Retirement Planning

The vast majority of individuals and couples in the United States can look forward to their retirement—that period later in life when they are no longer working full-time and are supported by financial resources accumulated during their working years. The average retirement age in the United States, based on data from the 1998 Survey of Consumer Finances, is 62.7 years. At this age, in 1998, life expectancy in retirement for an unmarried male was 16.4 years; while for an unmarried female life expectancy at this age was 19.8 years; and for a married couple it was 23.9 years. This means that the typical American needs to be able to fund spending needs for about twenty years of retirement living. Since life expectancies are increasing with advances in medicine, younger generations will have even longer retirements to contemplate. The main implication of this is that longer life expectancies can represent an increase in the risk of a shortfall in financial resources, or in the risk of outliving one’s resources. The risk of shortfall can be greatly reduced with proper financial planning.

The idea that it is never too early to begin planning for retirement is a reasonable one. For example, one should identify employer-provided retirement plans as part of the job selection process. Starting to plan while younger allows one to plan a long-term strategy that can be maintained and adjusted over time. In a world that is uncertain and volatile, retirement planning must be an ongoing process, with decisions made and reviewed as conditions and life circumstances change.

Retirement planning, broadly conceived, means preparing for one’s retirement years, which could extend for two or more decades of later life. This includes consideration of issues such as long-term care and the provision of an estate to one’s heirs. Planning for retirement comes down to a comparison of needs and resources. The main goal is to ensure that one is able to meet annual spending requirements as well as any one-time expenses that may arise. This is done by not only considering resources such as Social Security and defined benefit pension plans, but also considering personal savings. Defined benefit pensions, also known as formula-based pensions, are typically fixed annual payments based on years of service and salary level. Personal savings may include an individual retirement account (IRA) and 401(k), 403(b), or Keogh plans. Due to high administrative costs and maintenance, many companies have opted for, or converted to, defined contributions plans such as a 401(k). These plans allow an employee to make tax-deferred contributions through a payroll deduction. In some of these types of employer-provided plans, the employer may match some level of the employee’s contributions, which provides a guaranteed return. However the investment assets selected or asset allocation must be decided, at least in part, by the employee. This places the responsibility on the employee to not only elect how to fund the account, but also to determine how the account will be invested—which may or may not be advantageous, depending on the individual level of investment knowledge.