Lately I have seen a lot of blog posts and chatter about ways to fund retirement. Everything from discussion of drawdown strategies, to having backup plans, to tax optimization. One of the things I’ve seen mentioned but not discussed in too much depth is the 3-legged retirement stool.
(yes, I did have fun playing around with Paint 3D on my new laptop, thanks for asking)
Have you heard about the retirement stool? Much like Sissy Spacek, it has both an unfortunate name and was far more relevant decades ago. However, there are still some reasons to pay attention.
The 3-legged Retirement Stool
The 3-legged retirement stool is a metaphor for the three traditional (post World War II) ways to fund retirement – Social Security, employer pensions, and personal savings. Together the three legs held up your retirement – just like a stool. The concept is valid – you should have a variety of ways to support your retirement.
The legs have changed a bit for most employees as traditional pensions have disappeared from much of the workforce. In its place, the modern 3-legged stool is now Social Security, workplace savings (401k, 403b, TSP, etc), and personal (non-workplace) savings. Employers often contribute to workplace savings, but that only partially makes up for not having a pension. And of course, many people don’t even have access to a workplace retirement account.
The retirement stool relies on having multiple streams of income, which I’ve said before is a good way to protect yourself financially. However, this plan isn’t the safest. Between many people not having a pension or workplace retirement account, and many people not convinced that Social Security will be around by the time they retire, this traditional method doesn’t seem very secure.
I’d rather have a sturdier, more resilient retirement. For that reason, I’d like a bigger retirement structure supported by more legs. That’s why I’m working on building my 5-legged retirement platform.
The 5-legged Retirement Platform
Platforms seem more secure than stools, don’t they? Maybe it’s just me, but I’d rather have a whole platform supporting my retirement lifestyle than a measly stool. Plus, the thought of writing “retirement stool” 27 times in a blog post was just…off-putting.
My 5-legged retirement platform is made up of several sources of retirement income that will give me what I need to maintain my desired standard of living. As with the 3-legged stool, it includes personal savings (written here as taxable savings), Social Security, and a pension. But I’ve also added in my workplace savings (part of tax-advantaged retirement accounts) and the possibility of other income during retirement.
I took some real time figuring out how to size and place these legs. Heck, I even went back and forth with the colors and textures I used to really communicate my thinking. Let me explain mine, then we’ll talk about how to build yours.
My taxable savings leg is the medium sized leg of the group, because it will end up being a smaller amount in the end than my tax-advantaged accounts. It’s currently only a bit smaller but I contribute far more to my tax-advantaged accounts. By the time I’m ready to retire, the tax-advantaged accounts will probably be worth 2-3 times what the taxable account will be worth.
It’s hard to tell, but I made this leg into black “steel” (a Paint 3D option) to represent its strength. My taxable savings make up 32% of my current net worth and will be important in making early retirement happen. But I’ve placed it on the outer edge of the retirement platform because the things that are less stable/guaranteed go towards the outside, while the things I can rely on more are in the middle. Taxable accounts are towards the outer edge of my retirement platform because while it helps support the platform, it’s not the main base of my plan. It also contains my riskier investments. As I get closer to retirement, I imagine this leg moving further in but it will never become the main base leg.
The smallest and weakest of the legs is income – in this case, earned income through some sort of action I would take in retirement. I consider it the smallest leg because *if* I even earn an income in retirement, I doubt it would be much. And it’s the weakest leg (wood) because it’s the one least likely to be there – my retirement plans actually don’t include any kind of paid work. But I’m including it because as it turns out, many FIREes end up earning money in retirement that they weren’t planning for. Why? Well nobody has done a study yet that I know of, but the common explanation is that a group of people who are innovative and hard working enough to reach retirement at a young age tend to have skills that can turn into income – whether they mean for them to, or not.
Tax-Advantaged Retirement Accounts
My tax-advantaged accounts are in the center of the platform because I consider them the main base of my retirement plan. If everything else went away, I could make retirement work on just these accounts. My retirement platform wouldn’t be quite as stable that way, but it would stay up, gosh darn it.
The base leg is green because, well, money, and it’s the same “metal” texture as the black to represent it being a strong part of my plan. It’s also the size it is because I expect these accounts to be the bulk of my personal contribution to my retirement.
The red leg is Social Security – red-white-and-blue wasn’t an option. I don’t expect Social Security to be too much money so it’s smaller than most of the other legs. I put it towards the center because I do consider it “relatively” secure. I’d like to think there will be some sort of Social Security benefit still around when I reach Full Retirement Age, though it probably won’t be as much as currently advertised. I’m also not counting on needing it – you can see from the position of the leg that if it disappeared entirely, there’d be no change to the stability of my retirement platform.
I am lucky that I have the possibility of getting a pension from my career. There’s no doubt about that. But this base leg is on the edge of the platform because it’s not a guarantee. If and when I’m confident that I will receive that pension, I would move the base legs around to reflect that my pension is now the main base leg of my plan (because I consider a federal government pension to be the safest possible plan), with the tax-advantaged accounts moving into a secondary base position.
The pension leg is as large as the tax-advantaged account leg because either one *should* provide me with enough retirement income to meet my needs. I chose a granite texture because it is strong like bull…but liable to being chipped away.
