How much will you need to retire?
A Defined Benefit Plan and a Defined Contribution Plan Can Help You Meet Your Goals
Planning for Retirement
Retirement needs are different for everyone. However, most financial planners suggest that your retirement income should be 75-85 percent of your working income. They typically refer to a "three legged stool" as the ideal plan for retirement savings: Social Security, an employer pension, and personal savings.
Defined Benefit (DB) Plan
Traditionally, public and private sector employer pensions were provided in the form of a defined benefit plan. This type of plan specified the benefit employees will receive when they retire using a formula based on one's compensation and the number of years worked. Examples include Ohio Public Employees Retirement System (OPERS) Traditional Pension Plan, Ohio Police and Fire Pension Fund (OP&F), State Teachers Retirement System (STRS) Ohio Defined Benefit Plan, School Employees Retirement System (SERS), and Cincinnati Retirement System.
Defined Contribution (DC) Plan
Defined contribution plans were introduced as supplemental retirement plans. The amount employees have at retirement depends on the amount of contributions made, the investment choices, and investment returns. These plans are often referred to by their Internal Revenue Code Sections: 401(k), 401(a), 403(b), and 457(b).
Some public sector plans have introduced hybrid plans and defined contribution plans as optional primary retirement plans, in addition to the traditional DB plan. Examples of hybrid plans include the STRS and OPERS Combined Plans. Examples of primary defined contribution plans include the STRS Ohio Defined Contribution Plan and the OPERS Member-Directed Plan.
Ohio Public Sector Retirement Plans
With few exceptions, Ohio public employees have access to a DB plan1 and can voluntarily join a DC plan. Both plans are important because Ohio's public employees do not receive Social Security benefits from their public employment. Ohio Deferred Compensation is an example of a voluntary or 457(b) defined contribution plan.
How much money do you think you'll need for retirement? A review of Ohio’s retirement plans by Ohio Deferred Compensation shows that a typical retiree who qualifies for full benefits may receive about 62-66 percent of working income from his or her primary retirement plan, plus health care benefits. While this benefit is significant and valuable, personal savings, including defined contributions plans like Ohio Deferred Compensation, will be needed by most retirees to reach the level of retirement income suggested by financial planners.
1 Some plans offer a choice of a DB plan, DC plan, or hybrid plan.
The Benefits of a Defined Benefit (pensions like OPERS, STRS, etc.) and a Defined Contribution (plan like Ohio DC) Approach
DB Pension + DC Plan = stronger retirement income
Currently, the average annual defined benefit pension is $43,000 or $3,583 per month, compared to an annual working income of $65,900 or $5,492 per month. Let's see what this looks like if you want to have monthly retirement income equal to 80% of your monthly working income:
80% of monthly working income
Average Ohio DB monthly retirement income
Let's look at how a person can make up most, if not all of the monthly shortfall by contributing to a DC plan like Ohio Deferred Compensation. See the examples in the following chart:
|Current Age||Biweekly Amount Deferred||Net Biweekly Paycheck Reduction||Retirement Account Value at Age 65||Monthly Income for a 20-Year Systematic Payout|
Important Assumptions: Biweekly deferrals assume 25% tax rate for paycheck impact (state and federal), 6% annual rate of return during "building account value" phase, 4% annualized effective rate of return applied daily during "receiving income" phase and withdrawals taken at the end of each month. The systematic payout assumes a $0 balance at the end of a 20-year period. Withdrawals may need to be more than the amount shown to meet the requirements of the required minimum distribution; withdrawals will be taxed as ordinary income. This chart is intended for illustrative purposes only. It offers hypothetical examples and is not intended to predict or project investment results. It does not assume taxes, fees, or account withdrawals during accumulation; if it did, results would be lower. The results do not and are not intended to represent the performance of your deferred compensation program. Investments involve market risk including possible loss of principal. Actual investment results will vary during both the building and income stages and you may earn more or less than the annual return, depending on your investments and market experience. Income stream, durations, and amounts are not guaranteed.
