Did you do enough to avoid the retirement planning crisis?

Harvard business review (HBR) issued a terrible warning seven years ago. Most Americans don’t know how to implement a retirement strategy that addresses the most serious risk-income insecurity. With fewer people receiving guaranteed income from retirement plans, we have been forced to rely on our own planning to meet cash needs in retirement. How do you make sure you don’t run out of cash in retirement and have enough income each month to pay all your bills?

Despite discussions on the crisis in HBR, all is not dark. You can develop an investment strategy to prepare for a successful retirement. Educate yourself, focus on creating predictable income, and address the risks that matter most. If you can put these key considerations together, you’ll be on the right track.

Defined contributions replaced defined benefits

In the past, pensions were commonplace for retirees. Monthly income was not a concern for most households, which benefited from guaranteed pensions and social security paychecks for life. This income security is changing rapidly as fewer and fewer private employers are offering pensions.

About a quarter of full-time workers participate in a defined benefit pension plan, but the number is much higher for government employees. Only 11% of private sector workers currently participate in pension plans, up from 35% in the 1990s. This was a necessary change to avoid the bankruptcy of many companies, but it does mean the burden of creating a stable retirement income has been transferred to households.

Retirement accounts such as 401 (k) or IRAs have become more popular and are wonderful vehicles for building assets. However, this change resulted in two major shortcomings. First, people are generally not sure exactly how much they need to save for retirement (and most people are below the actual number). Second, a 401 (k) cannot guarantee predictable income streams when employees finally stop working.

A difficult change of course

Strong pension plans focus on creating stable income streams high enough to meet basic spending needs and lifestyle expectations. You need to make sure that you will have enough cash in retirement to live comfortably. Oddly enough, income planning usually takes a back seat to ROI when people talk about retirement accounts.

A few factors drive the emphasis on return on investment. First, it’s important to earn strong returns on your retirement assets throughout your professional career. It’s great to get the most out of your savings, so obviously you would want to maximize the possible gains within your tolerance for risk.

Investment professionals and the media also play an important role. Financial advisers and asset managers are often evaluated on the returns generated by their allocation strategies. Risk management takes a back seat and income planning isn’t even an afterthought in many cases. You hardly ever hear about income planning in the major financial media. It’s a bit boring and a lot less intuitive, and it’s not particularly appealing to viewers or readers until they’re near retirement.

The media and advisers should not be demonized for this. They meet the expectations of consumers, after all. Still, it’s clear that it can cause problems when people suddenly have to deal with an unfamiliar planning requirement at a pivotal moment.

Don’t rely on social security alone

Social Security is an important part of the retirement income puzzle, but it can’t be the only one. Average social security benefits are well below the median income for most households. In fact, Social Security for most people is only slightly above the federal poverty line.

Despite this glaring deficit, today’s seniors are too dependent on Social Security. It is the only source of income for 40% of retirees, and it is the largest source of income for over 90%. Given the potential for cutting government pension benefits in 20 to 30 years when the system might struggle to pay for itself, this could become a real problem for people who are not creating income elsewhere.

Solve the retirement income puzzle

You can’t fix the problem overnight, but there are a few steps you can take to protect yourself.

1. Save at least 15% of your income during your working life. A day later, your investment portfolio can be turned into an income generating machine. The amount of income it can generate depends on the amount of assets saved. Measure how much you put aside each month for your future and take full advantage of employer 401 (k) matchmaking programs.
2. Allocate your investment portfolio based on your age and risk tolerance. When you’re young, you have to prioritize growth. Index funds are great for this, but there are even better options that will generate bigger long-term gains despite increased volatility along the way. As retirement approaches, it is important to reallocate these assets to reduce volatility. In retirement, stability and income become the main concerns. A good bond allocation as well as reliable dividend-paying stocks are ideal for these purposes.
3. Understand the link between assets and income. Traditionally, financial advisers have used the 4% rule to estimate how much of your assets you can spend each year without running out of money in retirement. For every $ 1 million you saved, you can reliably make $ 40,000 a year. However, low interest rates and increasing life expectancy are prompting many financial planners to revise this rule down to 3%. Set your expectations accordingly and make sure that all of your expenses can be covered.
4. Develop a strong income investing strategy. For the most part, dividend yields and investment grade corporate bond yields are currently between 2-3%. There are the occasional opportunities to get out of this range, but it is probably not wise to bet your retirement on risky investments. These include high yield bonds with the risk of default, or stocks that the market has allowed to achieve high dividend yields.
5. Think about guaranteed income. You may be worried that your savings or investment skills aren’t enough to keep you and your spouse from running out of money in retirement. If so, consider an annuity. These are contracts provided by insurance companies and intended to provide guaranteed income for life. Carefully review the terms, fees, and reliability of your insurance agent before committing to it. Annuities can be very expensive or completely destroy your cash flow if not structured properly for your individual needs.