More Legs = Better Support
You could also consider some of those legs to really be multiple legs. For instance, if I retire from the military, I’ll also get cheap lifetime healthcare. Since healthcare can represent a huge cost, especially for aging Americans, this is an important part of supporting my retirement. Free healthcare is basically the equivalent of adding a large chunk of money to my investment portfolio.
Social Security is similar. While people tend to think of just the retirement benefits check (Old-Age, Survivors, and Disability Insurance (OASDI)) when they think “Social Security,” there are actually a variety of programs that fall under purview of the Social Security Administration. At the very least, I expect to receive some benefits from OASDI and Medicare.
And my taxable savings and tax-advantaged retirement accounts each have a couple breakouts. Within the tax-advantaged accounts, I have my Traditional TSP, my Roth TSP, and my Roth IRA. My taxable accounts are comprised of a large account with index funds and ETFs, and a small account with individual stocks.
And while I don’t know what that income leg will end up looking like in retirement, some possibilities are:
- income from a long term rental property
- blog income
Together, my 5-legged retirement platform is going to get me what I really want – freedom!!
How To Build Your Retirement Platform
Diversify, diversify, diversify.
I talked about this in the multiple streams of income post too. When you are working, having multiple income streams protects you financially; for instance, it would ensure you still have an income if you lost your job. It’s just as important to have multiple income streams in retirement. If something happens to one of them, the other legs can help hold up that platform.
Start With A Strong Base Leg…Or Two, If You Can
My recommendation would be to focus your first efforts on establishing your one or two primary sources of income in retirement. You want this leg to be strong and large – preferably, it’s enough to hold up the retirement platform all on its own if needed. The beginning of your retirement planning is not the time to take a flyer on Bitcoin or your buddy’s new restaurant. Save speculative or risky investments for later, once you have a firm base. After that is in place, you can branch out into the more “fun” investments if you want to…just keep them small. I usually see 1%-5% recommended as the limit. My “fun” investments currently make up about 1% of my investment portfolio.
This is not me being the boring personal finance nerd. I started with individual stocks in a taxable brokerage account. If I could do it again, I’d go back and buy me some nice, juicy index funds inside an IRA or TSP. Oh yeah…
If you are working towards a pension as one of your bases, there might not be much you can do to change the size of that leg. Sure, receiving promotions will usually make a pension check larger. But more importantly, you need to ensure you are qualifying for the pension. That means busting your butt to be good at your job and making yourself valuable to the organization. Bonus: that’s how you get promotions, usually. But don’t expect a pension if you aren’t willing to put in the work. A pension is too valuable to treat it as an entitlement or a given.
Regardless of your ability to earn a pension, start a tax-advantaged investment account as soon as you can as your main base. Or start your real estate empire, but realize the cost of entry is higher there in terms of both dollars and time so choose wisely. Either way, the point is to create the main thing that will give you retirement income. For me, currently, it’s my tax-advantaged accounts.
Strengthen That Base Through Diversity
One of the ways to diversify is to make sure that your stock/bond market investments are diversified. You may have a taxable account, an IRA, and a workplace saving account, but if all of those vehicles are holding S&P 500 index funds, you aren’t as diversified as you think. Sure it’s better than having all of your money in Enron, but you can do better. For instance, purchase some international stocks. Or, since the S&P 500 tracks large cap companies, maybe buy some shares of a small cap index fund.
I have also diversified my tax situation. I gotta tell you – I don’t know what taxes are going to look like 10 years from now, much less 40 years from now. Maybe my tax bracket will be lower. Maybe it will be higher. Or maybe capital gains tax rules will change completely. I don’t know. What I do know is that I have the ability to diversify my future tax situation, so that’s what I’ve done. I have some Roth accounts, a Traditional account, and some money in taxable accounts. What that will allow me to do (I hope) is be flexible in retirement. Instead of writing a plan in stone now, I’ll adjust as needed when I’m withdrawing funds from these accounts.
Build More Support Legs
Once your base legs are established, seek out other sources of retirement income for your support legs. As I mentioned, these could include long-term rental property income or an AirBnB. Or you could have residual income from writing a book, blog, or even a song. If you like creative ventures, maybe you can sell something that you make for fun. My father recently talked about flipping items he finds at flea markets – something that will keep him busy and bring in some pocket money. My main support leg is more stock investing through my taxable account.
Imagine if you had 10 small legs comprised of different low stress, low activity income sources. Maybe a rental property, Ebay sales, dividends, dog walking, etc. On their own, probably none of those is enough to support a retirement. But together…
That’s a lot of legs. You could knock out several of them from under the platform and still be fine. Again – maybe your retirement platform would be a little bit shakier. But it wouldn’t come crashing down.
Now imagine you built all of those little legs around a solid base. Maybe that base is a workplace savings account. Or maybe it’s a pension. Maybe you have two or three big bases and they are surrounded by several thin legs. That’s going to be a pretty secure retirement platform, right?
That’s what I want you thinking about. Instead of planning for one or maybe two income legs in retirement, think about how you can expand that. For my military folks that are looking for a full career, that means investing in something while simultaneously working towards that pension. It means exploring whether a real estate venture might be right for you. Maybe it means starting a side hustle now, which will not only give you more money to help build those base legs – it might give you a jumpstart on side income in retirement.
Start thinking, because this is something I want to explore more in 2018. I want to look at how we can all stabilize our retirement planning to make a strong platform, not a piddly little footstool.
Something this post doesn’t address? The plan for pulling income from each of those legs. Another time, my friends. That’s a whole ‘nother post.