Baby boomers are facing the perfect
retirement storm.
- Social security the corner
stone of retirement is facing serious problems and painful
adjustments are inevitable.
- Pension plans at many employers
are being frozen, reduced or eliminated.
- Many workers have failed to
take advantage of 401k and IRA opportunities.
- Many prospective retirees
have been borrowing rather than saving for years.
This confluence of events will
sink some retirees.
Just
how did we get in this mess? And who is to blame? (Actually
wanting to know who is to blame is symptomatic of the problem
that has gotten us into this mess.)
As I spend a few minutes on each
of the elements of the approaching storm I believe you will
find a common theme running through each problem. People
at all levels want to put off paying until tomorrow. All
these problems are quite complex when examined in detail.
I will try to brush over the highlights.
Who is to Blame?
Just about
everyone. Workers, managements, unions, politicians, voters,
Wall Street, banks savers and spenders. Did I forget anyone?
(Oh, Church leaders have been preaching and practicing thrift
and savings since at least Brigham Young’s day so we probably
can’t blame them.)
The
Problem with Social Security
The Social Security system has
always been a pay-as-you-go system. Taxes taken from your
check today are not invested to pay for your retirement tomorrow.
Rather they go to pay the benefit of a person already retired.
This means some future worker must pay your benefit.
At times the social security
system has run a surplus, collecting more taxes than were
being paid in benefits. That is the case today. Unfortunately,
the government has not saved those surpluses. For decades
our presidents and congressmen have spent the surplus dollars
on current needs such as roads, defense and welfare. U.S.
treasury bonds have been put in the trust like an IOU.
This is not all bad, treasury
bonds are considered the safest investment on the planet.
But it requires your taxes to pay them. And in this case
they will need to be repaid when social security has swung
to a deficit, meaning taxes need to be raised just to meet
current obligations. Sounds like a mess and it is. They have
all done it--Republicans and Democrats. And they did it because
they were representing us and we wanted government services
but didn’t want to pay for them, so they borrowed the Social
Security surplus to help balance the budget. Let’s have the
services now and we’ll figure out how to pay for it later.
It would have helped if the surpluses
had been saved, but it wouldn’t have solved the Social Security
problem. The problem is much more fundamental than that.
This is a pay-as-you-go system. Demographically, we are
facing a time when we will have too few workers supporting
too many retirees and the promises made to those retirees
have been growing.
The baby boomers are at the very
heart of this demographic storm. Some difficult political
choices must be made and politicians do not yet seem willing
to make them. This is unfortunate because as with everything
dealing with retirement the faster, you can address the problem
the better. The laws of compounding work everywhere when
it comes to retirement.
A year ago President Bush was
proposing a program that would make a small start toward moving
away from pay-as-you-go. What followed was politics at its
ugliest. There are politicians that want the issue to remain
an issue because they campaign on it year after year. Heaven
forbid that it should actually be solved because then the
politician’s issue would go away.
Further, many do not want the
other side to get credit for solving a problem no matter how
urgent it is. You can tell this is one of those issues because
the critics never proposed any solutions of their own.
One of
the most disgusting groups to get into the fray was AARP.
The facts are this; AARP went out of their way and spent large
sums of money to scare the wits out of their members, namely
retired senior citizens. AARP led them to believe that the
proposed changes would mean seniors would lose their social
security.
The truth is, and AARP knows
it, no proposal changes anything relative to the benefits
of people 55 years of age and older. AARP, as one of the
most powerful lobbying organizations in the country, for some
reason, was willing to mislead their members and frighten
them into opposing change.
Note, neither AARP nor the politicians
that lined up with them, have offered any reasonable alternative.
AARP’s position is all the more baffling because, as you remember,
the President’s proposal involved putting a portion of your
taxes into a private account that you own and invest. AARP
saw this as disastrous because you are too stupid to manage
your own affairs. (They point to the same facts that I point
to in the 401k section of this article. But the social security
proposal was not open to any of the same abuses that are common
with 401k’s.)
AARP takes this “you’re too stupid
to manage your own affairs” position while at the same time
they are one of the bigger sellers of mutual funds in the
country. If people can’t handle their private social security
accounts how can they handle a mutual fund account that AARP
sold them? Go figure. Only in politics.
