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Use the Investing Techniques of the Mega-Wealthy to Secure Your Retirement Future
By Jim Schlagheck
St. Martin's PressCopyright © 2008 Jim Schlagheck
All rights reserved.
IS RETIREMENT A DYING EXPERIMENT?
Retirement is a modern experiment. It is a noble, strictly nineteenth-to-twenty-first-century "work in progress." And it is now in danger in the United States because of inadequate funding, extraordinary demographics, and generally poor financial preparedness.
Retirement is in danger in the United States because Americans like you and me are not saving enough, not investing wisely enough, and not insisting forcefully enough on safeguarding our benefits and nest eggs.
In contemporary mythology, "retirement" is the period of our lives when we stop working, relax, and enjoy the fruits of our labor. In the myth, we all enjoy "golden years" in good health and financial security.
Of course, that vision is bunkum. It is, nevertheless, a vision strongly etched in the minds of most Americans. It is the picture drummed into us after years of watching television programs like Father Knows Best, N.Y.P.D. Blue, Law and Order, and the like — programs that depicted average-Joe Americans working hard, building up their retirement savings, and giving loyalty to their employer in exchange for retirement security and "corporate care."
Not only is the myth romantic and fictional, but now retirement-the-reality is under siege. For thousands of years, people normally worked until they died, became incapacitated, or were pushed off on an iceberg. There was no organized system of "retirement." So if today's ideal of "a long and happy retirement" sounds like something too good to be true — it is! It's an experiment that some Americans will regrettably never enjoy in the coming decades and that few of our ancestors ever enjoyed to begin with.
Let's take a moment to briefly survey the history of retirement. It's a fascinating saga.
In ancient Greece and Rome, people stockpiled jars of olive oil for their senior years. Olive oil stores well. So Greeks and Romans bought and stored jars of oil during their adult lives, which they eventually sold for income in old age. The ancients also bought income contracts called annua — — the world's original "annuity" contracts — to guarantee old-age income. A person bought such a contract with a onetime payment, and the contract guaranteed lifetime income beginning at a later age. The very same kinds of contracts are helping retirees even today.
During the Middle Ages, workers turned to guilds for old-age and disability benefits. Guilds paid income to members who became disabled or infirm. So the first pensions were initially "help your fellow worker" income programs aimed at solidifying guild membership. For example, one guild in England promised, "If any man or woman of the fraternity becomes so enfeebled through illness or old age that he cannot work or engage in commerce, then he shall be supported, at the cost of the gild, in a manner fitting his status."
Barring incapacity, however, guild members were meant to work until they dropped. They were, as well, only a small part of the total population. Most people who reached old age at that time — the average life span was in the thirties — primarily relied on the largesse of their families to provide for their later-age needs.
In colonial America, elderly people sometimes wrote wills and made them public, promising their heirs an inheritance if the beneficiaries provided old-age care — lodging, meals, and a specific amount of firewood. Referring to those times, one historian noted, "There is also ... evidence that people viewed children and savings as substitute strategies for retirement planning." Senior care primarily came from family members. The average life span was up to thirty-five, but most people still worked until they could no longer do so.
Other than these rudimentary attempts to provide income or care, few societies organized "retirement" or "senior citizen" benefits on a large scale. Not, at least, until modern times.
For much of recorded history, in fact, there has long been one primary "retirement planning" technique: people have traditionally had many children to care for them in old age.
Americans never entertained the idea of "retirement" until the 1800s. Typically, our forebearers worked until they died or became disabled and had seven or eight children to care for them long term. In 1880, 78 percent of American men ages sixty-five and older were still working. Among men age sixty-five and older in 1880, nearly half lived with children or relatives. Today fewer than 5 percent do. So people at the end of the nineteenth century usually worked until they died and often lived with family members when they were older. Retirement then was quite different from what it is today. It was exceptional and "family-funded."
By the mid part of the nineteenth century, however, important changes began taking place. Pensions for U.S. Civil War veterans and railroad workers first took shape in the mid-1800s. The New York City police force set up the first public-sector retirement-income plan in 1857, and in 1875 American Express introduced for its employees the first corporate pension plan. This plan benefited employees who had at least twenty years of service at the age of sixty. It rewarded employee loyalty. And many companies soon followed American Express's lead.
