Here’s a thought to keep you up at night: you probably have to save more than you think.
Many Americans are facing what experts consider to be a retirement crisis in the coming decades, meaning we have to prepare for the future today.These days it seems that there’s a new crisis every time we turn on the evening news, so, what’s new?
With the massive reduction in pensions, concern about a shaky Social Security system, and fewer people inheriting their parent’s estate, America’s retirement crisis lands square on each of our shoulders. This requires all of us to intentionally examine and prepare for the probability that attaining the “work-optional” lifestyle we someday desire is going to be harder in the future, and we will need to take more ownership of our own retirement plans. In other words, “You’re on your own”.
What Happened to Pensions?
Except for a select few long-term employees of old-line “Blue Chip” corporations and a spattering of Federal, State, and Local government employees, the idea of a pension is almost completely a thing of the past. Very rarely are today’s workers promised a lifetime income benefit for their loyalty to a company.
Pensions are inherently a benefit to employees to entice them to remain loyal to the company. Through 20-30 years of dedicated service, the employer would allocate a portion of their pay to a pension fund. At retirement, the pension fund would promise to provide a monthly income to the retiree for the remainder of their lives.
Developed as an employee benefit in the late 1800’s, the employee pension started gaining traction by several large corporations in the early 1900’s, and in 1921 Congress encouraged funding of employee pensions by making the contributions exempt from corporate income tax. As America came out of the Great Depression and into the Industrial Revolution during the mid-1900’s, the Corporate Pension was mainstream. By 1960, nearly 50% of the private sector workforce had a pension.1
During that time, the solvency of pensions was directly linked to the solvency of the company. In the 60’s and 70’s, as businesses started to struggle to meet their funding obligations to sustain the pension funds, pensions began to face challenges and increased government regulation.2 As bond yields have decreased and stagnated over the past 40 years, funding requirements have increased in order to meet their obligations, and overly optimistic investment predictions have not come to fruition, pension funds have had to lower payouts and reduce benefits.3 In addition, pension plans are a significant liability on an employer’s balance sheet, reducing their ability to issue debt, as well as expand and grow the business.
Because a corporation’s fiscal duty is to its shareholder, and not necessarily to its employee, Wall Street and corporations have been slowly removing the pension obligation from balance sheets in favor of the Employee funded 401(k), resulting in much less liability for the employer.
For those with pensions still available to them, the steady, fixed income source is a tremendous benefit in retirement. It provides a foundation of monthly cash flow that retirees are able to base their budget on, it reduces the amount of withdrawals that the retiree would otherwise have to take from their portfolio, and it serves as an “Estate Preservation” tool, allowing the retiree to pass on a larger inheritance to their children.
Along with my birthday, August 14th 2017 was the 82nd birthday of the Social Security Administration; one of America’s largest Federal spending programs, whose fiscal stability is questionable at best. According to the Office of Management and Budget, the proposed 2018 Federal budget is estimated to pay out a staggering $1.005 trillion in Social Security benefits.4 This amounts to approximately 36% of our total federal budget. Each month, Social Security pays out more than $66,000,000 in retirement benefits to retired workers and their dependents.
According to Social Security’s website,5 when Social Security was first implemented and began paying benefits in 1940, there were approximately 35,390,000 workers paying into the Social Security fund, and only 222,000 retirees taking benefits from the fund. This was a ratio of 159.4 workers paying in for every 1 retiree taking benefits. Five years later, in 1945 that number began to normalize, but the ratio was still very high, for every 1 retiree taking benefits 42 workers were paying into the system. However, over time, retirees have started to live longer, wages have stagnated, and the ratio of those contributing to the program compared to those receiving benefits from the program has dropped significantly. Social Security actually stopped publicizing the ratio in 2013, but at that point, as the chart below shows, for every 1 person receiving benefits from Social Security only 2.8 workers were contributing to the program.
As Baby Boomers enter retirement and Social Security payments increase, it results in significant pressure put on the Social Security Trust Fund. According to the 2016 US Census data, we are seeing a wave of Baby Boomers enter retirement over the next few years, and the generation behind them (represented by ages 30-45 in the below chart) is not large enough to fully cover the costs of the Social Security benefits.
Current budget projections6 by the OASDI (Old Age Survivors and Disability Insurance) estimate that the Social Security Trust Fund has enough reserves to last until 2034, at which point Social Security will become an “unfunded obligation”. This unfunded obligation means Social Security payments will be paid for by a combination of FICA taxes on American workers and government issued debt. Within the next 20 years, Social Security will become a tremendous source of contention in Congress as politicians determine how to fund an obligation that has become massively unsustainable. Whether that involves extending the “Full Retirement Age” out to 70 years old, increasing taxes, or means-testing individuals to determine the amount of benefits they receive, there are sure to be changes to the current system, which will ultimately negatively affect America’s workforce.
