Retirement & the Work-to-Retirement Ratio
A podcast recently mentioned Alex J Pollock's 2006 article, "Retirement Finance: Old Ideas, New Reality". This article introduces the Work-to-Retirement Ratio, which compares the number of years of projected retirement to the total number of years in the workforce.
The concept of retirement is a fairly new one – until the 19th Century, people who needed to work for income (i.e., not born wealthy) simply worked their entire lives. German Chancellor Otto Von Bismark created the first old-age social insurance program in 1884. Eligibility began at age 70 – at a time when average life expectancy was around 45 years old. A person who started work at age 18 and managed to live to the ripe old age of 72 would have a Work-to-Retirement ratio of 26:1 – one year of retirement for every 26 years of employment.
Starting with the post-WWII boom in the middle of the 20th Century, though, many Americans embraced the idea of retirement and more private companies began offering retirement benefits like pensions. It was around this time that the retirement age also crept down to 65 (life expectancy in the U.S. during 1950-60 was around 65-67 for men and 71-73 for women), while the age for entering the workforce moved up as more people pursued college degrees. A person who entered the workforce at 20, retired at 65, and lived to 70 would have a W:R ration of 9:1 – nine years of employment for every one year of retirement.
Since that time, though, life expectancy has grown by about 8 years (75-76 for men and 80-81 for women) while the average retirement age has only increased two years (to 67). The rise of the "thought economy" – in which more people are employed in an intellectual capacity and fewer as labor – has also meant that more people are waiting until after college to enter the workforce. A person who starts professional life at age 22, retires at 67, and lives to 76 would have a W:R of 5:1 – five years of employment for each year of retirement.
So what does this mean? In a nutshell, the modern earner has fewer working years with which to fund each potential year of retirement. Someone living a century ago might have five decades in which to amass enough benefits to pay for a year or two of retirement, while a present day worker might expect to live decades after retiring.
So what is a modern worker to do, especially since many (including yours truly) do not start contributing to retirement accounts immediately upon starting professional life? The good news is that there are a few steps you can take – some starting today – to put you in a much stronger position.
• Save – save whatever you can, as often as you can, even when there is not a specific goal. Saving is the most crucial step in building a solid retirement plan, and money set aside today can be put to use in the future (when you may not want to work as hard). As a reference, a savings rate of 20% is equivalent to saving an extra year's worth of income for every five years worked – the same as a W:R of 5:1.
• Invest – any cash not specifically needed in the next 3-5 years can be put to better use by investing for the long-term. Cash is king in the short-term, but for long-term goals like retirement – which might be decades away – investing allows your money to work for you as it grows and compounds. Investments with historical average returns around 10% (like large-cap stock index funds) should double about every 7.2 years, while those returning averages around 6% (like diversified bond funds) should double about every 12 years.
• Use tax-advantaged accounts – many accounts offer tax benefits to encourage saving for retirement, such as 401(k)s, IRAs and HSAs. While Traditional and Roth retirement accounts differ on when income tax is paid on contributions, both allow investments to grow tax-deferred – no taxes are assessed on growth, dividends, or capital gains while assets are held in the accounts. This allows investments to compound even faster since the amount that would have gone to taxes can continue to grow. HSAs offer a unique triple advantage: contributions reduce current year taxable income, investments can grow tax deferred, and distributions for qualified medical expenses are tax-free.
• Delay retirement – delaying retirement by as little as 1-2 years can have a huge impact on the total growth of retirement investments, as well as increasing the monthly amount received from Social Security.
Interested in discussing your own retirement strategy? Schedule a call.
Iseler Financial, LLC | Registered Investment Advisor | Durham NC
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