The Future of Retirement Plans
by Dallas Salisbury, Employee Benefit Research Institute®
Like never before, the American public is being reminded each day of the retirement challenges that lay ahead. For both the employers that sponsor retirement plans and the workers who participate in them, the future of employment-based retirement plans seems to be in question:- Business failures and unemployment are both on the rise, and sages like Warren Buffett suggest that things will not return to “normal” for perhaps five years.
- The recession has brought a flood of employer announcements that 401(k) matches are being reduced or eliminated, and that defined benefit pension plans are being “frozen in place” (so that benefits will not grow) or replaced by less generous retirement plans.
- Financial publications report the ongoing decline in value of the largest asset for most Americans — their homes — and an ongoing rise in foreclosures. That’s a direct threat to many Americans’ ability to afford a comfortable retirement as it dims their prospects of selling their houses for big capital gains or taking out reverse annuity mortgages.
- An ever-growing number of surveys report that those lucky enough to still have a job now expect to work many years longer because they cannot afford to retire.
- Social Security is described as “fixable” but unsustainable without either more income or a reduction in benefits. Yet, it is the only source of income for one-quarter of current retirees, and the primary source for nearly three-quarters. That dependence will only grow for baby boomers.
- Retirement plans currently account for the bulk of employers’ spending on benefits, but health care will soon be the number one benefits expense. The health care system is described as being in “crisis,” with the rate of health cost growth threatening the benefits promised by employers, Medicare and Medicaid. Yet, for more than half of all retirees, Medicare and Medicaid are the only meaningful health and long-term care protection they have in retirement — and, again, that dependency will only increase for baby boomers.
Retirement plans, retirement programs and the very concept of retirement are all changing at a rapid pace. The current economic “war” will drive more change at several levels: government policy, employers’ plan-design decisions and worker and individual decisions on participation, contributions, asset allocation and distributions. Many retirees are already being forced to change their decisions on spending, investments and lifestyle, among other things.
Many retirees would now like to return to work. Phased retirement, which has been advocated in recent years as a way to keep individuals from leaving the work force entirely, could now shift to becoming a way to ease people into retirement more quickly.
PPA Changes to 401(k) Plans
Even before all this challenging news, employers and the government were concerned about the nation’s poor preparation for retirement. The most current data (for 2006) show that, among all nonagricultural wage and salary workers (the ones most likely to have benefits), almost two-thirds (64 percent) had an employer that sponsored a retirement plan at work, but less than half (47 percent) participated. For workers who are in a 401(k)-type retirement plan, the average annual employee contribution is 7.5 percent of salary.
My Child Will Retire At 75? Not If I Can Help It!
Irecently saw a Money article that said today’s college graduates can expect to retire at 75! With a lifespan of 84, that gives them only nine years to enjoy retirement, if that. Of course, many people die long before 75 and have no time to enjoy retirement.
While I want my children to work hard, I also want them to enjoy their lives.
Why Retirement Is Being Pushed Back
According to the article, high student loan debt is causing recent graduates to delay other life events like buying a house. Without the investment of a house and the equity and tax breaks it often brings, they are not able to retire as early.
Simply put, recent college graduates are expected to spend so much more time servicing student loan debt that they can’t invest through home ownership until later in life.
Teaching Financial Responsibility As Soon As Possible
My oldest is in 6th grade, but we’re already working on teaching him financial responsibility. Here’s how we’re doing it:
His allowance is not all his. He earns an allowance for doing a variety of chores around the house as well as doing his school work diligently. If he gets lazy and doesn’t do his chores (as sometimes happens), he doesn’t get money. When he does get paid, 10% goes to giving, 20% goes to investing, 10% goes to saving, and 60% is his to spend.
We match his investments. My husband and I have not set up college funds for our children and will not likely be able to do so. Instead, with the help of our investment planner, we’ve set up a separate account earmarked for our son but still under our name. This is his college fund. Every few months, he takes the money from the 20% that goes to investing from his allowance, and we match the amount he invests. If he has $40, we match that, and he invests $80.
Because of this incentive, he wants to put more money in the account. He’s put birthday money in there, and one time $20 he found in a parking lot. Rather than spend it, he put it in his invest account, and we matched it.
We talk about retirement savings. My son and I have had numerous discussions about the power of compounding interest and the benefit of starting a Roth IRA when he gets his first job. He is planning to invest in one during his teen years.
