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The Income Revolution

Humanix Books

THE RETIREMENT CRISIS

You've been working hard all your life — "busting your butt," as they say. Building your career, perhaps building a family, and hopefully building a financial legacy.

And someday, you'll retire. Receive the golden watch. Pack up your desk, go to your going-away luncheon, and head triumphantly out the door to enjoy the "three Gs" of retirement: golf, gossip, and grandkids. With perhaps a bit of travel, crafting, reading, and relaxing thrown in for good measure.

But wait. Your earned income stops at retirement, and it — or most of it, anyway — needs to be replaced by something. Last pay-check, now the first — what?

As more Americans approach retirement, they get curious. How will they pay the bills? How will they provide for the enjoyment retirement can bring? But these days, it's harder than ever to achieve that secure, "rock-solid," worry-free retirement we all strive for.

Retirement, in fact, was once a fairly steady state designed to last forever, particularly if you worked for a big company or a public sector agency with a solid pension plan. Today, companies have thrown the shackles of the defined benefit pension — where they take responsibility for earning and providing you that steady payout forever — off their backs.

Sadly, these organizations have thrown that responsibility over the wall to you. They have transitioned to defined contribution plans where the contribution is predefined (and most of it comes from your earnings), and the investments and thus the outcome become your responsibility. Increasing ranks of entrepreneurs have also helped extend this change. Do mom-andpop businesses have pensions? Nope.

The Retirement Crisis may have started with this transition, but surely it didn't stop there. Fluctuating investment returns can wreak havoc on retirement incomes, as we saw in recent stock market shocks in 2000–2002 and 2008–9.

But a number of other factors have turned the placid, pension-based retirement model on its head, creating the "Retirement Crisis."

What is the "Retirement Crisis," you might ask? Put simply, it's a crisis in confidence that any retirement base is safe and solid over the full course of retirement for an individual and, importantly, for his or her spouse.

Today, more and more factors and influences create fear, uncertainty, and doubt about (1) whether you can build a sufficient nest egg and (2) whether that nest egg will last through (an ever longer) retirement.

This chapter addresses the many moving parts of the Retirement Crisis. The Crisis is real, but here's the good news: There are solutions, and these solutions will be touched on in this chapter and discussed throughout the book.

Retirement in a Nutshell

Before embarking to describe the Retirement Crisis, it helps to frame just what we mean by "retirement" — financially speaking.

Here, a picture helps:

It doesn't take long to realize that this is a basic budgeting model, with "expenses" having to be matched (or preferably, exceeded) by income.

The "resources" on the right half of the chart come from

• entitlements, chiefly Social Security, the venerable government pension for all

• any pension or regular payout beyond Social Security

• savings, which cover the rest — and importantly, any "unplanned" expenses

As we will soon see, the "Retirement Crisis" creeps into every part of this picture. Retiree expenses are rising and becoming less predictable. Social Security is secure for now, but for how long, and how much of the equation does it really provide? Traditional pensions are disappearing, and savings — if you have any at all, and a surprising number of us don't — are challenged more and more by volatile stock markets and low interest rates.

In short, crisis is everywhere.

As we'll see throughout the rest of the book, annuities — a pension-like contract that you buy that can last for the rest of your life — are an effective medicine to deal with the crisis when used right.

It Costs More: The Relentlessly Increasing Cost to Retire

For a variety of reasons, in an average retirement, we need more money. Routine expenses are higher, unplanned expenses are larger, less is covered by insurance, and it all comes over a longer period as we live longer — and the resources are becoming less reliable than ever before. Talk about a crisis!

Living Better, but for Less?

By the time we approach retirement, we have a pretty good idea of the essential costs of living needed to cover in retirement: food, clothing, home maintenance, basic health care (like over-the-counter medicines), transportation, property/casualty insurance, and so forth. If we've been good budgeters over the years, so much the better.

In retirement, you'll be able to scrap certain costs for commuting, FICA taxes, office clothing, and so on. But here's where the Crisis starts to happen: You'll have a lot more spare time on your hands and want to travel, visit the grandkids, and so forth. More greens fees and more money spent on hobbies drive costs higher. Medicare isn't free. More important, you'll start wanting (or having) to pay others for routine tasks, like home maintenance chores you once did yourself.