By 1882, the Alfred Dodge Company-a builder of pianos and organs — introduced a pension plan wherein workers contributed 1 percent of their pay to earn 6 percent interest paid by the company. The Dodge plan reflected America's "pay your own way" bias as regards benefit programs, a philosophical approach that underlies most of the country's retirement systems even today.
But an even more important retirement breakthrough took place in Germany in 1889 when Kaiser Wilhelm and Chancellor Otto von Bismarck established the first-ever state pension system. In this unprecedented national program, all German citizens qualified for a "retirement pension" when they reached age seventy. It was the first attempt by any country to provide income for its senior citizens.
The original German pension system equated age with disability; it set seventy as the official retirement age; and it equated old-age pensions with "state care." In the United States, the approach to pensions and senior benefits would undergo substantial modification on all three counts. The United States would emphasize "individual contributions" and frown on "it sounds like socialism."
America's nationwide social insurance program — Social Security — came into being in 1935. It was a response to the Great Depression and the widespread financial hardships of the 1930s. Provided you and your employer contributed to the program, Social Security paid you a small amount of money beginning at age sixty-five. Since the average life span for an American at that time was only fifty-nine for men, Social Security payments were originally meant to be the exception rather than the rule. In fact, most early Social Security benefits were actually paid to surviving spouses — not to workers themselves.
Medicare, the national health insurance program, was established by Congress in 1965. It was designed to pay for some — but not all — of the medical expenses of disabled Americans and people sixty-five and over. Many Americans believe that Medicare and Social Security were avantgarde programs meant to guarantee a comfortable retirement and secure golden years for all workers. That is not so. By the time Social Security was established in 1935, thirty-four other countries already had national social insurance programs up and running — ours was nothing new. Both Social Security and Medicare were designed to make only limited contributions to a person's financial and health-care well-being. They were not designed to cover all health-care costs or income needs. The emphasis has been and continues to be on personal savings and "pay your own way" retirement funding.
Following World War II, companies vied with each other to attract and retain skilled, loyal employees, and corporate pensions and retirement benefits became commonplace. Americans came to rely on them. And by the 1950s and '60s, an era of "corporate paternalism" had set in. Most workers could look forward to retirement with a handsome company pension.
That, however, was soon to change. Longer life spans and spiraling health-care costs eventually caused U.S. companies to rethink their pension pacts. A little-heralded but blockbuster shift took place. Beginning in the 1980s, many U.S. companies began cutting back retirement benefits and halting pension programs outright. Most companies directed workers to take full responsibility themselves for retirement funding via 401(k) and similar plans. From "corporate care," Americans were herded into do-it-yourself retirement-funding responsibility.
Today, Americans look forward to retirement supported by a mix of different programs, benefits, and funding mechanisms: (1) traditional employer pensions or "defined benefit" plans; (2) "defined contribution" plans such as 401(k), 457(b), and similar programs; (3) IRAs or individual retirement accounts; (4) Social Security; (5) Medicare; and (6) whatever other savings you can muster. As we will see, this mix of benefits and funding mechanisms is piecemeal and is not uniformly available to all.
Many Americans take it for granted that all workers have access to pension or savings plans and still cling to the myth that retirement is "a dazzling, decades-long vacation at the end of life." The myth prevails, but the reality is starkly different.
Americans are retiring earlier — the average retirement age is now sixty-two. Americans have also come to enjoy much longer lives. Instead of the average life span of sixty-one and a half years for both men and women when Social Security was created, today's younger Americans can now expect to live into their late eighties or nineties. Life spans are decidedly longer and growing. That means that individuals need more capital to fund their retirement at the same time that they are increasingly expected to amass that capital on their own.
So contemporary "retirement" is quite unlike that experienced by our parents or grandparents. Even as recently as 1985, eight out of ten American workers in medium-size and large private companies participated in a traditional pension plan. Today, only two out of ten do. In the 1960s and '70s, American workers could look forward to an average of ten years of retirement life supported by government payments and company pensions. Today's workers have a much longer, self-funded retirement ahead.
