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Financial Freedom

How to Create Your Own Pension

My dad spent 35 years working in inner-city schools. When he retired, he received a pension equal to 75% of his final salary.

For the rest of his life.

When he told me that, my mind was blown. As someone who has literally been saving for retirement since I was 21 years old, the idea of having reliable income every year is astounding.

Pensions barely exist anymore. And it’s really no surprise. The associated costs to businesses have risen 135% in the past decade. As The Oxford Club’s Editorial Director Andrew Snyder recently wrote, pensions have become “a burdensome ball and chain.”

Government institutions and the few companies that still offer them are doing whatever they can to reduce liabilities – including offering to buy out employee pensions with a lump sum today.

Of course, to retirees, the idea of a pension is extremely attractive. Who wouldn’t want to know that a check is coming every month in retirement?

A pension can help keep you from drawing down your savings too quickly. It can pay for vacations, evenings out and, importantly, healthcare.

These days, the responsibility of being financially prepared for retirement falls mainly on the employee. Sure, some employers help out with a match in the 401(k). But that still won’t equal the monthly “paycheck” from a pension.

Or will it?

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If you have some years until you need the income, you can invest in Perpetual Dividend Raisers – stocks that raise the dividend every year. If you reinvest the dividends, you’ll own more shares… which generate more dividends… which buy more shares… and so on. That’s called compounding. The longer you compound your dividends, the more money your investment will be worth – and the more it will generate in income.

For example, let’s say you start with $100,000 invested in stocks that yield 4%. The dividends grow at a 10% annual pace and the portfolio rises 7.84% – the same as the S&P 500 average over the past 50 years.

Five years in, the portfolio will have grown to $178,736 and will generate $7,105 in dividends. After 10 years, you’re looking at a nest egg of $326,723 and annual income of $14,308.

If you let the funds compound for 20 years, you’ll have $1,168,556 in the portfolio. If, at that time, you decide to start taking the dividend income in cash – instead of letting it compound – you’ll receive $62,336 annually. Kind of like a pension.

And if tax rates stay the same (a big if), that income will be taxed at a lower rate than a regular pension, which would be taxed at your ordinary income rate. In fact, $62,336 at the 15% tax rate would be equal to a pension of about $70,000 at the 25% income tax rate.

However, the stocks you own are still raising their dividends every year. So you’re still getting that annual increase.

To create your own pension, you either need a large starting nest egg or time. The beauty of the latter is that you don’t need a lot of money right out of the gate. As long as you’re saving and letting those dividends compound over the years, you’ll have the income you need when you need it.

And if you can contribute some funds along the way, that’s even better.

Just as someone dutifully puts in time at a job for years in order to collect a pension, so should you invest. The big difference is that no one is going to cut your income (if you’re on top of your investments) or buy you out of your nest egg, suddenly leaving you without the cash you need in your later years.

You’ll maintain complete control over your self-made pension.

Good investing,

Marc

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About

A master of the steady, reliable science of income investing, Marc’s commentary has appeared in The Wall Street Journal, Barron’s and U.S. News & World Report. He has also appeared on CNBC, Fox Business and Yahoo Finance. His book Get Rich With Dividends: A Proven System for Double-Digit Returns achieved best-seller status shortly after its release in 2012. He captures the hearts and minds of readers approaching their golden years in his daily e-letter, Wealthy Retirement.

 

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