Studies still show most people think they can live on 70 to 80 percent of their preretirement income. I happen to think the real number for most is higher, perhaps closer to 90 percent or more.

Health Care Costs: Up and to the Right

Estimates vary, but couples on Medicare spend an estimated $218,000 over the course of a 20-year retirement on deductibles, medicines, and dental care, which are not covered under Medicare. Eye care and hearing aids are also not covered. Costs can rise substantially if the couple is unlucky enough to incur major or persistent expenses related to a chronic disease.

The cost, its unpredictability, and its inevitable rise at rates greater than inflation all contribute to the Crisis.

Retiree Insurance: Going the Way of the Dinosaurs

The rising cost of health care has forced many companies to drop retiree health coverage or to make it so expensive that it doesn't really help. Only 18 percent of companies recently surveyed provide such coverage, and this figure dropped 25 percent from 2010 to 2014. (If you're employed in the public sector, you have better chances.) Not only is this perk going away, but companies are under no obligation to continue the benefit — you can face the crisis of losing coverage during retirement. Of course Medicare is a good fallback, but ...

Stretching It Thinner: Rising Longevity

If you're a constant member of the "Life is too short" camp, that's great; you're probably very productive and enjoying yourself being so. However, you may miss the boat when putting together your retirement plan.

Our lives are getting longer and longer. Advances in health care, lifestyle, disease management, and a number of other factors have us now living longer than ever before. Since 2000, our average lifespans have increased 2 years for 65-year-old males (to 86.6) and 2.4 years for 65-year-old females (to 88.8).

Your estimated lifespans are longer the older you are (if you're 80, you're more likely to make it to 90) and the wealthier you are. All these factors add "stretch" to a retirement planning horizon and make it more important to cover the "what-ifs" — what if you live 10 years longer than your planning (and savings) took into account? Life is too long, no?

A crisis will occur for retirement plans based on savings, especially with inflation taken into account. You'll run out of money!

Making Ends Meet: The Resources Side

We've covered many, but not all, of the ideas and "gotchas" on the expense side that have caused or fed the Retirement Crisis. But that's not all — ambiguity and change can also fuel the Crisis on the resources side. The following are some things to consider.

Entitlements: Will I Always Be Able to Collect a Social Security Check?

Government entitlements — Social Security, generally speaking — are the most rock-solid part of your resource portfolio. They are guaranteed for life, backed by the government, and indexed for inflation. The problem is, they cover only about 39 percent of our retirement needs, on average. So they represent a great foundation, but other resources must come to fill the gap.

Many question the future viability of Social Security. With current age and payment levels in place, the government trust fund that supports it is expected to be exhausted by 2037 — within the horizon for most of you currently planning retirement. As we'll examine in chapter 5, there are fewer workers for every beneficiary, and there are many discussions about changing starting ages and benefit levels.

That said, most don't expect Social Security to disappear, including me. But adjustments will have to be taken into account, especially by younger workers planning to retire.

Pension Suspension: A Great Retirement Solution Going Away

As pointed out in the chapter opening, in an effort to control cost and risks, companies have shifted away from defined benefit pensions, where you get a contracted payout and the company invests the resources and takes the risks to make it happen. Markets drop 40 percent? You still get the same pension.

Pensions are great and almost as good as Social Security. They provide regular income usually to death with surviving spouse benefits. If backed by a solid company or a government agency, they are especially safe, and the Pension Benefit Guaranty Corporation guarantees cover much of the remaining risks. Some are indexed for inflation (mostly government pensions); some are not.

The problem is, only about 18 percent of today's private industry employers offer pensions. Most have switched to defined contribution plans, which are savings plans that shift most of the risk onto the employee.

Pensions are great — if you're lucky enough to have one. Their demise is a main root cause of the Retirement Crisis, for it leaves us exposed to other, more risky retirement resources, like invested savings.

Savings: Ever More Important, but Ever More Under Fire

As a member of the workforce, you've had it drilled into your head from Day One: Save for retirement. Take a few dollars off the top of your paycheck to contribute to a 401(k), 403(b), or some other retirement savings plan. Add some more with traditional or Roth IRAs. You knew it was important to do — now here's why.

Simply put, savings make up the retirement "gap" between available entitlement and pension resources and what you need. They can produce a regular "paycheck" in retirement, and they also cover unexpected and irregular expenses like dental work, hearing aids, and new tires for your car.

