There are many options available to individuals who wish to set aside money for retirement. Each has its own share of benefits, such as tax deferrals or shelters, market growth, and rates of return. Employer-sponsored retirement pension programs, retirement accounts, and government benefits represent some of the most common retirement-planning instruments available to workers. Life insurance is another possibility. In this blog series, we will discuss how life insurance can become part of an overall retirement planning strategy, helping retirees save money for a secure and stable financial future.
Before discussing any retirement planning options, it is a good idea to understand the concept of “earning power”. Earning power is simply a person’s ability to earn an income, and this factor is of absolute importance when talking about financial assets. Your monthly or annual income is your most valuable asset; without it, you will not be able to cover your current expenses or to set aside money for the future.
Earning power is comprised of four income sources:
- Your income (salary from employment)
- Your spouse’s income (if applicable)
- Investment income (from stocks, bonds, real estate, and the growth of other financial assets)
- Other income (gifts, inheritances, work bonuses, etc.)
Now, let’s take a look at some statistics. If your family earns an average income of $100,000 per year from age 30 to age 65 (retirement age for this exercise), you will earn $3.5 million dollars. This figure does not include the possibility of salary raises, bonuses, or investment growth. Bump that annual average income to $250,000 for the same period of time, and you have the potential to earn $10 million. The longer you work and the higher your average family income, the more you earn. The key to remember here is that if you are unable to work and do not draw a salary as a result, how will you pay for your current and future expenses?
Retirement Income Sources
As mentioned in our introduction to this blog series, there are several sources of retirement income available to workers. The three primary retirement income sources are:
- Social Security Benefits – every U.S. worker is eligible for retirement benefits provided by the Social Security Administration. However, these benefits may not cover all of your expenses in retirement. The average retired worker receives about $1300 per month, which is about 40% of the average pre-retirement income for workers. One drawback to the Social Security plan is that the more you make before retirement, the smaller percentage of that income is replaced by these benefits.
- Employer-sponsored Pension Plans – many employers offer a retirement savings plan for their workers. These plans can include pensions, IRAs, and employer-matched 401(k) accounts. Employees are expected to contribute at least a portion of their income to these plans during the course of their employment, and these plans are designed to supplement the benefits one may receive from Social Security and government pensions.
- Personal Retirement Accounts – taking charge of one’s retirement savings is critical, as employer-sponsored plans and government benefits may not be enough to attain the financial stability and freedom one desires. Personal retirement accounts fill this gap, and include IRAs, property investments, and other financial assets like stocks and bonds. Retirement savings can also include life insurance, annuities, and brokerage accounts.
When evaluating the range of options available to workers, it is important to remember that of these three primary sources of retirement income, personal retirement accounts represent the ultimate control we have over our financial futures. Social Security and other government benefits may not be sufficient to cover future expenses, and not all employers offer retirement plans of their own. In these cases, funding personal retirement accounts is of critical importance.
Information to Know about Social Security Benefits
While Social Security is designed to provide income for retirees, this government-sponsored program is not without its drawbacks. There are several things to consider when discussing Social Security, as the program has changed substantially over the years.
First, the retirement age, as far as Social Security is concerned, is going up. In fact, there is something called the Social Security Normal Retirement Age, which is 66 for those born between 1943 and 1954. For those people born after 1954, the Normal Retirement Age is 67. In addition, early retirement results in a permanent reduction in Social Security benefits. Someone who retires at age 62 instead of the Normal Retirement Age of 66 will receive 25% less benefits, and this is irreversible.
For a worker retiring at the full retirement age in 2017, the maximum monthly benefit is $2687. This is a fraction of the monthly income many workers make during their careers, and relying solely on Social Security for future expenses is a risky bet. It is important to also consider the average monthly benefit under the program, which is just over $1300. With these figures in mind, it becomes clear that additional retirement income is critical. Another consideration is the spousal benefit, provided when the person drawing the Social Security benefit passes away. Under current laws, the spousal benefit is limited to a maximum of 50% of the retired worker’s benefit. This can cause a loss of financial security for the surviving spouse.
Financial experts warn that the Social Security plan is on its way to failure; serious benefit reductions or high tax increases are some of the factors that the government may have to impose to keep the program solvent.
The Life Insurance Solution
In our next article, we’ll introduce life insurance as a way of filling the gaps between government-provided retirement benefits and the assets in personal retirement accounts. There are several types of life insurance, each with their own strengths and benefits. Stay tuned for more information on this potential retirement income solution.