McCombs Knowledge To Go April 7, 2015
Crisis in Retirement Professor Michael H. Granof Ernst & Young Distinguished Centennial Professor in Accounting
Crisis in in Retirement: Are Agin ing Workers Heading for a Fis iscal Cli liff? Michael H. Granof The University of Texas at Austin
Focus of Discussion • What’s the problem • Demographics • Changing pension practices • Social Security and fiscal status of federal government • What can we do about the problem as a country • What should be do about it as individuals
Life Expectancy At Birth At Age 65 Calendar Year Male Female Male Female 1940 61.4 56.7 11.9 13.4 1960 66.7 73.2 12.9 15.9 1980 69.9 77.5 14.4 18.4 2000 74.4 79.4 15.9 19.0 2012 76.3 81.1 17.9 20.4 2020 77.4 82.0 18.8 21.1 5
Number of People Turning 65 Each Day 6
Social Security Population and Dependency Ratio (in thousands) 65 and "Workers" to Year Under 20 20-64 Over Total Retirees 1950 53,902 92,382 12,769 159,052 7.25 2000 82,387 170,000 35,693 288,080 4.76 2012 84,951 191,124 43,574 319,650 4.39 2020 87,583 198,463 56,558 342,604 3.51 2025 90,549 200,598 65,994 357,142 3.04 2050 100,009 223,831 85,963 409,803 2.60 2070 108,729 240,679 99,881 449,290 2.41 Source: Report of the Social Security Trustees, 2013, Table V.A.2 7
Only 55% of Private Sector Workers Have Access to a Retirement Plan at Work Source: The Continuing Retirement Savings Crisis The National Institute on Retirement Security, (March 2015
Of These, 60% Have Only a Defined Contribution Plan Source: The Continuing Retirement Savings Crisis The National Institute on Retirement Security, (March 2015
Defined Contribution vs. Defined Benefit Plans Defined Contribution Plan: Specifies the amount of contributions to an individual’s retirement account, not the benefits, to be received. Benefits to be received will depend on the amount contributed to the participant’s account and the returns earned on those contributions. May give the participant a choice of investment vehicles Defined Benefit Plan : Specifies the benefits to be paid to retirees, usually as a function of factors such as age, years of service and compensation. All assets are pooled.
Advantages of Defined Contribution Plans Over Defined Benefit Plans • Risk is borne by employees rather than by employer • Employer doesn’t have to report a balance sheet liability • Avoid Employee Retirement Income Security Act (ERISA) regulations • More portable 11
DB Plans Are More Efficient than DC Plans • Source: Almeida and Fornia , “A Better Bang for the Buck, The Economic Efficiencies of Defined Benefit Pension Plans,” National Institute of Retirement Security, 2008 12
401(k) Balances By Income, Ages 55-64 Source: 401 (K)/IRA Holdings in 2013, Center for Retirement Research, September 2014
State and Local Plans are only 76% funded 14
States Face $1 Trillion+ Gap 15
16 Source: Morningstar, “The State of City Pension Plans, 2013”
Social Security is the Primary Source of Income for Most Retirees
Social Security is Not in Great Shape
The Federal Government Clearly Has a Long-term Deficit Problem
And a Long-term Debt Problem
There’s Little Opportunity to Cut Expenditures
Percentage of Households at Risk (Projected Income Will Fail to Meet Target Replacement Rates) Source: Are Retireees Falling Short, Center for Retirement Research, March 2015
Median Income for Households Aged 65+
Surveys Show Americans are Rightfully Worried Source: Retirement Security 2015: Roadmap for Policy Makers, Americans’ View of the Retirement Crisis, National Institute on Retirement Security
What Can the Nation Do? • Reform defined contribution plans • Reform public sector plans • Ensure sustainability of Social Security • Enhance fiduciary responsibilities of brokers managing retirement accounts.
