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Explaining the 3-Legged Stool of Retirement

October 10, 2020 · 8 minute read

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Explaining the 3-Legged Stool of Retirement

Envision sitting on a three-legged stool. Maybe it’s a barstool, and you’re enjoying a delicious cocktail or mocktail with a friend.

The seat is propped up by the three legs of the stool. Now, imagine what would happen if that stool was missing a leg—the stool (and you) would topple over, unable to stand on its own. This is the idea behind the three-legged stool analogy.

The three-legged stool of retirement used to be a popular model for retirement that refers to a worker’s three sources of income during their golden years: Social Security, employee pensions, and personal savings, such as those in a 401(k).

Each of the individual legs is important on their own, and together they create a multi-faceted but unified plan for long-term financial saving and investing.

Unfortunately, the three-legged stool model has declined in popularity over the past several decades. This is largely because employee pensions are disappearing, but also because the future payout rates of the Social Security program are not totally known.

This leaves the three-legged stool model with just one strong leg, which happens to be personal savings. Therefore, saving might be more important than ever before.

Here’s what you need to know about each of the legs of the three-legged stool for retirement—and what you can do to plan for retirement, even if you don’t have access to all three legs.

The Three Legs of the Three-Legged Stool

Saving for retirement is no small job. Think about it: You’re living for 20 or more years with no income from a traditional salary. An appropriate response to such a big undertaking could be to tackle the job from multiple angles.

Enter the three-legged stool, an approach to retirement income that considers multiple sources. Here is an overview of each of the different legs in the model.

Personal Savings

This refers to any money that you’ve personally saved for use in retirement. This could be money saved in a savings account at a commercial bank or an online financial services company, held and invested within a brokerage account, or heldin an account specifically designed for retirement, like a 401(k) or a Roth IRA.

For those looking to beef up their retirement savings, accounts specifically designed for retirement could be a good bet. In general, retirement accounts have preferential tax treatment as compared to saving money in a savings account with your bank and within a non-qualified brokerage account.

Though of course, you might want to check with a tax professional for the best plan of attack given your tax situation.

Some retirement accounts are offered through an employer, such as a 401(k) , 403(b) , or Thrift Savings Plan .

Generally, contributions will be taken from your paycheck and deposited into the account. Workplace retirement plans may have the added benefit of offering a match program.

When you contribute money to your account, your employer may match that amount fully or partially—it is generally a good idea to take advantage of this since it’s essentially free money.

In addition to a retirement account at work, you may want to open up a retirement account on your own, such as a Traditional IRA or Roth IRA. IRA stands for “Individual Retirement Account”. Self-employed folks might look to open up a SEP IRA or Solo 401(k).

You can open any of these accounts at a financial services company of your choosing. More importantly, it would be up to you to fund these accounts. You could do this through intermittent contributions throughout the year but may find it helpful to set up an automatic contribution each month in order to mimic a workplace retirement plan.

Automating is one way to encourage regular savings and has the added bonus of removing any work for you.

It is also possible to open up savings accounts beyond your retirement accounts. If you have maxed out what the IRS allows you to put into a retirement account, or you do not qualify for or have access to one, that doesn’t mean you shouldn’t invest for the future.

You could consider opening a brokerage account—which does not offer the tax benefits of a retirement plan but does allow you to invest for the long-term.

Once the money is held within any sort of account, you may want to consider investing that money as well. This way, your money could grow over time, earning compound returns.

Workplace retirement plans might have default options, such as target date funds or diversified mutual funds. With investing, two good rules of thumb are to make sure you know what types of investments your funds are invested in and to understand the fees that you are paying on your investment options.

Retirement plans offered through workplaces are also known as “defined contribution” plans—it is up to the employee to contribute to them. Compare this to “defined benefit” plans, which are the pension plans described in the next section.


Pensions, or defined benefit plans, are retirement programs wherein the employer saves, invests, and disburses money on behalf of their employees. Basically, the company takes care of everything.

