Free Agent Society

What’s the free agent society?  You’re living in it right now—where employees change their jobs frequently.  Loyalty is a thing of the past. Onward and upward…let’s get to where the grass is greener.  What’s the benefit with this mobility?  Well, sign-on bonuses, raises, and stock options sound pretty enticing.  Who wouldn’t mind getting a raise and a reserved parking spot right by the front door?  Just about everyone.  What’s the biggest cost of being a free agent?  A pension—the check your former employer sends out every month to you in your retirement.  It’s a bummer when this puppy isn’t coming in.  How come you might not get a pension with your new job?  First, many companies have done away with their defined benefit pension plan.  They determined the cost associated with these plans was more than they projected and have terminated them.  Second, even if your employer has a pension plan, you may not be eligible.  Perhaps you won’t work at a company long enough to become vested in the plan.  Even if you do become vested, the benefit may not be very much.  So, the biggest trade off with this mobility is a modest or, perhaps, no pension at all.

What does all of this mean?  Well, being a free agent sounds pretty cool.  Hopping from job to job, always getting more money and extra perks along the way.  However, the trade off is you’re on your own with planning and funding your retirement.  This means relying on your 401(k), IRA, Roth IRA, and other savings accounts.  Oh yeah, and maybe a social security check for some beer and pizza.  Strange, isn’t it?  The free agent society provides the freedom to pack your bags and move on to the next assignment that’s willing to pay your price.  But with this freedom comes a perverse cost—personal responsibility.  Without a pension, what will you have in retirement?  Only a plan you can put together on your own.

Plan for a Long Retirement

Will you have a long retirement?  Hopefully you will, but probably only if you planned properly.  And certainly a major factor in this is your health.  The notion of retirement, however, isn’t what it used to be.  In the past, a traditional retirement began when you reached the age of 65.  An early retirement was considered to be when you stopped working prior to 65.  Now a combination of factors has changed what we still call retirement.

A longer life expectancy, the decline in company pension plans, and changes in social security are just a few of these factors.  Oh yeah, and a lot more people want to continue leading active lives in retirement.  They don’t want to sit in their rocking chair counting down the days.

Safe Investments for a 30-year Retirement?

Having a long retirement sounds great.  What could possibly be the problem?  A long retirement may eventually cause unexpected financial troubles for some people.  Unfortunately, a number of pre-retirees and recent retirees start to think they can’t lose any principal in their investment portfolio and should therefore only own “safe” investments.  So they back up the truck and load up on the theoretically safe fixed income investments such as Certificates of Deposit (C.D.), bonds, and fixed annuities.  Are these investments considered safe over a retirement that might last thirty years?  Sure they’re safe in that you shouldn’t lose any principal, but that is not what’s important over a long retirement. People who are heading into or already in the distribution phase need to be educated about the new math of retirement.  Without learning and applying the new math, a lifetime of savings can start eroding away.

The New Math of Retirement

The new math is based on a projected longer life expectancy.    Unfortunately, the old education and habits are so ingrained, that change can be difficult.   The new math means taking a hard look at investing exclusively in these supposedly safe investments.  Like going on a diet, you may need to do some “push-backs”.  A push-back is when you push back the food at the dinner table and don’t dive in for seconds.  You may have to do some push-backs on these safe investments.  How come?  As these investments are lower risk, they typically have a lower return.  You may be able to earn about 5% on these investments depending on various factors such as the length of time your money was committed, the institution issuing the C.D., bond or annuity, and what the guarantees are.  However, looking at the real rate of return after taxes and inflation, there may be almost no return.  Remember that interest rates will change over time.  The key is to focus on what you get to keep after taxes and inflation—not on what you earned. 

Why should you consider having fewer safe investments—time.  Let’s imagine your plan was to retire early and you achieved this goal.  When combining an early retirement with an increased life expectancy, you could be looking at a lot of time.  While it’s nice to have this “extra” time, you’ve still got to be cautious.  The more time you have, the more inflation can slowly upset your lifestyle.

Let’s take a look at life expectancy.  It’s no secret people are living longer.  Back in 1901 the life expectancy at birth was 47 years.  By 2003 it jumped to over 77 years.  So, in a little over a hundred years life expectancy has increased by 30 years.  This trend of increasing life expectancy is predicted to continue.  Today, someone age 85 has a life expectancy of almost 92.  This means if they retired at age 62 they could be retired for thirty years.  Are many people psychologically, much less monetarily, prepared to spend up to thirty years or one-third of their life in retirement—probably not.  Don’t be fooled by life expectancy numbers.  They aren’t the easiest to understand.  This number doesn’t tell you how many years you have left on this earth.  Life expectancy numbers are a median.  This means you have a 50% chance of living longer.  Your retirement plan needs to take into account the probability of a longer life expectancy.

Adjust Cash Reserves Before and During Retirement

Before you slide into the distribution phase, you’ll need to adjust your cash reserve fund.  As you are (hopefully) investing for total return and not just income, a portion of your portfolio will be invested in equities (depending on your suitability).  As a consequence of this, you’ll need to increase your cash reserve fund.  During the accumulation phase we recommend having a cash reserve fund of between three and six months of living expenses.  When you shift into the distribution phase, your cash reserve fund should be increased to between eighteen and twenty four months of your living expenses.  Having a larger cash reserve fund should allow you a longer time to ride out any significant market fluctuations.  This is done so that you’re not forced to sell equities at an inopportune time.

If you any questions with your retirement plan, please call Tom Scanlon at (860) 646-21465 or e-mail TomS@Borgidacpas.com