Retirement Planning Focus VII

by  /  News, Retirement Planning

Today we continue to review the six challenges for retirement security and personal savings in the Bipartisan Policy Center’s (“BPC’s”) 146 page report on the future of retirement security (the “Report”).

  1. Americans Are Increasingly at Risk of Outliving Their Savings
    • An American male born in 2000 will have a 20-year life expectancy at normal retirement age of 65, 6 years longer than if he had been born in 1900. For women the life expectancy increased by 5 years, to 23 years [Report].
    • On average, 31% of women and 20% of men will live to age 90 and 45% of couples will have at least one survive to 90 [Report].
    • Defined Contribution (“DC”) Plans, such as 401(k) Plans, put the burden of determining the future retirement assets needed on the employees, who do not know how long they will live or what their investments will do.
    • Experts debate over whether a safe withdrawal rate is 3%, 4% or 5%. The IRS requires Minimum Required Distributions at age 70 1/2 that start at 3.65% and increase annually [Report].
    • One solution might be to purchase a lifetime annuity contract, in which an insurance company provides a stream of monthly payments guaranteed for life in return for a premium payment. Retirees transfer longevity and investment risk.
    • Only 20% of retirees purchase annuities contracts or opt for the monthly payments from a pension plan, most take a single-sum distribution [Report]. It is very hard to surrender access to large amounts of retirement money if they might face a large expense or if they die shortly after purchasing an annuity. Riders to annuities that provide such access are available, but expensive.
  1. Home Equity is Underutilized in Retirement
    • Americans own more than $12.5 billion in home equity, nearly equaling the $14 billion in retirement savings [Report].
    • More than 50% of all homeowners over 62 have more than half their net worth held in home equity [Report]. Many older Americans will have to rely on home equity to supplement social security. 
    • But how will this be accomplished?
      • Down-sizing and freeing the equity for other uses.
      • Second mortgage or home equity line of credit (HELOC).
      • Reverse mortgages require no mortgage payments until the owner passes away or sells.
    • The number of older households with indebtedness (primarily tax-deductible home indebtedness) has doubled in the last 25 years [Report].
    • Holding mortgage debt limits retirees’ ability to tap home equity for supplemental cash flow, increasing risk.
  1. Many Americans Lack the Basic Financial Knowledge to Prepare for Retirement
    • Many Americans are unfamiliar with fundamental financial principals, such as compounding interest, investment diversification and the impact of fees on account performance. This obviously results in lower balances in retirement plans, even if the participant has been diligent in funding them. 
    • Sponsors of 401(k) plans serve a fiduciary role, acting in the sole interest of plan participants, but IRA sponsors are not necessarily held to the same standard. Brokers are only held to a lower suitability standard. The recent DoL Fiduciary Rule, which we have discussed thoroughly in previous submissions, provides a key protection.
  1. Social Security (“SS”) is at a Crossroads
    • In 1940, the first year that SS paid monthly benefits, 220,000 qualified for benefits. SS has expanded both the benefits payable and the potential beneficiaries so that, in 2014, 48 million beneficiaries collected $707 billion in benefits. The payroll tax rate has increased six-fold times, while the maximum amount subject to the payroll tax has more than doubled (inflation adjusted) [Report].
    • SS provides over 70% of the disposable income of seniors in the bottom 40% of the lifetime-earnings distribution [Report], but SS was not designed to be the sole source of income for retirees.
    • SS faces major financing challenges, already paying out more in benefits each year than it collects. The SS trustees project that the SS trust fund will be exhausted by 2034, when revenues will only cover 77% of SS obligations, necessitating benefit cuts, tax increases or a change in the historical funding mechanism [Report].
    • The ratio of covered workers paying into the system has dropped relative to the seniors drawing benefits from roughly 4-1 in 1965, to under 3-1 in 2015, and projected at 2-1 by 2030 [Report]. This is compounded by the earlier discussed increase in life expectancy.
    • SS provides a base for retirement, but should not be the primary cash flow source, particularly given its potential changes in the not so distant future.

We have discussed the issues. Next time we will look at the Report’s proposed solutions.