Bouncing the Last Check
As medical technology advances, today’s retirees are continuing to live longer - meaning that they are more likely to access their savings and portfolio, which otherwise might have been passed on to the next generation. According to a recent Investor Survey by Natixis,7 research shows that 70% of young people expect to receive some type of an inheritance, whereas only 40% of parents plan on leaving one. In fact, 35% of Baby Boomers plan on spending their entire portfolio on themselves and 24% of Baby Boomers are actually expecting that their children will help to pay for some of their expenses during retirement!
Adult day care, assisted living facilities, nursing homes, memory care facilities, hospice, medications, and estate settling costs are very large expenses that happen toward the end of life, and you may soon discover that that large inheritance you were expecting has slowly whittled away over time. Your retirement plan should not be dependent on the possibility of a large inheritance at some point in the future; all the more reason to take ownership of your retirement plan now.
The 401(k) is the primary source for retirement savings in America. Currently participants are allowed to contribute $18,000 into their 401(k)s each year, participants over 50 years old are able to contribute an additional $6,000 as “Catch-Up” contributions, offering participants the ability to save between $1,500 - $2,000/mo each year. On top of the employee’s savings, the company will often provide some type of profit sharing or a company match on a portion of the employee’s contribution.
Recently, 401(k) Plans have begun offering the ability for employees to contribute to a Roth 401(k) as well as the traditional tax-deferred 401(k). This is another tremendous benefit to retirement plans and we encourage clients to review and understand how their 401(k) plan works. According to a study by Transamerica Institute, “The Current State of 401(k)s: The Employer’s Perspective” (June 2016),8 74% of American employers offer some type of a 401(k) retirement plan for their employees.
Not all companies offer a 401(k); but, of the companies that do offer 401(k)s, about 73% of the plans provide some type of a company match to employee’s contributions. That number tends to increase with larger companies as they try to attact more talent. In this chart, we see that only 71% of companies with fewer than 100 Employees (Micro) have employer matching 401(k) programs, and 85% of Large companies (with 500+ employees) provide an employer match on 401(k) contributions.
A good rule of thumb for 401(k)s that offer a company match is to at least contribute enough to get the full company match. It’s free money. But, as income increases and retirement gets closer, you are going to want to be saving a lot more than the minimum each month; you are going to want to really push up your savings rate over time.
Intentional Planning Puts You In Control
Because of the risks we see to our client’s ability to retire in the future, we take the approach that being intentional in our lives requires a deeper discussion about retirement planning than a one-time Financial Plan. With most of our clients, we will develop a Financial Plan and update the plan regularly to ensure that they are on course to meet their goals. Working with a Financial Planner to review your current situation and develop strategies and solutions provides clients with a sense of security and an action plan that they can work toward.
In addition, we encourage clients to understand their current financial picture. There is no tool more powerful in providing clarity and ownership of your finances than a monthly budget. As the radio host, Dave Ramsey, is quick to tell you, “The monthly budget allows you to tell your dollars where to go, instead of wondering where they went.” As a helpful tool for you, we have provided a monthly budget template that you are able to download from our website; otherwise there are a number of great resources you can find on various websites or mobile apps. Feel free to fill this out and bring it in to your next meeting, we are more than happy to review this information with you.
Invest Like Your Future Depends On It
There is a common misconception that we run into on a regular basis, and that is to compare investment returns to the stock market. It’s fully understandable, because these are the numbers that we hear on a regular basis. The Dow Jones Industrial Index, the S&P 500, and the NASDAQ are all common indexes that are readily available, so we fixate on the performance of these indexes when reviewing our own portfolios. However, none of these indexes care about when you plan to retire, when you plan to make a downpayment on a house, or when you plan on sending your kids to college, or any other goals you may have.
If the entire stock market took a 30-40% hit, life on Wall Street would continue to go on, but what would the impact be on your own portfolio and your ability to retire or maintain your quality of life?
Because our clients live in a world constrained by life events, we have to invest with the mindset that the portfolio will be used to fund future needs for our clients, so we must analyze market risks and protect their portfolios from significant market corrections as best as possible. Our goal will never be to “beat the market”; our goal is to provide you with risk-adjusted returns and a portfolio that will be there when you need it.
Ultimately the choices we make in life are going to have consequences one way or the other. Being aware of the potential risks and rewards in life give us the ability to thoughtfully consider options and make important decisions. We have concerns about the ability of a company’s or a government’s ability to make long-term fixed income payments in the future, so we encourage you to work with a trusted Financial Planner and Advisor to review your needs, wants, and goals to develop a plan for moving forward.
To amend my previous statement, “You’re on your own, but we’re here to help”.
Your future is too important to leave it up to the whims of Wall Street, government or your employer. If you are interested in discussing how you can proactively develop a plan for the future, we are always happy to schedule a time to talk, and offer a 90-minute complimentary consultation.
This article has been prepared and distributed for informational purposes only and is not a solicitation or an offer to buy any security or investment or to participate in any trading strategy. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a financial professional. Past performance is no guarantee of future results.