The Problem with Pension Plans
Pension
plans, or defined benefit plans, promise to pay the employee
a certain amount of money each month after retirement. Law
requires that the employer contribute a certain amount of
money each year into a trust, usually administered for the
employees by a bank. Then, when the workers retire, the money
will be available whether the employer is still in business
or not.
Unlike
Social Security, these plans are intended to be “invest-now-spend-in-the-future”
plans. Further, the employer cannot use the funds for its’
own purposes. The money belongs to the employees not the
employer. Generally, the company can’t even buy its own stock
with the money in the trust.
Many
employers offer these plans. Pension plans have been a mainstay
of employee retirement benefits for many years and many baby
boomers have been counting on them.
Recently there has been a lot
of news about some major corporations eliminating their pensions.
The fact is most pension plans in the country are still OK
and will meet their obligations to their retirees. However,
there are some high profile plans that are in trouble and
beyond those, there is now a trend toward freezing pension
plans by otherwise healthy companies. Freezing the pension
can hurt some employees and they tend to be “boomers.” Here’s
a bit of history.
A Bit of History
Unions and managements
made mistakes. You will note that most of
the plans making big news are associated with companies that
have powerful unions and have had difficult labor relationships
for years. These include industries like airlines and automobiles.
All these issues are complex with many points of view. However,
one thing that has occurred is a “settle-it-now- and-we’ll-pay-for-it-later”
approach.
During strikes and difficult
labor negotiations, at times the solution has been to provide
new pension benefits for existing and retired workers. Retired
medical care has been another popular item. These actions
often created huge unfunded liabilities for the companies.
The thinking was, we can settle
this strike now and figure out how to pay for it later on.
And what the unions won was generally extended to non-union
workers. “Later on” is here in many cases and the companies
cannot figure out how to pay for it. This has resulted in
some plans being substantially under funded. The costs associated
with these unfunded liabilities leaves the company uncompetitive
with competitors who have not made such agreements.
Management and Wall Street
made mistakes. The law requires that the employer
contribute an amount into the pension fund trust each year.
How much they are required to contribute is the result of
highly complex actuarial calculations. One of the key figures
in these calculations is the assumption of how much the fund’s
investments will earn. The higher the assumption the lower
the required contribution. The lower the immediate contribution,
the higher the reported earnings for this quarter.
In the late 1990’s the stock
market was roaring. Helped along by Wall Street’s assurances
many managements increased their actuarial assumptions to
unrealistic levels. It was sort of we will report lower pension
expenses now and figure out how to pay for it later. When
investment reality set in, the market slumped and some plans
were left with a substantial under funded liability.
Most corporate pension plans
are insured by the Federal Government. The problem is that
the Pension Benefit Guarantee Corporation (PBGC), that government
entity that insures them, has never been adequately funded
and premiums for the insurance have never been high enough.
Now large bankrupt corporations like United Airlines are dumping
their plans on the PBGC. Taxpayers will wind up holding the
bag.
Many companies are trying to
figure out how to get out from underneath the expense and
burden of their pensions plans. One solution has been to
freeze the plan. This does not mean the company takes all
the money back and employees get nothing. The money already
contributed to the trust belongs to the employees not the
employer. But it does mean that in many cases the employee
will not get what he thought she would be getting at retirement.
Their benefit stops growing now and often that is a fraction
of what the employee might have reasonably expected to get
if the plan remained in effect and the employee had become
fully vested.
Much of the news has focused
on large companies in bankruptcy or facing serious financial
challenge. Companies like General Motors and United Airlines
have received considerable attention. However, the idea of
freezing pension funds is catching on and we are likely to
see many more financially healthy employers follow-suit.
Often companies are replacing
the pension benefit with an improved 401k benefit. Some employees
might actually make out better in the long run. (But see
the section on 401k’s below.) Those employees that stand
to do better are younger workers. Those who stand to be hurt
are older workers especially if they have been job hopping
and have not built up much of a vested benefit in the employer’s
current pension plan. In this case they get little from the
pension and have little time to build much wealth in a 401k.
This is the situation for many baby bombers.
The Problem with 401k’s
The popular 401k retirement benefit
is a defined contribution plan. This means the employer contributes
money to an account for the employee based on a formula.
The company does not guarantee the outcome. That is the company
agrees to put money in but how much that money will be worth
when the employee retires is not guaranteed by the employer.