In the past, Americans often retired — at least in the national mythology — with a farewell party and send-off gift at age sixty-five or a retirement age of their choosing. Today's Americans are often not in control of when they retire. Today, many people — more than one- third — are thrust into early retirement whether they are financially ready for it or not. Four in ten retirees report that they retired earlier than expected due to job loss, downsizing, poor health, or some other factor. More than a quarter of the workers who recently retired before the age of sixty-five did so because of changes at their company "such as downsizing or closure." And the retirement incomes of many Americans are not at all robust. Today, about one in six Americans over the age of sixty-five lives at or near the poverty lever.
So "retirement" is a modern, not necessarily carefree experiment. The "live happily ever after" picture of retirement in the United States is not true for many current retirees. And it is going to be much worse for people retiring in the future.
We are, in fact, in the midst of a developing crisis. We are moving from the security of traditional company pensions, which once guaranteed some retirement income, to do-it-yourself retirement savings that guarantee nothing at all. Our benefit programs, once solvent and sound, now suffer massive funding shortfalls. And many millions of Americans are about to enter their golden years with little retirement preparedness, minuscule savings, and little awareness of the precarious state of their benefit programs. You, however, can and will enjoy a financially sound and secure retirement. But to do so, you must understand what you're up against and why counting on government and corporate benefits instead of personal savings would be naive.
DEFINED BENEFIT PLANS
A "defined benefit" plan — meaning a company pension plan — is a benefit program where your employer bears the risk of generating sufficient cash to pay you retirement income and/or other retirement benefits. Such plans were once the mainstays of American retirements. They are, however, dwindling in number today, and many are bordering on failure.
At present, only 21 percent of American workers in private enterprise have access to a defined-benefit pension or retirement benefits. A much larger 80 percent of all government workers do. Even if we add public and private-sector workers together, however, the majority of all workers do not have access to any pension. This ratio of "haves" to "have-nots" is the inverse of what it was only decades ago.
Increasingly, fewer and fewer workers have access to defined benefit plans and fewer companies offer them. The number of pension plans plummeted 70 percent between 1983 and 2000. Today, only one company in ten offers a pension, and even that number is shrinking. Pension and benefit reductions are also becoming common. In its recent survey of retirement practices, the Employee Benefit Research Institute found that: "nearly half of workers report that recent changes to the employer pension system have made them less confident about the money they can expect to receive from a defined benefit (or "traditional") pension plan.... Seventeen percent of workers have personally experienced a reduction in the retirement benefits offered by their employer within the past two years."
Whatever the access and cutbacks, defined-benefit payments may not materialize for many Americans because of pervasive underfunding. The little-acknowledged fact is this: of those companies or government agencies that offer defined benefit plans today, many have immense funding shortfalls. Underfunding is the pervasive cancer undermining defined benefit retirement programs nationwide. And many Americans counting on pension benefits may be in for a rude surprise.
The most recent data available shows that the majority of the country's largest companies — the five hundred that make up the S&P 500 Index — had less than full pension funding at the close of 2005. Their pension shortfalls alone amounted to $140 billion. Add in the underfunding of other "postemployment benefits" such as promised medical coverage, and the total underfunding for all retirement benefits among S&P 500 companies was a whopping $461 billion. That's almost a half of one trillion dollars of funding shortfall just among the country's top companies alone. For smaller companies the statistics are similarly dismal.
Of course, these numbers change from time to time depending on the investment performance of corporate pension plans. Even so, the magnitude of the problem is sobering.
According to the Congressional Budget Office, the total funding shortfall for all pensions and other "defined benefits" among all U.S. companies is now over $600 billion. That staggering amount will not, in all likelihood, be replenished anytime soon.
The situation is just as bad, precarious, and inexcusable in the public sector. At last count, some 80 percent of the state retirement systems that report data for the Wilshire Report on State Retirement Systems are also underfunded. By 2003, at least nine states had pension fund liabilities that actually exceeded their total annual budgets! Of the municipal and county systems that report data to Wilshire, 77 percent were underfunded at last count as well.
That, however, is just the tip of the iceberg. Many municipalities, states, as well as corporations are funding their pensions with limited contributions expecting their pension plans will generate high investment returns. Many of their return projections are unrealistic. In other words, many direct-benefit plans are counting on money that will simply not come in! So if the underfunding of defined benefit plans today is pervasive and dangerous, the situation is likely to become even worse in the future. We're in crisis territory.
Excerpted from Ca$h-Rich Retirement by Jim Schlagheck. Copyright © 2008 Jim Schlagheck. Excerpted by permission of St. Martin's Press.
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