Remember, it’s not what you make that matters…it’s what you keep!



Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

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Retirement Planning Focus VI

by  /  News, Retirement Planning

Let us resume where we ended last time, with our discussion of the Bipartisan Policy Center’s (“BPC’s”) 146-page report on the future of retirement security (the “Report”). Today we will start to address the six challenges for retirement security and personal savings we mentioned last time.

I. Too Many Americans Lack Access to Workplace Retirement Plans—

  • Traditional pensions were defined benefit (“DB”) plans, guaranteeing covered employees (who met a minimum-service requirement), a specified portion of their salary from retirement until death, requiring the employer to properly fund and manage the DB funds.
  • Traditional DB plans benefitted individuals who worked for an employer for many years, retired and qualified for benefits based on their last few years’ earnings levels.
    • This equation disadvantages workers who are laid off or leave their employer years before they are eligible to retire or whose DB plan is closed by their employer mid-career.
    • Their benefits are significantly eroded because they do not include the wage gains between the ending of participation and the actual retirement.
    • DB plans were by no means perfect, but they placed the responsibility in the hands of the employer, not the employee.
  • 401(k) plans were defined contribution (“DC”) plans that were introduced in 1978 to supplement (not replace) DB pension plans.
    • Employers saw that 401(k)/DC plans provided employees an opportunity to accumulate significant sums for retirement, without the cost and risk to the employer of DB traditional plans. The onus shifted from the employer to the employee.
    • The assets in private DB plans have dropped since the early 1980s to $2.9 trillion, while DC plan have ballooned to $6.7 trillion. [Report].
  • Many state and local governments still provide their employees with generous DB plans, but many are severely under-funded, raising issues as to how they will be paid.
  • Only about two-thirds of private sector employees have access to an employer-sponsored retirement plan of some sort, and, of those, three-fourths participate, for an overall 50% participation rate. [Report].
    • Many workers in the service industry, in part-time or low-wage jobs or at small firms, lack access to DC plans. A 2012 study found that 71 percent of employees in large (100+ employee) private sector firms participated in a plan, versus 42 percent at smaller firms. [Report].
    • Workers who do not have access to workplace plans do not usually open and fund IRAs instead. In 2012, contributions to private-sector DC plans were ten times the size of those to IRAs. [Report].
  • The lack of retirement plans is likely due to the complexity and expense to the employer of managing them.
    • Much of this burden has been alleviated in the last ten years, through changes such as automatic enrollment, requiring those who do not wish to participate to opt out, and automatic escalation of deferrals, up to a certain limit.
  • The nostalgic story of the college graduate going to work for a corporation, moving up the ranks, and retiring forty years later with a full pension, has all but disappeared. Today’s success story is transient, working in numerous situations during his/her career. Rules have placed the responsibility for funding the retirement plan on the employee, with the employer potentially matching deferrals. The retirement assets are housed in a 401(k) plan that can be moved from employer to employer during one’s career and eventually rolled over to an IRA upon retirement. Employees have been given portability of their retirement assets in exchange for the obligation to fund them. This is more consistent with today’s mobile work force, but not necessarily consistent with our cash flows needs during retirement.

II. Many Americans Lack the Resources to Save for Short-Term Needs

  • An emergency fund serves as protection against unexpected shocks, but nearly half of individuals polled said that they could not come up with $2,000 in 30 days without selling possessions or taking out payday loans. [Report].
  • Section 529 savings plans assist with higher education expenses and health savings accounts assist with health insurance deductibles.
  • Leakage from workplace retirement plans, from plan loans, hardship withdrawals and cash-outs, remain significant issues.
  • As a general rule, workers who are able to accumulate retirement savings and keep them intact during their working years are FAR more likely to be living well in retirement.

Discount these scary statistics any way you wish, but it seems inevitable that at some point in the near future there will be innumerable Baby Boomers retiring without adequate savings to provide for themselves during their remaining years. How will we fund this additional financial strain?

We will address more challenges in our next submission. Until we meet again… SAVE!

Remember, it’s not what you make that matters…it’s what you keep!



Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

read more