How To Retire Right

by: Dirk Leach


Many people haven't saved much if anything for their retirement years.

Traditional pensions are no longer offered by most private companies and government pensions are not far behind.

Social Security alone is not sufficient to meet most retirees' financial needs.

IRAs and other qualified retirement plans are available to fill the gap between Social Security payments and a comfortable retirement.


Many people today don't have adequate savings for their retirement years and a significant fraction have no retirement savings. Social Security was never intended to provide for all of a retirees' financial needs; only to provide a very basic income to keep retirees from falling into poverty. While you might get by on Social Security alone if you've already paid off your mortgage, car loans, and credit card bills, and you don't mind living on the frugal side, it certainly won't be a very comfortable retirement. It doesn't have to be that way. A bit of sacrifice and frugality during your working years sufficient to allow regular periodic investments will easily fill the gap between Social Security payments and a comfortable retirement.

What Happened to Pensions?

If you work for a Federal, State, or municipal government, it is likely that you have a traditional defined benefit pension. If you work for the private industry, it is likely you do not have the benefit of a pension. As life spans increased and the global economy enhanced competition, pensions became an expensive benefit for corporations. With the implementation of 401(k) plans, IRAs, and other qualified retirement plans, most private companies shifted the responsibility for retirement savings from the corporation to the employee.

Today, only about 10% of employees of private companies have a traditional defined benefit pension and that number continues to shrink. As I noted at the beginning of this paragraph, Federal, State, and municipal workers often continue to enjoy that benefit but the days of defined benefit plans in government are numbered. Several cities have already broken their old pension contracts in bankruptcy filings (e.g. Detroit, San Jose).

Several states (e.g. Illinois, New Jersey, California) have state pension programs that are severely underfunded with taxpayers balking at footing the bill to fully fund those pension programs. It won't be too many years before the State and municipal pensions are no longer offered to new employees. With pension programs either non-existent or under financial strain, it would be wise to have a backup even if you are lucky enough to be included in a pension plan today.

Retire Right Regardless

Unless you are lucky enough to have a pension plan that is rock solid and well funded, you should be taking advantage of one or more of the many types of qualified retirement savings plans available. There are plans that are geared specifically for the self employed (e.g. SEP, KEOGH, individual 401(k)), those that have primarily W-2 earnings (IRA, ROTH IRA), and those that have an employer sponsored 401(k) program. It is truly unfortunate that so few people take advantage of the tax free contributions and earnings available via traditional IRAs, 401(k) plans or tax free earnings and distributions available via a ROTH IRA.

The chart above shows that more than 50% of those in the 18-29 age bracket have no retirement savings. Maybe even more surprising is that 23% of people in their prime earning years have no retirement savings. Retirement will not be much fun for those folks and it doesn't have to be that way.

A simple time tested traditional IRA or ROTH IRA would go a long way to making retirement a lot more fun. A simple example of how much you can accumulate in a traditional IRA is provided below. The going in assumptions are as follows.

  • Annual Deposit = $5,500 (2016 Maximum Deduction)
  • Investment Return = 7% (Before Inflation)
  • Annual Inflation Rate = 2%
  • Age to Start Withdrawals = 65
  • Number of Years of Withdrawals = 25
  • Compounding Annually

The chart below shows the results as a function of years of accumulation.

The table above shows that if you start making deposits at the age of 50 and begin withdrawals at the age of 65 after 15 years of accumulation, you would have a total of $124,616 in your IRA account and you should be able to take an annual distribution of $8,241 for 25 years before the money runs out. While that is not a huge sum of money, an extra $8,400 per year will help make retirement a lot more fun.

Obviously, if you start making deposits earlier, you end up with a lot more at retirement. If you were to start making deposits at the age of 20 and retired at the age of 65, you would have $922,271 in your account at retirement and you would be able to withdraw $62,321 annually for 25 years before the money ran out. I suspect that most of the readers of this article would be really happy to have an extra $62,000 in each year of their retirement.

