Trouble in All Retirement Paths
Are your retirement accounts on the proper path to meet your goals? For too many people, the answer is no. Surveys consistently show that many Americans are not saving enough for retirement. Realistically, without a change in financial habits, these people are going to be facing a retirement crisis.
According to Jack Bogle, the founder of Vanguard, America's retirement crisis is not just at the individual level, it is at the national level. Recently, he went so far as to say there isn't a single retirement crisis; there are three. Each crisis as defined by Bogle covers a different major retirement funding mechanism: Social Security's funding shortfall, underfunded defined-benefit pension plans, and problems with defined-contribution plans such as 401(k)s.
Is Bogle right? Let's examine each of Bogle's crises in greater detail, and then you can judge for yourself.
Social Security: Future Squeeze
The first crisis regards Social Security and the projected shortfall of funds in the future. The 2016 annual report from the Social Security Board of Trustees projects three more years of Social Security surpluses. However, with interest income excluded, Social Security's income (payroll taxes) is lower than the program's cost, and has been since 2010.
Social Security is expected to start running deficits in 2020 and beyond. Reserve funds and interest income can plug the gap until 2034. Beyond that point, projections show that payroll tax income will only cover 75% of retirement benefits if Congress does not act to change the rules.
The standard 75-year projection used by Social Security predicts $11.4 trillion in unfunded retirement benefit obligations by the year 2090. When one uses the "infinite horizon" method of calculating the shortfall, meaning that future liabilities are taken into account beyond the 2090 mark, the 2090 shortfall grows to $32.1 trillion. Small changes in assumptions make a huge difference in the projections, and that's part of the problem. It's too easy to argue the problems are not as bad as they really are.
Congress has not been completely inactive, as the 1983 Social Security Amendments gradually adjusted full retirement age to 67. (Of course, that action mostly deferred the burden to future generations.) It seems unlikely that Congress will take actions that actually affect current or near-future retirees, no matter how much that action is required. Raising payroll taxes or raising the limit on income subject to Social Security taxes are more likely than cutting benefits, and even those actions are unlikely in the current environment.
Bogle is probably correct in that the crisis can be averted with proper action but our current government is unlikely to do so. It seems more likely that accounting tricks and growth assumptions will keep deferring the problem to future generations.
Pension Plans: Underfunded
Bogle's second crisis addresses pension programs. State and local pensions are underfunded, but, as with Social Security, accounting practices put the amount in debate.
According to Forbes, state and local pension plans are approximately 74% funded, but this method assumes a discount on the benefit liabilities based on the assumed return of pension plans' investments. Many of these investments are skewed toward higher-risk vehicles such as stocks or hedge funds, and thus the assumed return is near 7.6%. That's not an unreasonable assumption, since from 1990-2015, the median pension fund return has been well over 8% — but current economic conditions make such returns more dependent on riskier vehicles and more prone to disaster in economic turndowns.
If state and local pension funds adapted recent recommendations of the Pension Task Force of the Actuarial Standards Board and adapted the "market value" approach that does not allow discounting of liabilities — similar to corporate pension rules and other pension rules worldwide — the funds would be only 39% funded with $5 trillion in unfunded liabilities.
State and local governments are attempting to address this issue in any way that does not burden budgets, including shorting the contributions necessary to fund liabilities. In 2015, Alex Brown, the research manager of the National Association of State Retirement Administrators (NASRA), noted that almost every state had enacted some type of pension reform since 2009, including increasing eligibility requirements, reducing benefits, suspending cost-of-living increases, or increasing employee contributions. Note the absence of one category: increasing the state's contribution.
How about corporate pensions, to the extent they remain? These fare a little better, as in 2013, they were estimated at 88% funded by Milliman, a pension fund consultant. Even so, the largest 100 companies in the survey had a combined funding deficit of $193 billion.
Meanwhile, the Pension Benefit Guaranty Corporation (PBGC), the government-mandated insurance fund that steps in when multiemployer pension plans fail, claims to need $15 billion in funding over the next ten years. Congress sets the rate that pension fund insurance premiums pay to fund the PBGC, and without changes, the PBGC projects a 93% likelihood of becoming insolvent in 20 years.
As with Social Security, shaky assumptions and the inability to face hard decisions make Bogle's crisis argument reasonable.
Defined Contributions: Fees vs. Advice
The crisis in defined contribution plans is a bit different from the other two categories. Funding is not the issue. Instead, the concern is about individuals not getting the most out of their 401(k) because of excessive fees, incomplete understanding of 401(k) and retirement options, and bad advice.
Regarding the corrosive impact of fees, Bogle gives the example of a mutual fund that has a gross return of 7% along with an annual fee of 2%. Over the course of 50 years of investing, that 2% fee removes 63% of the retirement funding that you could have earned. The same power of compounding that drives home the importance of investing early also drives home the importance of finding low fees.
The retirement fund industry may argue that low-fee, passively managed funds could not have earned the 7% return in the first place, but it has been difficult for active funds to make that case based on their relative performance to passive funds in recent years.
Regarding education and advice, Bogle notes that the recent Department of Labor rule that all financial advisers must meet the fiduciary standard (putting the best interests of their clients first) is a step in the right direction. However, it is up to individual investors to educate themselves and make the best decision regarding fees — and too few people take advantage of readily available information.
Bogle's points on retirement crises are well taken, and it makes sense to consider them individually because each crisis will require a different solution set. However, the common threads are straightforward — accurate and objective assessment of the size of the problem, and the willingness to take politically challenging steps to remedy them. In normal political times, that would be difficult; in today's climate, it borders on impossible.
Meanwhile, the solution to your individual retirement concerns is the same as the solution at the national level: a solid, reasonable plan combined with the fiscal discipline to carry it out. You can't impose fiscal discipline on the government — wouldn't it be nice if you could? — but you can impose it on your own accounts.
Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.