Shortly after the last turquoise and white Cruiser sedan rolled off the assembly line at the Studebaker plant in the mid-1960s, thousands of employees not only lost their jobs, but their pensions as well. The Studebaker pension plan travesty prompted sweeping legislation aimed at protecting the future financial security of retired American workers. Known as the Employee Retirement Income Security Act of 1974, along with subsequent amendments, ERISA established minimum standards for private industry pension plans.
ERISA paved the way for the Internal Revenue Code to add section 401(k) in 1978, which caused an explosion in retirement plans that were less expensive to maintain. As a defined contribution plan, 401(k)s created a predictable cost for employers, while the cost of their forerunner, defined benefit plans, varied from year to year. Retirement plans have become especially important with the pending crisis in the Social Security Administration. Current Social Security payments scarcely cover bare essentials and future payments are at risk.
As a rule of thumb, people need to save 10 percent of their income during their working years to pay for their retirement, or desirement years -- when they will be able to do everything they desire. Yet, on average, the 50 million employees, who are covered by 401(k) plans, contribute a dismal 3 percent to 4 percent of their salaries. This is a disaster waiting to happen!
It's the duty of financial advisors to encourage their clients to save at least 10 percent of their income for retirement. Financial advisors must also educate retirement plan participants so that they are well aware of the financial statistics: The amount of the participant's current expenses, of which 70 percent to 90 percent will exist in retirement; the amount of money that they will need in retirement; and the amount of every paycheck that they need to contribute to reach the retirement amount by the end of their working careers. The goal of every financial advisor should be to create a paycheck for life for their clients.
To jump start the education discussion, here are nine principles that advisors can explain to participants, so they achieve a successful and secure retirement.
Principle no. 1: Act Like An Entrepreneur
All Americans have the opportunity to start their own businesses and become their own bosses. Plan participants should think of their 401(k)s like their own private Paycheck Manufacturing Companies. They must act like entrepreneurs -- maximizing their companies' profits and minimizing expenses.
Principle no. 2: Determine Your Desirement Mortgage
Participants should think of their retirement as expenses, which they need to pay each month -- like their home mortgages. In order to know how much they will need, they must first calculate the total cost of their retirement (on average about 70 to 90 percent of their current income) and break it down into monthly payments. In order to enjoy the full benefits of their hard work, they must be just as diligent in making their desirement mortgage payments as their house payments.
Principle no. 3: Use Other People's Money To Capitalize The Business
Many people have the misconception that they must save for retirement using only their salaries. Other people's "free" money is available to participants of a 401(k) plan. Using Uncle Sam's pre-tax money (through salary deferrals) and their employer's money (through matching contribution programs), participants can boost their retirement savings with annual returns of 50 percent to 100 percent.
Principle no. 4: Harness The Power Of Compound Interest
Compound interest is one of the greatest forces in the world. Participants should learn to use its power in order to grow their retirement savings. Oftentimes, participants don't understand that compound interest pays them interest on the principal as well as the interest already paid, which means that their retirement assets will increase exponentially! Financial examples of compound interest drives home this powerful tool that everyone should understand.
Principle no. 5: Use Technology To Save Automatically
Emotions and investing don't mix. Participants should take advantage of all the automatic features in their 401(k) plans, which help prevent emotional investing. Automatic features such as auto-enrollment, auto-placement, auto-escalation and auto-rebalance, are designed to help participants reach their desirement years successfully.
Principle no. 6: Manage Risk By Outsourcing
No matter how smart people are, they cannot be experts at everything or do it all alone. By outsourcing the management of their investments and opting into a target-date fund or managed account based on their age of retirement, the average 401(k) participant can access the skill, knowledge and expertise of investment professionals better suited to managing their long -term investments.
Principle no. 7: Control Fees And Expenses
Like all good entrepreneurs, participants must learn to keep down costs associated with their Paycheck Manufacturing Companies in order to maximize their returns. Plan participants should learn about the types of fees that are associated with their plans and the reasonableness of those fees for the services they are getting.
Principle no. 8: Guarantee Paychecks For Life With Annuities
More companies are offering "lifetime income alternatives" within 401(k) plans. These alternatives behave similarly to annuities, which have many benefits and can offer participants peace of mind. However, they are not right for all investors. Participants should be educated about annuities and then decide about using them.
Principle no. 9: Take Advantage Of Tax Benefits With A Roth
The truth is that people don't know what tax bracket they will be in when they retire. For this reason, some people prefer contributing to their retirement with post-tax dollars into Roth accounts. When they reach retirement, all the money they've accumulated in their accounts will be theirs to use, without the worry of taxation.
The job of every financial advisor is simple. Educate participants to help them create a paycheck for life, so they are financially secure during their retirement years. Anything less is failure.