The problem is, although savings plans effectively manage and grow your savings, often with a company match of some sort, they can also be subject to the vagaries of the investment markets, in particular the stock market. And if you don't invest in the markets, your returns may not keep up with inflation. What you've saved over the years can take a 20 percent haircut in a single bad year, setting your entire retirement plan on its head.

Pay Up: Here Comes the High Cost of Inflation

Inflation, though quite muted today, plays an important role in the Retirement Crisis. All savings resources are subject to the ravages of inflation. Even at today's moderate inflation rates of 2 percent, a $100,000 savings plan will have only $66,760 in purchasing power at the end of twenty years. The stock market, which rises to a degree with inflation, protects against this somewhat, but it brings risk and volatility with it.

As a consequence, many retirees like to "fix" their savings into a regular, steady payment for life by using at least some of those savings to buy a pension, an annuity. Note that it's a bad idea to convert all savings into an annuity payment — it would be harder to cover unexpected expenses. Also, it is good to maintain at least some exposure to the stock markets. They do go up sometimes, and they do counter inflation.

What's That Interest Rate? 0.1 Percent?

Not too many years after companies started doing away with traditional pensions, a funny thing started happening to monetary policy. Basically, monetary policy governs the amount of money placed in circulation by the Federal Reserve. Once tied to high interest rates to combat rampant inflation — mainly oil price based and mainly in the 1970s — monetary policy started to be deployed to stimulate the economy. Translation: lower interest rates.

In the early 1980s, you could put money in a savings account and earn 5 percent. Some entirely safe money market funds earned as much as 10 percent. Although inflation was higher than it is today, you could make pretty decent and safe retirement returns just by putting money in the bank.

No more. With Federal Reserve benchmark interest rates near zero since the Great Recession in 2008, savings in all forms — from regular savings to CDs to money market funds to safe bonds — return practically nothing, generally not even the inflation rate.

Another "pillar" of the Retirement Crisis is that you have to invest in something risky to get a decent return.

Here again, annuities offer a way to beat low interest rates and to deploy some savings into an investment with relatively safe returns and a guaranteed payout.

Up We Go, Down We Go: The Volatility Roller Coaster

Another danger we can encounter in the dark forests of the Retirement Crisis is the two-headed monster of risk and volatility. The two heads bring angst and instability to your retirement savings. Risk is the possibility that an investment may collapse due to any number of factors internal or external to the investment. Volatility is the up-and-down movement of an investment or market around an average, or a trend line. This is tech talk, but what it means is that your investment can gain or lose value at any time due to any number of factors you can't control.

We'll go after volatility a bit more in chapter 6, but as a quick illustration, consider the movement of the S&P 500 broad-based stock index over 20 years, from 1996 through 2015. On average over that period, without dividends, the index gained 7 percent. Darned good! you might rightly exclaim.

Yes, darned good. But with a lot of volatility, again as we'll see. In fact, from 2000 through 2015, the average gain was only 3.5 percent — with even more volatility. With bad years like 2002 and 2008 in hindsight, the gain (the reward) may not always be worth the risk!

However, as table 1.1 shows, there's a heck of a lot of variation around this average.

Now, I usually like to show ups and downs as a graph, but here it has more impact as numbers. Remember that placid, friendly 7 percent gain over the period mentioned just now? Well, did you know that over the 20 years, the annual gains or losses ranged from a heady 32.4 percent gain in 2013 down to a disastrous 38.5 percent loss in 2008? Wow. Does any year actually get close to that calm 7 percent? We had 9 percent in 2004, but everything else is simply all over the place.

As I said, "Wow." The crisis isn't the gain or loss — in fact, we've gained (whether we will continue to do so is another question) — it's the volatility that can grind up a retirement plan. Those who planned to retire in 2008 found out the hard way.

Summing Up: A Crisis for All of Us

• Nobody can avoid the Retirement Crisis. Increasing life expectancy, rising costs, and less dependable retirement resources will get us sooner or later.

• A rock-solid retirement is still possible, it is just harder to attain with traditional resources and more likely to fail due to the unforeseen.

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Excerpted from The Income Revolution by Joseph Stark, Peter Sander. Copyright © 2016 Humanix Books. Excerpted by permission of Humanix Books.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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