In this way the employer shifts the risks of market volatility
and poor investment decisions from the company to the employee.
Many people working for government or not-for-profit employers
have similar plans with different names like 403b. These
little acronyms represent the section of the tax code that
creates them.
In theory the 401k is one of
the brightest employee benefit ideas to come along and I have
been enthusiastic about them for decades. The law allows
the employee to be far more involved in his/her own retirement
decisions. This is something I personally believe in deeply.
The problem is sometimes people really do make dumb short
run decisions and we’ve seen a fair amount of that when it
comes to 401k’s. (It must have been a very hard decision
for God to give us agency knowing how many of us would use
it badly.)
Failure to use the 401k.
Most 401k plans provide an employer match. For example, if
the employee will have 4.5% of her salary withheld the company
will put in 4.5%. In this they are giving away free money
and great tax benefits. Many feel they need all their money
now and elect not to participate fully or at all. I need
the money today, I’ll figure out retirement later on.
Failure to roll the 401k
over. One great advantage of the 401k is that
the employee can take it with him when he changes jobs. Usually
this is done by rolling it into an IRA. These days people
change jobs frequently. Unfortunately, large numbers of these
job hoppers look at the check representing their 401k benefits
they receive from their former employer and decide to keep
it and spend it rather than roll it over. This is an especially
poor decision because the government hits them with a 10%
penalty plus current income taxes on the full amount for doing
this but people do it anyway. Spend it now and figure out
retirement later.
Taking a loan from the
401k. Many plans allow
the employee to borrow from her 401k. Most of these get paid
off properly with some modest loss of investment return to
the account. However, if the employee is laid off or quits
the loan is due and payable immediately. In that case the
many simply don’t pay and the value of their 401k declines
accordingly. This event is also viewed as a premature withdrawal
by the IRS with exactly the same penalties and taxes as described
above. The actual effect is to borrow from your retirement
today with penalties for doing so and figuring out how to
take care of your retirement later on.
Investing too conservatively.This
is a long subject but studies show many employees are too
conservative with their investment selections thus hurting
their accumulation of retirement dollars.
401k’s are truly one of the best
employee benefits to come along when the employee understands
the intent is to accumulate retirement dollars and handles
it well. Too many make short-term decisions that can mean
they have little or nothing in the 401k when retirement actually
comes.
The Problem with Consumer Debt
In January we all heard the news;
2005 was the first year since the Great Depression that American’s
spent more than they earned. The cumulative national savings
rate was negative.
Faithful MoneyWise readers saw this coming since I have written
on this subject several times and included the statistics.
Our economy is not in a great depression. Economically, 2005
was a very good year with low inflation, low interest rates,
solid employment and rapidly expanding GNP. However, unlike
the Great Depression, there was in 2005 a national mind-set
of buying now and paying later.
Way back in 1980 I wrote a piece
that argued essentially that just the opposite would be occurring
right now. Historically, young adults must consume and borrow
more than their current earnings to accumulate their first
cars, their first homes, their first babies, etc. That’s
where the boomers were in the 70’s and 80’s. Over the years
this has always reversed itself with people in their forties
and fifties paying down their debts and saving for retirement.
With the huge post war baby boom
entering these traditional savings years in the late 1990’s
and early 2000’s, it seemed like a safe calculation that the
national savings rates would be rising. I was wrong. The
boomers have lived their entire lives in a period of amazing
affluence with more and more things always available to buy.
Many boomers have never had anyone tell them “No” and many
boomers have never developed the ability to tell themselves
“No”. For many there has always been an attitude that I deserve
what I want now and I will figure out how to pay for it later
on.
Some Will be Caught in the Storm
Of course, many boomers have
handled themselves very well and will do well in retirement.
Unfortunately, the statistics show many have not. I do not
wish anyone bad luck or hardship I truly don’t. But some
baby boomers are facing the perfect retirement storm.
Social security, which has always
been hard to live on, may be even less than expected, corporate
pensions may come in well below past expectations, 401k’s
and IRA’s may have been used up or never invested in to begin
with and retirement is at the door with large credit card
debts, a refinanced home and a leased car. If that is your
forecast I encourage you to begin today to do everything you
can to point yourself in a different financial direction.