In retirement, employees would simply receive a monthly check. How much of a pension they would receive depends on how long they worked for the company, their position, and other variables.

Pensions plans are now exceedingly rare within corporate America. For example, only 16% of Fortune 500 companies offered pension plans to new hires as of 2017. This is down from 59% of those same employers in 1998.

With the ushering in of defined contribution plans such as 401(k) accounts, employers are largely leaving behind the pension model, for reasons such as pensions being expensive and difficult to manage. That leaves the onus on the employee.

That said, pension plans are not totally extinct. For example, teachers, firefighters, and other government workers may have pension plans. They may be more common for workers in the public sector than they are in the private sector.

But even then, some of these public pension plans are at risk due to underfunding. Employees with pension plans are still encouraged to put money toward their personal savings.

Social Security

Social Security is guaranteed lifetime income for workers who pay into the program each year via their FICA taxes. Both the employee and the employer pay into Social Security. Social Security benefits can generally start being paid out between the ages of 62 and 70 .

You will have a full retirement age, depending on what year you were born. For every month earlier than that age you claim your benefit, it will be reduced. For every month later than that age you claim your benefit up to age 70, it will be increased.

Therefore it could be advantageous to delay social security, but that decision all depends on your family’s resources, age, and health.

(Social Security is the government entitlement program that funds both retirement benefits and disability benefits. For the sake of discussing sources of income in retirement, this section is referring to the benefits one would receive from Social Security upon reaching retirement age as determined by the program.)

How much you’ll receive in Social Security generally depends on how much you pay into the system throughout your working career, though the monthly program currently caps out at $2,861 per retiree in 2019 for those beginning their benefit at full retirement age. In addition to claiming social security based on your own earning history, you can be entitled to receive benefits based on your spouse.

The portion of their benefit you are entitled to depends on if they are alive or dead, so it is important to work with a financial planner before deciding the best social security strategy for your family.

As with private pensions through companies, the current Social Security benefits are not necessarily a sure bet for those saving for retirement. There is some risk that Social Security becomes underfunded which could lead to reduced benefits, lower inflation adjustments, or higher taxes in the future.

It may not be a great idea to rely on Social Security as your only source of retirement income. The fate of Social Security is not certain, and even if it were, it might not be enough income on its own.

It is important to keep in mind that some expenses go away in retirement, but there are new expenses that typically keep your lifestyle costs in the same ballpark as they are now.

Getting Ready for Retirement

Unfortunately, the three-legged stool may no longer be accessible to the majority of workers.

While it can be frustrating for young people to hear that they may not be entitled to the same types of retirement income that previous generations have enjoyed, there are ways to take action to ensure a fruitful retirement.

First, know that many workers might want to save in multiple accounts for the long-term. This may mean managing some combinations of 401(k), Roth IRA, brokerage, and savings accounts.

If you have access to a 401(k) or other workplace retirement account, you may want to take advantage of that first if you have an employer match. An employer match is when your employer contributes to your workplace plan when you do.

So for example, if you put in 6% of your pre-tax salary and your employer put in 3%—they “match at 50%.” If your employer has a great match program, they may match at 100% (if you put in 6%, they put in 6%).

Next, investors may want to consider having multiple investment types, to diversify their portfolios and, ultimately, their income streams. While there is no one combination of accounts that is perfect for everyone you should explore how much you contribute to your 401(k), Traditional IRA, Roth IRA, and Brokerage Account. These different types of accounts have different tax benefits both now and in the future.

It might also benefit investors to regularly check in on their retirement accounts. One way to check in and make projections is by using a retirement calculator. Although saving for retirement can sometimes feel like a moving target, a retirement calculator might help you to understand whether you’re on track.

If saving and investing for retirement requires a multi-pronged approach, even if it’s not the three-legged stool method, it’ll be important to stay organized and on top of all of the moving pieces.

Because, even though the pieces may be separate, they are all working together with the purpose of achieving one very important goal: helping you not just to retire, but to thrive during your retirement years.

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