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Retirement sources of income have often been compared to a three-legged stool. The first leg of the stool is Social Security. The second leg is your employer's retirement plan. And the third leg is your personal savings. How much you depend on the third leg depends on the strength of the other two. The strength of each leg may change, and then you'll need a new plan of action to reinforce the retirement stool. Specifically, changes to your financial situation will require you to be more educated about financial matters. It will take more discipline and planning to keep that stool strong.

Stool Leg #1: Social Security

Social Security was designed to provide a minimum level of support (subsistence level). That is why it is also known as social insurance.

For every dollar (up to certain limits) you earn, the government takes a percentage to support Social Security. Your employer is also required to pay the same amount. If you are self-employed, you must pay both the employee and employer amounts. When you retire, having a history of higher earnings means Social Security will replace less of your pre-retirement income.

What can someone who is 30 or 40 years old today expect from Social Security when he or she retires? While there will always be a need for social insurance, no one really knows what Social Security will look like in the future.

Much controversy exists as to whether Social Security will survive. The baby boomer explosion into retirement, combined with longer life expectancies, means that there will be fewer workers supporting a much larger retired population.

It is likely that Social Security will be around for some time to come. However, the odds are it will represent a smaller percentage of your retirement income in the future than it would today.

What might we expect down the road? You might have to wait until a later age to get your full retirement benefit from Social Security. The age at which you can receive full benefits is increasing, reaching age 67 in 2027. A larger portion of your benefits may be taxed and future cost-of-living increases may be reduced. For workers today, it may also require higher payroll taxes and other general taxes to keep the system going.

The message here is clear. While it is likely that Social Security will always play some role in your retirement planning, the further you are away from retiring, the less you should expect. The burden of retirement clearly lies with you.

Stool Leg #2: Retirement Plans

Retirement plans come in two forms: defined benefit and defined contribution. A defined benefit plan pays you a retirement income and is usually paid in full by your employer. A defined contribution plan provides an annual contribution to an account in your name, based on either your annual salary or an amount that changes yearly based on the company's profits. With a defined benefit plan, you have several different payout options. With a defined contribution plan, you typically receive a lump sum, which you can either invest yourself or annuitize to receive a monthly income over your lifetime.

If you have a defined benefit plan, chances are your anticipated retirement income won't be as large if you change jobs frequently. Changing jobs could result in a substantially smaller benefit from a combination of defined benefit plans from two or more employers than if you had continued earning benefits under one plan for a long period of time. That's because retirement benefits from defined benefit pension plans are generally based on age and length of service, so unless that new job is paying you substantially higher wages, staying where you are has long-term advantages.

Look at the illustration below:

Assumes the formula 1% times the highest five-year earnings out of the last ten years times years of service. Ray has 40 years of service at Job 1. Mitch has two years at Job 1, two years at Job 2, 25 years at Job 3, and 11 years at Job 4. Both stated earning $15,000 and received 4% increases each year.

*Must complete 5 years of service to be entitled to a benefit

As you can see, Ray accumulates a much larger benefit by staying in one job for an entire working career.

Stool Leg #3: Personal Savings

Increasingly, your retirement income will depend on your savings. Companies are putting more of the responsibility—and opportunity—on you through company savings plans (such as 401(k), 403(b) and 457 plans). These plans are tax-advantaged, but they work only if you participate in the plan by contributing a portion of your current income. That's why it is not part of the pension leg, but instead part of the personal savings leg of the stool. You have an opportunity to save on a pre-tax basis and watch your money grow tax-deferred.

With a company savings plan, you'll be contributing a percentage of your current income to your retirement account, depending upon your company's plan limits and how much you decide to contribute. You'll be responsible for making the investment choices that affect your long-term performance, so it is important that you understand these choices.

If you want to contribute more than your plan permits, your company savings plan may contain a feature which allows you to make after-tax contributions that grow on a tax-deferred basis.

Beyond company plans, there are Individual Retirement Accounts (IRAs) and Roth IRAs; for the self-employed, there are Keoghs, SEP-IRAs, and SIMPLE plans (these types of plans can also be offered to employees of self-employed individuals or of small businesses). There are also deferred annuities. Investments in all these plans accumulate tax-deferred, which means the earnings on your money are not taxed until (in most cases) you make a withdrawal. Money saved in a Roth IRA will never be taxed upon withdrawal, provided you meet the eligibility requirements and the holding period rules.

SUGGESTION: Whenever you think about your long-term savings, think tax-free and tax-deferred. While you may eventually have to pay taxes on your future earnings, you are taking advantage of tax-deferred compounding. Saving on a tax-free basis means you will never have to pay taxes on your savings and earnings.