by Jonathan Goudy / 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”).
- 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.
- 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.
- 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.
- 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!
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.