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The Three-Legged Stool: what is the idea behind it?

It is an old phrase that once financial planners used to define the three traditional sources of retirement income: personal savings, employee pensions, and Social Security. They expected that these three points would together produce a solid financial foundation for the senior years.

Times have changed, and after many years the three-legged stool theory changed as well.

KEY TAKEAWAYS

  • The three-legged stool: an old term for the three sources of retirement income: personal savings, employee pensions, and Social Security.
  • One leg of the stool – pensions. Defined-contribution plans (placing the investment burden on the person) replaced it.
  • Another leg of the stool – Social Security. It looks weak, with predictions that the system might run out of resources by 2033.

 

A New Leg to the Stool

In the private sector, the pension leg has been changed and replaced for younger workers. Instead of a pension, workers now have 401(k) and other retirement savings accounts (also known as defined-contribution plans).

 

Originally, the idea behind these retirement savings plans was not meant to serve as a pension. Instead, they were to be additional savings accounts, making the third leg of the stool. Although, ever since the beginning of the 1990s, employers have been saving some money for themselves. They were also keeping financial responsibility by replacing the corporate pension guaranteed with these tax-advantaged plans. There are some companies that will still match the employee contribution up to a specific percentage, but many other companies do not even offer that level of assistance.

 

The State of Social Security

The condition of Social Security seems a little bit unstable. According to the 2021 Annual Report of the Social Security Board of Trustees, the Social Security Trust Fund might run dry in two decades. It warned that at the current output rate, the OASI Trust Fund (the Old-Age and Survivors Insurance), responsible for paying retirement and survivors benefits, has recourses to pay planned benefits on a timely basis by the year 2033. At that time, experts predict that the fund’s reserves will become drained while maintaining tax income will be sufficient to pay around 75% of scheduled benefits.

These estimations are, of course, theoretical, and it’s still not entirely predictable what the lasting effects of the current pandemic will be. The forecasts also do not account for increasing interest rates, raised revenue, or several other circumstances. Finally, it is less probable that the U.S. government will decide to let a meltdown happen without action and stepping in. Although, it is a date that still creates concerns. In the United States, workers can review their Social Security accounts online to see how much in profits they will receive at age 70, full retirement, or early retirement.

Personal Savings for Retirement Remain Low

The Three-Legged Stool: Savings, Pension, Social Security That is the third leg: personal savings. Over the last decade, savings rates have been remarkably low for workers in the U.S. 

Stagnant wages and recessions have made it difficult to put money aside and save for the future. Although, with the rest of the stool looking unsteady, people will need to start keeping a larger portion of their income for savings and continue to use tax-advantaged retirement plans. Such plans include IRAs and annuities to create their retirement bases.

Financial advisors recommend allocating at least one-fifth of your annual earnings for retirement. Experts suggest that the earlier you start saving, the better set up you are to get the advantage of increasing investment returns. Finally, advisors recommend adding enough contribution to your 401(k) to increase the employer match if your employer proposes one.

 

The Bottom Line

In theory, the three legs serve in concert to accomplish financial health. Each leg comes with its outside challenges and cannot be defined independently for financial health.

After some changes and replacements of plans in the three-leg stool, including the fact that the retirement savings accounts replaced the pensions, now it looks like a two-legged stool. However, it is still not something you could actually rely on securely. Besides, the U.S government has debated possible solutions to these issues. They analyzed the ways to solve the retirement-savings problems for Americans. Their discussions included talks about hybrid pension plans and creating national or state-level retirement savings plans. These plans were meant for people without any offered plan through their work. 

The government also considered creating the federal Thrift Savings Plan for all Americans. It is a defined-contribution plan which is currently available to government employees. It is also considering options to subsidize Social Security and guaranteeing it doesn’t run out of funds. In the meantime, it might be helpful to think of tax-advantaged retirement plans as the second leg of the stool while working on creating the third leg with other saving strategies, including investments such as stocks, real estate, and many other forms of investment.

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