What is the Three-Legged Stool of Retirement?

Quinlyn Manfull
November 10, 2022

The “three-legged stool” is a metaphor historically used by financial planners to describe the three most common sources of retirement income: 

  • personal savings,
  • employee pension plans,
  • Social Security.

For decades it was expected that this trio would together provide a solid financial foundation for sources of income during retirement. The metaphor was to show that relying on only one or two of these legs would result in a wobbly stool.

The Three Legs of the Three-Legged Stool

The 3-legged stool of retirement used to be a popular model to explain retirement security. Each leg refers to a source of income needed to support your lifestyle in old age. While each leg is important on its own, together they create a unified plan for long-term personal finance goals such as a nest egg for retirement.

This model has declined in popularity in recent decades. This is largely because employee pensions are disappearing, but also because the future payout rates of the Social Security program are unknown.

Personal Savings

The first leg of the stool refers to any money you’ve personally saved for retirement. This could be money saved in a traditional savings account, money held and invested in a brokerage account, real estate, or money held in retirement savings accounts such as a 401(K) or a Roth IRA.

Accounts designed specifically for retirement tend to have the best tax advantages. Tax-free and tax-deferred plans are designed to promote saving for retirement and reinforce this with high tax penalties for early withdrawals.

Pension Plans

Pensions, or defined employee benefit plans, make up the second leg of the stool. These are retirement funds where the employer saves, invests and disperses money on behalf of their employees. These are essentially retirement accounts that your employer takes care of completely.

In retirement, employees who receive a pension would receive a monthly check. The amount of these checks would typically depend on how long the employee worked for the company, the position they held, and other variables.

While they used to be extremely common, today pension plans are exceedingly rare in corporate America. As of 2019, only 14% of Fortune 500 companies offered pension plans to new hires. This is down from 59% of those same employers in 1998.

Social Security Benefits

The third leg of the stool is one we may not have a few decades down the line.

Social Security is the guaranteed lifetime income for workers who pay into the program each year via their FICA taxes. Both the employee and their employer pay into Social Security.

Social Security benefits can generally start getting paid out between the ages of 62 and 70. The amount will be reduced for every month before the retirement age you claim your benefit. For every month later than retirement age you claim your benefit up to age 70, the amount will be increased.

Therefore, it could be beneficial to delay social security, but that decision depends on your own personal resources, age, health and other variables.

If you are concerned, any American worker can look online to review their Social Security accounts. Using the Social Security Administration Retirement Calculator, users can see how much in retirement benefits they are set to receive at early retirement, full retirement, or age 70.

History of the Three-Legged Stool Metaphor

The earliest use of this metaphor — as noted by the Social Security Administration — was by Reinhard A. Hohaus, an actuary for the Metropolitan Life Insurance Company, in a speech in 1949. At the time, he was using this metaphor to persuade investors to purchase annuities to supplement Social Security benefits. The phrase caught on from there.

Although Hohaus seems to be the originator of the metaphor, the basic concept was clearly understood and widely shared by the creators of the Social Security program. In a 1942 speech, Hohaus approvingly quoted the Social Security Board Chairman Arthur Altmeyer. 

When the Social Security program was signed into law in 1935, private-sector pensions were rare and there was no national system promoting retirement savings.

Once established, Social Security and Medicare reduced the poverty rate for seniors drastically. In 1966, 28.5% of Americans older than 65 had family incomes below the federal poverty line. By 2019 that rate had dropped to 8.9%.

How Has Retirement Planning Changed?

For younger workers in the private sector, the pension leg of the stool has mostly been replaced. Instead of a pension, workers typically have a 401(K) and other defined-contribution plans, also known as retirement savings accounts.

Originally, these retirement savings plans were never meant to replace the role of pensions, instead were supposed to only be supplementary savings accounts. However, since the 1990s, employers have been systematically moving away from pensions and towards tax-advantaged plans.

Some companies offer an employer match for employee contributions to their 401(K) up to a certain percentage, but many do not even offer that level of assistance. According to Bureau of Labor Statistics data, only about half of all private sector workers have access to retirement benefits of any kind.

How Has Social Security Changed?

The 2021 Annual Report of the Social Security Board of Trustees warned that the Social Security Trust Fund could run dry within the next two decades based on the current rate of output. More specifically, they said scheduled benefits could be paid until 2033. At that point, the fund’s reserves will become depleted and they would only be able to pay out 76% of scheduled benefits based on expected payroll taxes.

Of course, this is only hypothetical as of now. Projections don’t take rising interest rates, increased revenue or other factors into account. There are also long-term impacts from the COVID-19 pandemic that we have yet to see.

Personal Retirement Savings Remain Low

Savings rates have been very low for US workers over the past decade thanks to recessions and stagnant wages.

With the rest of the stool looking wobbly, there is more pressure on individuals to start saving a larger portion of their income and continue to use tax-deferred retirement plans such as 401(K)s or tax-advantaged plans such as IRAs and annuities.

Financial advisors typically recommend saving at least one-fifth of your annual earnings for retirement. The earlier you start, the better set up you are to take advantage of compounding investment returns.

Key Takeaways

With defined benefit pension plans being replaced by retirement savings accounts, the three-legged stool is practically down to two legs. Based on this metaphor, that is not enough for a secure retirement.

There is currently pressure on the US Government to provide solutions to the current retirement savings issues. Some recommendations have included hybrid pension plans, creating a national or state-level retirement savings plan for people who do not have one offered through their employer and even opening up the federal Thrift Savings Plan (a defined-contribution plan, currently available only to government employees).

In the meantime, it might be time for another metaphor.


Quinlyn Manfull
Quinlyn Manfull is a a New York based finance writer covering alternative investments, crypto, and NFTs. Previously she worked as an Investment Analyst for HSBC Private Bank covering capital markets. Her byline has been featured in the Anchorage Daily News, and her university newspaper, The Willamette Collegian. Quinlyn earned a B.A. in Economics from Willamette University and holds her FINRA Series 7 License.