Ensure that Employees Take Full Advantage of 401K Plans • Only about 70% of eligible employees participated • Fewer than 10% contributed the maximum • More than half don’t take full advantage of employer match • 53% of companies provide investment advice Source: “ Trends in 401(k) Plans and Retirement Rewards, A Report by WorldatWork and the American Benefits Institute, “March 2013 26
Provide Incentives to Improve Defined Contribution Plans • Require employees to opt-out rather than to opt-in • Ensure meaningful contribution and matching rates (perhaps combined total of 12%) • Reduce “leakage” (through in -service withdrawals, cashouts owing to employment termination and loans) • Encourage “target date” investing • Encourage annuitized withdrawals. • Establish “collective “ (i.e., hybrid) plans in which risk is shared, asset administration is improved, and withdrawals can be in the form of annuities
Enhance Fiduciary Responsibilities of Brokers Handling Retirement Accounts
Reform Public Sector Pensions • Contribute the actuarially required contribution • Eliminate spiking • Increase retirement age (to perhaps 65) and delay payout until that age • Change formulas to require more years of service • Require employees to make contributions • Put a cap on eligible income • Ensure that benefit plans are viewed as part of an overall compensation package • Adopt GASB GAAP (with reasonable discount rates)
Ensure Sustainability of Social Security Over 75 Year Planning Horizon • Appreciate that Social Security is not a pension system and that from the perspective of the government as a whole there is no trust fund • Cut benefits across the board by 17 percent (Cut shortfull by 100%) • Cut benefits to high income participants • Raise full retirement age to 67 (Cuts shortfall by 20%) • Eliminate or reduce cost of living adjustments
Ensure Sustainability of Social Security Over 75 Year Planning Horizon ( Con’t ) • Increase payroll tax by a combined total of 2.9% (Cut shortfull by 100%) • Raise the earnings cap (from $117,00 to $217,00) and thereby cover 90% of earnings (currently 83%) • Do Nothing and payout 77% of benefits after trust fund is deleted • Change law and make up shortfall with general revenues
What Can You as an Individual Do? • Save early and save a lot!! • Work longer (or live shorter) • Invest wisely; Keep funds in 401(k) plans; do not roll over to IRA’s. • Avoid leakages • Pay off mortgage debt
How Much Does a Household Need to Save Assumes a real rate of return of 4 percent Source: How Much Should People Save?, Center for Retirement Research, July 2014
Needed Retirement Savings • You and your spouse each earn $50,000 • You expect to retire at age 65 and live for another 25 years. • You expect to need $75,000/year upon retirement • You expect to earn a real rate of return on investments of 3% per year • You will receive $37,578 in Social Security • Upon retirement you will need $651,634 34
Required Annual Savings To Achieve That Goal Years to Retirement Annual Savings 10 $56, 842 15 $35,036 20 $25,251 25 $17,873 30 $13,697 35 $10,778 40 $ 8,642
Work Longer (70 vs. 62) Assume $10,000 saved each year earning 7 percent annually Value after 25 years: $ 632,490 Value after 32 years: $1,102,181 Delay taking Social Security For an average-earning individual Social Security benefits claimed at age 62 would be $14,900 per year; benefits claimed at age 70 would be $26,200
Pay off Mortgages Share of Adults Ages 62 to 69 with Mortgages and the Median Value of the Mortgage, 1998-2010 Source: Butrica and Karamcheva, Does Household Debt Influence the Labor Supply and Benefit Claijming Decisions of Older Americans
Avoid Cashing Out of 410(k) • When changing jobs, leave assets in the employer plan rather than • Cashing out completely • Rolling over to an IRA • Avoid withdrawing at age 59 ½ when 10% tax penalty is no longer imposed • Avoid “hardship” withdrawals (i.e., those for medical or educational costs or for buying a primary residence) • Avoid borrowing against the plan (and high risk of either default or repaying the loan rather than making additional contributions).
Invest Wisely • Avoid actively managed funds. High expense ratios (about 1.12% of assets for a large cap fund) plus other transaction costs vs. about .06 for a total market index fund. Returns seldom justify the added fees. • Consider target date funds
A test of a people is how it behaves toward the old. It is easy to love children. Even tyrants and dictators make a point of being fond of children. But the affection and care for the old, the incurable, the helpless are the true gold mines of a culture. --- Abraham Joshua Heschel
Recommend
More recommend