As you can see by the chart, the earlier you begin saving, the better.
Now we are able to bump up the pre-retirement income replacement from 65.3 percent to 80 percent.
|Average Ohio DB monthly retirement income||$3,583|
|DC monthly payout||+ $811|
As you can see, a "Combined Approach" that includes both a DB pension, and supplemental savings in a DC plan like Ohio Deferred Compensation can be critical to successfully meeting the challenge of having adequate retirement income.
Investing involves risk, including possible loss or principal. Nationwide cannot guarantee the accuracy of information regarding defined benefit plans. Please contact your pension system for complete information regarding your individual circumstance.
Many Americans do not think that they will have enough money for basic living expenses in retirement. If you're relying solely on your work pension to fund your retirement years, get ready to take a pay cut. Most pensions weren't designed to replace 100 percent of your working income.
Follow these four easy steps designed to help you evaluate your retirement needs and answer some questions you might have about planning your retirement.
Step 1: Consider Your Life Expectancy
How many years do you need to plan for?
Today, people want to retire earlier than ever. The longer you plan to spend in retirement, the more you will need to save. So, how many years should you plan for? The answer depends largely on your life expectancy. Life expectancies are stated as statistical averages, meaning you could live more years or fewer years. While about 50 percent of all people could die before their life expectancy, another 50 percent are expected to live beyond it.
People are living longer than ever
With medical advances and improved lifestyles, life expectancies are increasing. The life expectancy table below can help you determine how many years you may need to plan for in retirement.
|Life Expectancy at Retirement|
|Age at Retirement||Years in Retirement|
If most people retire between age 55 and 65 and live well into their 80s, that's a lot of years to plan for.
Source: Society of Actuaries Annuity 2000 Mortality Table.
Step 2: Evaluate Your Income Sources
Over time, your earnings really add up. The chart below gives an idea of how much money a person might earn during his or her working years.
|Hypothetical Example Lifetime Earning|
|Years Worked||Starting Salary|
This chart is a hypothetical illustration of the 10, 20, and 30–year earnings of an individual with a starting annual salary of $20,000, $40,000 or $60,000 and receiving a 3 percent annual salary increase.
Investing just a small portion of your earnings each pay period can help secure your financial future in retirement.
Where will your money come from in retirement?
You know the source of your income today. But how will you afford the lifestyle you want in retirement? The money you live on will probably come from your employer-sponsored retirement plan, supplemental retirement plan, Social Security, personal savings, and part-time work.
How much you need to invest depends on what you might receive from your employer-sponsored retirement plan and Social Security, and what your investments could earn between now and the time you retire.
Keep in mind, while significant, an employer-sponsored plan was never meant to replace 100 percent of your income, and many people feel the future of our current Social Security system is uncertain. That's why your supplemental retirement plan and personal savings have become a more important part of the retirement equation.
Investing involves market risk, including possible loss of principal.
Our calculators can help you determine your financial needs at retirement and help you estimate how much you may need to invest to reach your retirement savings goal.
What can you expect from Social Security?
The current Social Security system is projected to become insolvent around 2029 due in part to the fact that the ratio of workers paying FICA or Social Security tax is declining. In 1950, it was 16.5 workers to 1 retiree. Today the ratio is about 3.3 to 1. And, by the year 2030 there will only be 2 workers for each Social Security recipient.
Some employers are exempt from Social Security, so that may be one less benefit to consider. However, you may want to contact the Social Security Administration to learn more about spousal benefits, etc.
To find out what you might receive from Social Security, you can request a Social Security statement.
Supplemental Retirement Plans
Supplemental retirement plans and other individual investments have gained prominence as significant sources of retirement income. Employers are offering plans such as 401(k), 401(a), 403(b), and 457(b) plans to enhance or replace a pension program. These plans allow employees to place pre-tax dollars into a selection of investments and allow that money to accumulate, tax-deferred until retirement.
Withdrawals from the plan will be taxed at ordinary income rates.
