Planning for Retirement: Does the Three-Legged Stool Work?

DECEMBER 16, 2013 VOLUME 20 NUMBER 47

For decades accountants, financial planners, lawyers and government workers have talked about Social Security and the “three-legged stool.” The metaphor had a simple attraction, especially when Social Security was a young program. The three legs? Social Security, private retirement programs and personal investments. You should have some of each, according to conventional wisdom.

The problem with the metaphor, of course, is that such a large portion of retirement-age Americans have just one leg, or maybe one strong leg and part of a second. According to the Social Security Administration, about half of retirees get more than half of their income from Social Security alone. In fact, Social Security makes up more than 90% of all income for about a quarter of elderly recipients.

Is the three-legged stool important? Maybe, but it was viewed as received wisdom as early as 1949. More modern metaphor development recognizes the predominance of Social Security in retirement planning by turning the three-legged stool into a pyramid.

According to this new view, Social Security can be seen as the broad base of the pyramid, with other sources of retirement income as higher levels. Actually, “income” may be the wrong word — better to think of retirement “resources.” The next tier of the Investment Company Institute’s pyramid, for example, is home ownership. And that analysis comes from an industry group interested primarily in encouraging individual investments in retirement accounts. The reality, though, is that ownership of the home is the second-most-common bedrock resource for retirees.

In addition, there seems to be a growing recognition on the part of near-retirees that they will need to build substantial resources for their impending retirements. Defined benefit retirement plans, once the mainstay of private pension arrangements, are shrinking as a percentage of available benefits. As a result, fewer and fewer retirees will be able to count on a pension-like retirement benefit, and more and more will come to rely on the contributions they have managed to make to their own Individual Retirement Accounts and 401(k) and 403(b) plans.

Still, the news about the private retirement plan level of the pyramid is not all bad. According to the Investment Company Institute analysis mentioned above, Americans have accumulated $20.9 trillion in assets earmarked for retirement (and that’s not counting Social Security). That investment has increased much faster than inflation or the number of potential retirees since 1975.

The private pension part of the retirement pyramid is broken out as two separate parts: employer-sponsored retirement plans (like defined-benefit plans, 401(k) and 403(b) plans) and individual plans (IRAs). The top level of the pyramid, narrow but important for those who have been able to build personal wealth, is described as “other assets.” One commentator suggests that perhaps we should include another level: part-time employment. That may sound cynical, but reflects the reality that many retirement-age adults will have to work at least part-time — a notion that was not contemplated in the original three-legged stool metaphor.

One other point about rethinking the metaphor: it inevitably leads to thinking about maximizing the Social Security level of the pyramid. And not just maximizing the individual retiree’s share, but consideration of how to maximize a married couple’s benefits when taken together. Today there is a cottage industry of websites and individual advisers reviewing retirement options and strategies for maximizing a couple’s (or an individual’s) Social Security benefits.

For the 10,000 Americans turning 62 each day, it is increasingly important to think about how to maximize Social Security (and total retirement resources), what tax consequences will flow from different strategies, and how to think about the difference between not working (“retirement”) and drawing benefits (“retirement”). It is a complicated and confusing area, but thoughtful planning (and information collection) can literally be rewarding.

 

©2017 Fleming & Curti, PLC