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Friday, September 27, 2013

A $1000/month pension equals $200,000 in savings CORRECTED

On the road today, but my wife referred me to this article by Lynn Parramore* (originally published here) on how the 401(k) "revolution" was a big bust for the middle class, something I have also written about. I just wanted to add one quick point to her discussion.

Parramore references the common recommendation that you have at least $1 million in savings to retire. This is usually related to the "rule" that you can take 4% of your savings per year and not exhaust it. That would give you $40,000 per year in income. However, with low interest rates and flat stock market performance (the S&P 500 just topped its 2000 peak this spring), even 4% may be too high as you run a greater risk of outliving your savings.

The flip side of that rule, which I haven't seen mentioned anywhere else, is that a $1000 per month pension equals at least $300,000 in savings, as $300,000 times 4% is $12,000 per year. If 4% is too high, then its value is even greater. If you can only take 3% of your savings per year safely, it would be equal to $400,000 in savings, for example. about $200,000 in savings, as it wold take about that amount to buy a $1,000 per month annuity (see Lyle's comment below).

This shows how important it is to protect pensions where they do exist, primarily at the state and local government level. They are being chipped away at varying rates, mainly but not exclusively in red states. Oregon, for example, looks set to cut state pensions in a special legislative session via reductions in cost of living adjustments similar to the idea of using a less generous inflation measure for Social Security to provide backdoor cuts.

It should be obvious that this is even more true for Social Security, since everyone is eventually eligible for benefits. That is why I have argued that expanding Social Security is the best solution to the coming middle class retirement crisis.

* Disclosure: Lynn Parramore is the editor at AlterNet who commissioned my article there on state and local government subsidies to business.

Cross-posted at Angry Bear.


  1. You are missing one very important factor in your calculations -- 401(k) and 403(b) plans belong to the owner, not the company or the government. As such, they are inheritable. Everyone is NOT eventually eligible for Social Security -- they have to LIVE long enough first. Not everyone does. A $1000/month pension is worth nothing if you die before you retire, but your heirs would still get the $300,000 in retirement savings. The 4% withdrawal rate commonly quoted will almost always leave something to one's heirs, no matter how long one lives.

    Now, if people are not saving for their retirement, how is that someone else's fault? If a person were retiring now at 65, having worked forty years at median household income (assuming an average 3% inflation), saving just 10% each year, earning a steady 8% (which is WORSE than market returns), he would have $655k -- about $26k/yr at a 4% withdrawal rate.

    Social Security takes FIFTEEN percent, does NOT belong to you and your heirs, and the average annual payout was $14,760 in 2012. (The best guesstimate for median HOUSEHOLD payout, for comparison, would be half again that number -- about $22,000/yr.) AND, Social Security will take 50% back if you make too much money.

    Personal responsibility is the best solution.

    Of course, we could just allow people over 65 to take money directly from their children and grandchildren -- cut out the wasteful government bureaucracy.

    1. Yes, of course it is correct that you cannot inherit the pension or Social Security benefit.I should not have assumed it was obvious, since it is an important difference.

      This does not make "personal responsibility" the solution to the coming retirement crisis. Only 31% of private workforce has 401(k).

      Moreover, I know plenty of people who are in no position to save even 10% of their income a year, and I doubt that one can expect a "steady 8%" return on one's savings. You are completely forgetting about risk. Millions of people lost their jobs, 401(k) savings, and houses as a result of the Great Recession. The great advantage of Social Security is that the individual does not have to bear market risk.

    2. What "market risk"? Seriously, we're talking about investing for FORTY YEARS, possibly fifty (ages 18 through 67) and planning for another THIRTY YEARS in retirement. Over those time periods market risk is ZERO.

      Over time periods like that you can expect 11% from the stock market, plus a bit from dollar cost averaging.

      You find me even a lower-middle-class family, and I guarantee you I can find a family living on 10% less in the same area.

      I am one of those who lost his job during the recession. (Twice, in fact.) But because I had been saving voraciously before that, I could ride out both stints of unemployment. I only buy used cars (our "new" car now has over 200k miles on it), and I work hard in the off hours to keep my professional skills up.

      I have two kids in college, both working to pay for it. The third is getting his A+ certification as a junior in High School so that he can do the same, and he is a certified life guard and pool operator. The fourth is a Red Cross certified baby-sitter. The fifth is still too young to work.

      THAT is personal responsibility.

      Now, if two families earn the same income, but one squanders it on new cars, a big house, and vacations, what does our government do? It subsidizes their college costs and retirement. Meanwhile, the one who saves for his kids education and his own retirement gets TAXED AT A HIGHER RATE!

      Or government subsidizes irresponsibility and punishes responsibility.

      That is insane.

  2. Also if you are willing to give up the inheritance part, 3000 k will get you between 1700 and 1500 a month in an annuity depending on what settlement options you way. I just checked and got a rate of about 7.1%. Also with an annuity you transfer longevity risk to the annuity payer (these are without any inflation riders, but even at a 5% rate you would not get any inflation increase unless you invest in equities.

    1. Thanks, Unfortunately, I've just come across these options in real life, and you are right. That would make the $1000/mo. pension more like $200,000 than $300,000. Social Security would be slightly safer than the private annuity because the issuer is more likely to go bankrupt than the federal government, but in most cases that risk is probably not high.