I was watching the 1986 movie The Three Amigos starring Steven Martin, Chevy Chase, and Martin Short. It’s not an award winning movie but I was in the mood for a silly show.
But like I do with most things in life, my attention quickly turned to personal finance. I started thinking about the most important Three Amigos in my retirement planning. For me, pension, social security, and my investment portfolio are The Three Amigos.
These Three Amigos used to be called the Three-Legged Stool. I say “used to” because pensions are now rare and getting more so every year. And then most people just don’t have any retirement savings. So really, you don’t have a stool. You’ve got people relying on social security to keep them alive during retirement.
A one-legged stool is not a retirement that I desire. You are likely living in poverty and you can forget any discretionary spending. Unfortunately, this is the life of many Americans. I finally woke up and made sure all 3 legs on my stool are solid.
Pension
My company pension has about 22 years accrued so far and I’ll have 26-27 years in it by the time I retire. Of course, that is assuming they don’t freeze it in the next 4 years. Since I recently received a promotion at work, I’m not sure how that will impact my pension. Let’s just say it will pay me at least $75,000 annually when I retire in 4 years at age 62. It will pay until both my wife and I are dead.
I didn’t come to this company because of the pension. And the pension didn’t really hit my radar until my first 10 years with the company. Then at around 15 years (about 50 years old) the pension started taking on a new meaning.
It really meant something to me then because I only had a net worth of of $115,000 at 48 years old. I started to become aware of my future and the pension started to become potentially valuable. I say “potentially valuable” because I was near broke and still many years away from retirement.
Here’s the funny thing about that pension, as I got older (around 50) it almost started to handcuff me to the company. I suppose that’s because I didn’t have much to my name, so my biggest hope of retiring now stood with the pension.
My Pension’s Value
I will officially become a millionaire this month, which means my net worth will cross the $1,000,000 threshold. This net worth is made of about $630,000 of an investment portfolio and $370,000 of home equity. It does not include my very valuable pension.
But the annual cashflow the pension will generate for me is very real and is worth a lot. Many have shown ways to calculate a pension’s value but I’ll show one easy (yet less accurate) and one I consider to be very accurate.
Method 1: (Easy But Less Accurate) $75,000 annually / 4% = $1,875,000 using the 4% rule. This is easy to figure but I consider this highly inaccurate. It doesn’t consider several important factors. Either way, it’s one easy way to consider how valuable your pension is to your net worth.
Using Method 1, this basically means my current $1,000,000 net worth would increase by an additional $1,875,000 if I included the pension value. That would give me a net worth of $2,875,000. That sure sounds pretty good.
Method 2 (Preferred): Since the pension is really an annuity, I consider the most accurate way to figure it’s current value is to visit an insurance company’s annuity calculator; Charles Schwab’s calculator is the one I used. The calculator told me that if I wanted $75,000 annually for a joint life only (my wife and I) annuity, I’d have to provide a premium payment of $1,604,911.
That $1,604,911 is how much Charles Schwab would value my pension. And regardless of the approach to value a pension, it’s real money paid in retirement. I only showed two methods but there are many others. I like the annuity calculator method because that tells me how much the investment community values $75,000 annually in today’s dollars.
Income Floor
If I didn’t have a pension, I’d seriously consider buying some annuities to generate some guaranteed income. I’m a big fan of having an income floor to help cover essential expenses. In fact, if I leave my kids an inheritance then my recommendation to them is to use some of the money to go buy an annuity(s) that starts paying them a guaranteed income in retirement.
I’ve done several cash flow scenarios (most recently in January 2021) and they all show my essential expenses being covered by an income floor. The income floor is guaranteed and consists of my pension and social security.
Social Security
The greatest income floor is that of social security. Unfortunately, most people are taking their benefits at the early age of 62. Our plan is to wait until age 70 to maximize our benefits.
If you take social security at 62, you’ll receive a 30% reduction in monthly benefits. And for every year past your full retirement age (67 for me) up to age 70, you receive an 8% increase in benefits. These are big numbers, they last your lifetime and receive cost of living adjustments plus they are guaranteed. What’s not to like?