Clearly, this is a simulation and everyone's results will vary both higher and lower. This simulation also will not be applicable to everyone's individual situation. If you want to personally tailor the simulation to your situation, you can click on IRA Calculator.

I've written a couple of articles on the subject of retirement planning and investment. Interestingly, most of the critical comments I received back were focused on the rate of return I chose in the model with most of those comments being that 7% was too high. While you can use whatever rate of return you prefer in your simulation, a return of 7% before inflation (5% after inflation) is pretty conservative particularly over very long periods of time. If you look at the historical market returns, the market has returned 9-10% before inflation.

The chart above shows the 90-year history of the S&P 500. The shaded areas are periods of recession. Interestingly, even the 2008-2009 great recession doesn't look so onerous over a 90-year period. The point of the chart is that over long periods of time, the market has continually marched upward. Another way to look at historical market returns is to view them for each decade.

The interesting thing to note about this chart is that there is only one decade with a negative return and that decade (1930s) included the Great Depression. For readers that would like to tailor their view of historical returns, you can click on Returns for Any Period.

Finally, we can also get a good indication of potential returns by looking at the performance of mutual funds and ETFs. I use Vanguard Group funds and I picked three of my favorites as examples. Vanguard is a conservative stand up company with some of the lowest management fees in the industry. However, there are literally thousands of mutual funds and ETFs, many of which would be just as good and maybe better than Vanguard's suite of funds.

The point of the table above is to show that a 7% return over long periods is not so hard to achieve. Readers will note that the 10-year returns posted above include the period of the last recession.

What To Invest In

On the other retirement articles I've written, I also received a lot of comments about particular investment vehicles or which fund is better. While I do actively invest in individual stocks and even write a few options to enhance my income, my retirement accounts are all invested in Vanguard mutual funds. These are very long-term investments and mutual funds work quite well in tax deferred accounts where I don't have to worry about the distributions being taxed.

A long-term investor could do a lot worse than putting his IRA funds to work in the Vanguard Wellington Fund (NYSE: VWELX), the Vanguard Equity Income Fund (MUTF:VEIPX) or the Vanguard Dividend Growth (NYSE: VDIGX). Readers should note that VDIGX is currently closed to new investors as it is an actively managed fund and the fund manager is having a difficult time finding fairly valued dividend-paying stocks to add to the fund.

Over the years, I've been through several Vanguard fund closings and all but one have opened again to new investors. I suspect once we have a significant correction, recession or other market turmoil that knocks valuations down, VDIGX will reopen to new investors.

There are many other suitable funds to choose from and they are not that hard to find. Several of the major financial magazines as well as US News and World Report publish an annual mutual fund guide. I particularly like the US News version as they have a very extensive list of funds. A word of caution is in order in picking a fund for long-term investment.

I focus on long-term fund performance because I want a fund that has had proven returns in up and down markets and has shown that the fund manager can weather whatever the market decides to throw at investors. This year's hot fund may very well be next year's dud. For the same reason, I prefer actively managed funds. A good fund manager can beat the indexes and even a half point higher return over 30 years makes a significant difference in the value of your account.


If there is only one investment you can make, it should be in your retirement plan. Traditional pensions are fading fast and many current pension plans are severely underfunded. Social Security will put a floor under your income in retirement but it will not provide for a comfortable retirement. Qualified retirement plans provide the ability to compound tax deferred earnings or tax free distributions (ROTH IRA). Pick the type of plan that suits your situation and start one today. When you retire, you will be glad you did.

Disclaimer: This article is intended to provide my opinion to interested readers and to serve as a vehicle to generate informed discussion in the comment posting. I have no knowledge of individual investor circumstances, goals, portfolio concentration or diversification. Readers are strongly encouraged to complete their own due diligence on any stock, bond, fund or other investment mentioned in this article before investing.

Disclosure: I am/we are long VDIGX, VEIPX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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