MSN Money
September 18, 2013
By Stacy Johnson

When retirement rolled around for my parents, they had it licked.

My father, a World War II and Air Force Reserve veteran, got a small monthly military retirement check, along with a pension from his career with the federal government. My mother was a retired teacher with a state pension and Social Security.

Despite their modest salaries during their working years, thanks to a Depression-era frugality they also retired with several hundred thousand dollars in Treasury bills. Those savings only grew after retirement, because their retirement income was not only more than they spent, after years of cost-of-living increases it was more than they made when they were working.

What a difference a generation makes. Things will be vastly different for many baby boomers and generations to follow. [EXPAND Read more]

Social Security isn’t the problem

Social Security was never intended to be the American worker’s sole retirement plan. Rather, it was designed to keep Americans affected by disability, death of a breadwinner, or old age from starving. Here’s how the father of Social Security, President Franklin Roosevelt, described it in a 1938 radio address:

The (Social Security) Act does not offer anyone, either individually or collectively, an easy life — nor was it ever intended so to do. None of the sums of money paid out to individuals in assistance or in insurance will spell anything approaching abundance. But they will furnish that minimum necessity to keep a foothold; and that is the kind of protection Americans want.

And Social Security still provides that. Social Security won’t be enough to keep me in my house: I pay more in property taxes and insurance on my Florida home in a month than my parents paid in a year. But would Social Security keep me alive? Yes.

If Social Security isn’t the problem, what is?

Balancing on a two-legged stool

For decades, the term “three-legged stool” was used to describe the three necessary ingredients of stable retirement income. The first leg is Social Security, the second an employer-sponsored pension plan, and the third, personal savings.

For my parents and many of their peers, that’s the way it was: three legs, stable retirement. Today, however, one of the legs — the employer-sponsored pension plan — has fallen off for many. From a 2010 Forbes article about private employer pension plans: “The Boston College Center for Retirement Research estimates that the number of employees covered by a defined benefit retirement plan (the ones we think of as traditional pension plans) declined from 62% in 1983 to 17% in 2007.”

With a defined-benefit plan, employers shoulder the entire cost. In the past, employees remaining with companies throughout their careers might have expected to receive up to 75% of their pre-retirement income for life. A nice leg to have on your retirement stool, but one that’s fading into history.

Many government workers still have generous pension plans. But for how long? Cracks are starting to surface as municipalities begin admitting they’ve made promises they can’t keep. Detroit’s pension plan is underfunded by $3.5 billion — one of the factors that drove the city into bankruptcy. It’s hardly unique. From a recent New York Times story:
In California, where more than 20,000 state and local retirees receive annual pensions of more than $100,000, the cities of San Bernardino, Stockton and Vallejo have filed for bankruptcy. Los Angeles’s public employee pensions are inexorably pushing the city toward bankruptcy — perhaps within four years. Chicago now pays $1 billion each year to its retired teachers alone. In New York City, pension costs have grown to $8 billion from $1.8 billion over the last 12 years.

Same with some unions. The Teamsters’ Central States, Southeast & Southwest Pension Plan recently announcedit’s underfunded by about $17 billion. The problem? The plan has only 65,000 union members paying into it, but it’s supporting 212,000 retirees.

As for federal government plans, they could easily fall victim to cost-cutting. Earlier this year, House Majority Leader Eric Cantor issued a press release  in response to sequester-related spending cuts. From that release: “Rather than take Border Patrol agents off the job, the president should instead choose to reform the federal employee retirement system so it matches what people get in the private sector.”

The handwriting is on the wall. And it’s no surprise. You can’t expect the millions of Americans losing their private defined benefit plans to fight to keep them alive for taxpayer-supported public employees.

So if Social Security isn’t enough, and the pensions my parents took for granted are fading, what’s left?

Substituting cottage cheese for steak

As traditional income-for-life pension plans disappear from the private sector and get dicier for the public sector and unions, they’re being replaced by 401k, 403b and other types of defined-contribution​ plans. As you already know if you have one, with these plans the employer might offer a match, but they more closely resemble the “personal savings” leg of the stool: You put in your own money, manage it yourself, and if it’s not enough to support you in retirement, that’s your problem.

Replacing a defined benefit, income-for-life plan with ado-it-yourself-and-h​ope-for-the-best plan is like replacing steak with cottage cheese. They both offer sustenance, but the cottage cheese is a poor substitute.

Accumulate $500,000 in a 401k plan and withdraw what it can safely earn — with today’s low rates, maybe 2% — and you’ll pick up an extra $10,000 per year. That’s a far cry from a defined-benefit plan that paid 75% of a pre-retirement salary for life.

And a $500,000 401k is a stretch. According to AARP, the average 401k balance for plan participants older than 55 is now $255,000. Earn 2% on that, and you’ll only be adding about $425 per month to your retirement income.

A new leg for your retirement stool

What are current and future retirees going to do? As they always have, the best they can.

First, it’s critical to strengthen the two remaining legs of your retirement stool: Social Security and personal savings.

There are strategies you can use to maximize the bang from your Social Security buck. Start by going to​yStatement, where you’ll get a personalized statement showing what you can expect at various retirement ages. Then read a few articles, including “13 Ways to Get More Social Security.” Finally, test various strategies by using free online calculators, like this one from AARP or this one from T. Rowe Price.

The Wall Street Journal recently tested and reviewed five Social Security calculators, some free and some that cost.

As for strengthening your savings, in addition to putting away as much as you can, start exploring options other than insured savings accounts.

Do alternative investments like real estate, stocks and peer-to-peer lending involve more risk and knowledge than a savings account? You bet. But stick with an insured bank account and your golden years may not be as golden.

When it comes to replacing the missing leg of the retirement stool — an employer-funded pension plan — all you can do is maximize your use of its “cottage cheese” replacement, a 401k or similar plan. But as with your personal savings, remember that taking no risk carries a risk of its own. And remember that the plan is your top priority. It’s more important than a new car, vacation or paying for your kids’ college (they have other options).

Finally, add a fourth leg to your retirement stool. Find something you love to do that pays and don’t retire, at least completely. Develop an interest, hobby or side job that might give you both enjoyment and income. You’re reading mine right now. [/EXPAND]