So why do so many people take social security at age 62? Many people are emotionally and/or physically exhausted by that age and we all know of the horrible retirement statistics. They literally have no choice.
I’m not sure exactly how much I’ll receive at 70 but let’s make some assumptions. I’ll likely get a minimum of $30,000 annually at 70 and my wife will get half of that amount. That’s a total of $3,750 per month. Like we did in our pension example, if we put those numbers in an annuity calculator it shows a value of $807,352. Since we are taking it at 70 years old, it will pay out a shorter timeframe. But like the pension, that’s $807,352 that could technically be included in my net worth.
The pension and social security payments will cover all of my essential expenses with plenty to spare. And since our plan is to NOT get long-term care insurance, I’ll use all of those annual surplus funds to self-fund long-term care.
Investment Portfolio
I’ve got a strong income floor that covers my essential expenses, all thanks to my company pension and social security. My investment portfolio is targeted for discretionary expenses. In 2006 at the age of 43, I only had $74,762 in my portfolio. What an absolute disaster I was back then. For comparisons, my 26 year old daughter has nearly $80,000 and my 23 year old new college graduate already has nearly $50,000.
Needless to say, I’ve done everything in my power to make sure they learn from my mistakes. Thank goodness I’ve got a higher income job or we’d be in deep trouble. Think of the risk I was taking back then (2006). I was about 7-8 years into a job (now 22 years) and the pension didn’t mean much to me back then.
In 2011, I had about $175,000 in my portfolio but my lots of debt. My net worth was only $115,000 at that time. So I was saving more but also taking on debt, which is definitely defeating the purpose. It wasn’t until 2017 that we started eliminating our debt. The portfolio started getting more attention in 2018.
In fact, 2018 was a set-up year for me as I created my approach to investing. The forecasted years of 2021-2025 are make or break years for the portfolio. Of course, after this year I’ll be debt free so my savings rate will go over 60%+. No kids in college, no debt, recent promotion means I could actually exceed the forecasted $1,250,174. Of course, interest rates and stock market returns will have a big impact too.
Again, these are my discretionary funds now that my income floor of pension and social security cover my essentials expenses. I’m feeling really good about our path but I’ve been in total recovery mode these last several years and I’ve been lucky. I could just as easily have become another retirement statistic in America.
Summary
All three amigos plus a debt free retirement should equate to a pretty decent financial life after 62. I could easily have just relied on the two amigos (pension & social security) but that would have been risky. Frozen pensions and reduced social security benefits are always possible. I plan to have those benefits provide an income floor and my investment portfolio is a Plan B. And we wanted a better retirement so having all three amigos should do the trick.
Dusty Bottoms (Chevy Chase): “Time for plan B. Plan A was to break into El Guapo’s fortress.“
Carmen: “And that you have done, now what?“
Dusty Bottoms (Chevy Chase): “Well, we really don’t have a plan B. We didn’t expect for the first plan to work. Sometimes you can overplan these things.”
The Three Amigos movie
So, I’ve got some income producing plans and an investment portfolio. If we could convert that guaranteed income to an asset value and add it to my investment portfolio we get this:
- Pension (joint life) @ $75,000 annually is the equivalent of $1,604,911 in assets
- Social Security (Mr. & Mrs. TLR) @ $45,000 annually is the equivalent of $807,352 in assets
- Investment portfolio at 62 is forecasted to be $1,250,174
All together, this is like having $3,662,437 of investable assets in retirement. With no debt, I feel very comfortable retiring at 62.
Given that most people in this country no longer have the three amigos to rely upon, you might have to create your own amigos. If no pension is available (which is likely) then consider an annuity. Reduced social security benefits means you save more. And if you want a retirement that covers both essential expenses and some decent discretionary fun then save even more.
You have to plan for all of this but you do have control if you are financially aware of your situation. I wasn’t financial aware in my 40’s and I almost paid the price by having a retirement (if I could have retired) that would have been horrible. A retirement that many in America are facing. I’ve said it before many times on this blog … don’t be an American retirement statistic.
Thanks for reading!
Mr. TLR