401(k) 101: An Introduction to the "Retirement Stool" Concept

February 6, 2018

Let’s get real: It’s hard to know where to start when it comes to saving for retirement. So, let’s simplify it—like, reaaaally simplify it—and start with…a stool. (Yes, just like that piece of furniture you’ll find at your favorite bar. Trust us: It’ll all make sense soon enough.)

For years, financial planners have used the metaphor of a three-legged stool to describe the sources of income that many public employees utilize in retirement. It’s a simple concept, but it happens to be remarkably helpful. The idea is that all three sources of income are vital to ensuring your comfort and stability in retirement. Without one of the legs, the stool falls down…and, well, your golden years might not be quite so golden.

The three legs of the stool consist of:

1. Employer retirement plans (a.k.a. pension plans or defined benefit plans)

If you’re a public employee in Colorado, chances are high that you receive a retirement benefit through the Colorado Public Employees’ Retirement Association (PERA)—the state’s public pension plan. While defined benefit plans have pretty much disappeared from the private sector, in the public sector, traditional pensions are still offered by about 84% of state and local governments. Regardless of where you fall, if you don’t have access to Colorado PERA or another employer retirement plan, you best double down on the next two sources of retirement income. 

2. Personal savings

Because defined benefit plans are costly for employers, many have scaled back dramatically or eliminated them altogether (this is especially true for employers in the private sector). Enter defined contribution plans such as 401(k)s and 403(b)s, both of which are tax-deferred savings plans that you fund with your own money. For many, this type of plan has become the sole retirement savings option offered by their employer; and hey, that’s definitely better than none at all. But, if you work for an employer that offers a defined benefit and defined contribution option—well, consider yourself lucky (and be sure you’re taking full advantage of both).

3. Social Security

You may already be quite familiar with Social Security—after all, you’ve probably been paying in to the system since you received your very first paycheck at your very first job. While members of Colorado PERA don’t contribute to Social Security (the plan is a replacement for Social Security rather than a supplement to it), any work prior to or following your PERA employment will probably call for a contribution. Since it’s hard to say what the benefit will look like when our generation retires 30 to 40 years from now, it’s a good idea not to put all your eggs in the Social Security basket. In fact, considering that Social Security by itself isn’t enough to sustain your retirement (now or in the future), this leg should generally bear as little weight as possible.

James Bear Retirement Income Stool.jpgPhoto credit: James Bear

There you have it: the three legs of the retirement stool. Where are we going with this? Well, it’s no coincidence that we here at The Dime have decided to dedicate the first three months of 2018 to exploring the what’s, why’s, and how’s of each of these sources of income in retirement. After all, it’s pretty hard to start caring about something if you don’t have an understanding of what that something is in the first place. So, we invite you to follow along with us as we dig into each—how they relate to us in the here and now, but, more importantly, what they mean for our future, living-the-good-retirement-life selves.

If you haven’t already, check out our month-long deep dive on the first leg of the stool: employer retirement plans (a.k.a. defined benefit plans). Next up is everything you ever wanted to know about defined contribution plans such as 401(k)s (comin’ atcha THIS month), and then, finally, we’ve got all things Social Security in March.

It sure is an exciting time here at The Dime. It’s enough to make us want to have a pint [while sitting on a STOOL at our favorite bar, of course].