Step 3: Calculate Your Income Needs
The American Savings Education Council suggests you will need approximately 75-85 percent of your current income to maintain your present lifestyle in retirement. If you are young and have your peak earning years ahead of you, want to increase your standard of living in retirement or amount of travel, or will have to pay a high percentage of your medical bills, you may even need 100 percent or more.
Investing involves risks, including possible loss of principal.
While some expenses in retirement may drop such as job—related expense, saving for retirement, and paying certain taxes, other expenses either stay the same—or increase.
Your basic living expenses typically stay the same. People still need transportation, they need to eat, talk on the phone, pay utilities, and do upkeep around their home. On the other hand, health care costs and medical expenses often increase. In fact, a 65-year-old couple can expect to pay $220,000 on health care in retirement, according to a study from the National Association of Government Defined Contribution Administrators Inc. (NAGDCA).
Your Income Needs Will Change
As you plan for your retirement income needs, it's important to know that your expenses will fluctuate in retirement.
In the early years, expenses may go up. People are usually healthy and active. They spend money doing the things they finally have time to do.
In the middle years, expenses may drop as people become less active and tend to stay closer to home.
Income needs in the later years are often determined by the need for medical and nursing costs.
Step 4: Determine Your Investment Strategy
How much should you invest?
There is no easy answer to this question, but the best general answer is "as much as you can,” as soon as possible.
You should also begin investing as early as you can to give your investments as much time as possible to grow.
This is the story of twin sisters.*
One sister started investing in a tax–deferred retirement program at age 30. She invested $2,000 each year for 10 years until she was 40, when she stopped investing completely.
The second sister waited until she turned 40 to begin investing in her tax–deferred retirement program. She invested $2,000 each year until she was age 65, which is 15 years longer than her sister invested.
Assuming they both earned 8 percent annually on their investment, who do you think was better off at age 65?
If you guessed the first sister, you're right.
She invested only $20,000 over a period of 10 years, but her account grew to $214,295 by retirement. Her sister, who invested a total of $50,000 over a period of 25 years, ended up with $157,909.
The difference? The power of time and compounding.
*This example is a hypothetical compounding example that assumes $2,000 annual deferrals for 10 years and 25 years respectively. It illustrates the principle of time and compounding. It is not intended to predict or project the investment results of any specific investment. Returns are not guaranteed and will vary depending on investments and market experience. If fees, taxes, and expenses were reflected, results would be lower than those shown.
Understanding Investment Options
Retirement Plans like Ohio DC offer several types of investment options. Mutual funds are the most common type and are the most familiar to participants. Many large institutional investors like Ohio DC, which has over 200,000 participant accounts, can also offer professionally managed investment options called collective investment trusts (CITs) and separate accounts. These options are similar to mutual funds and are attractive because of their ability to lower costs to participants.
These types of investment options can be recognized by brand name (example: T. Rowe Price Large Cap Growth Fund) or as a “white label” option based on the investment strategy or objective (example: Ohio DC Large Cap Growth Fund). The purpose of a “white label” investment option is to focus on the investment strategy or objective rather than the brand name. These investments are still professionally managed just like their mutual fund counterparts. The use of white label funds has increased in recent years, but the approach is not new. For example, the Ohio DC Stable Value Option, which is the most popular option for our participants has been a white label option since January, 1994.
If you are interested in learning more about the Ohio DC investment options, please review these definitions and charts.
For retirement savings, it's often best to contribute first to your employer–sponsored supplemental retirement plan. With this program, your money is invested before it's taxed, which reduces the amount your paycheck is currently taxed.
Also, any earnings on the money invested grow tax–deferred. You don't pay taxes on either the contributions or the earnings until you take a distribution, which are then taxed as ordinary income. Plus, investing here is relatively easy because the money comes right out of your paycheck, automatically deducted, before you have a chance to spend it on something else.
If you are already investing the maximum allowed by your employer's plan, you might also want to consider other investment vehicles such as traditional IRAs, Roth IRAs, fixed and/or variable annuities, or mutual funds.
Investing involves risk, including possible loss of principal.
If you have any questions, please contact us.