annualized net return of 9.9%.(2)
We don’t believe it’s out of the realm of possibility for you to expect 10% returns on real estate investments (or other asset classes) if you invest wisely. By using the 10% as the bottom benchmark for property investment returns, you would only need to invest about $750,000 in real estate with a 10% return to earn $100,000 a year in retirement (as opposed to $2,500,000 with an unreliable 4% return).
In our opinion, that’s a pretty big difference in savings, with the added benefit that you may have more security in retirement. At the very least, the self-directed IRA is an option worth exploring if you’re seeking creative ways to increase your chances of achieving a successful, secure, and enjoyable retirement.
How Chicago Trust Administration Services Can Help
Self-directed IRAs allow you the opportunity and freedom to invest in what you know. But the mechanisms and prohibited transactions surrounding self-directed IRAs can be tricky even for the savviest investors.
Chicago Trust Administration Services is here to help. Although we don’t provide advice or guidance on the investments you make, we do help you navigate the taxes and legalities associated with making investments through your self-directed IRA. To learn more, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
1) https://www.fool.com/retirement/2017/06/19/does-the-average-american-have-a-401k.aspx
2) https://www.pionline.com/memoriam/david-swensen-remembered-his-influence-generation-investors