We discuss college. . .a lot! It’s never too early to discuss college. My son knows that my husband and I want him to go to college, and he wants to, too. He knows about the importance of picking a major that will lead to a decent income. He knows the dangers of student loans.
Because we’ve talked about this so early and because my son is self-driven, he’s already checked out books from the library about scholarships and colleges. He has found scholarships that 7th and 8th graders can apply for, and he plans to do so.
He also knows that since my husband works at a university, he can go to any of the three state colleges here and just pay 25% of state tuition costs. Obviously, we’re encouraging him to do this in addition to finding scholarships.
We teach him how to stretch his money. It’s never too early to learn how to make your money stretch further. I’ve watched my son take a book or two from the freebie table at a homeschool curriculum swap to set aside as Christmas presents to give to his little sisters. He coupons for groceries, and scans the ads for the best deals.
We don’t buy him everything he wants. While we happily cover his needs, we don’t buy most of his wants. If he really wants something, he knows that he has to save his money and buy it himself.
I know my son is only in 6th grade and things might change once he is a teenager or young adult. However, he’ll always have the basic foundation we’re giving him to fall back on. My hope is that by educating him early, he won’t have to retire at 75. Maybe he could even retire early!
How do you teach your children about money and life expenses to give them the best start financially?
“There is no such thing as luck. There is only adequate or inadequate preparation…”
I believe many Federal Employees are fast approaching major financial instability.
Surprisingly, (if I am right) it will be triggered by something as mundane and (idealistically) anticipated as retirement. However, retirement itself isn’t the culprit. The lack of pre-retirement planning will likely cause this future instability.
Feds are often unaware of and unprepared for retirement obstacles such as:
- Budgeting.
- Inflation.
- Taxes.
- Knowing how much income they will have during retirement.
- Knowing how much income they will need during retirement.
- When to turn on certain retirement income benefits.
- How to plan to ensure income and resources last a lifetime.
I believe most Feds can not only survive, but thrive, if they plan for their financial futures. Not only could they pursue a comfortable retirement income, they may be able to retire well ahead of their current “plan.”
But, here’s the rub. Feds (for the most part) seem to fail to make any real effort to realistically plan for their financial futures. Some are guilty of thinking that they will take care of it later. Others feel overwhelmed by the prospect of figuring out what to do. And yet another group are simply afraid of making a mistake. The result of all three is they do nothing and hope for the best.
Eight years ago I met Jim Enlighten (a Federal Employee) that was determined to buck this unfortunate trend.
Jim and his wife had a retirement dream and pursued it throughout their working years. By the time I met them, they had already done a good job of saving and keeping their eye on the prize. But, they didn’t have a plan, so much as a goal.
Their original strategy called for both of them to retire when Jim turned 60. I’m happy to announce, they retired 2 years earlier, when Jim was 58, just by developing and sticking to a solid financial plan!
Quick Clarification – What is a financial plan? (Get ready for some jargon) I would describe it as being a comprehensive evaluation of a person or couple’s current and future financial state by using known variables such as: current assets, future income needs, current expenses, future anticipated expenses, etc… The idea is to attempt to predict future cash flows, cash flow needs, asset values and an intelligent withdrawal plan. It may include current and future budgets which are designed to organize finances and should include a series of steps or specific goals for spending and saving in the future. Taking into account, inflation, taxes, risk management, estates and retirement.
The following will show some of the course changes the Enlightens were able to make after creating their own personal Financial Plan.
The first step was to complete a Federal “Retirement Readiness Review” (RRR). It does what its name implies. It’s an in-depth review that determines the retirement readiness of a federal employee.
The Enlightens felt they were “Moderate Conservative” investors. Which, by the way, is the most common self-description I see used. Coincidentally, it is also the most commonly misused self-description I see used. They were actually much more aggressive in nature than they thought, yet their retirement accounts reflected a lean towards an ultra-conservative approach.
Investing
The couple quickly completed both at “Retirement Readiness Review” and a risk analyzing test. With this information in hand, Jim was able to make intelligent changes to his TSP and IRA allocations. These course corrections made his portfolio more susceptible to achieving their desired growth rate. Other changes included funneling non-retirement CD’s into investment options that offered greater growth opportunities, also much more in line with the couples risk comfort zone.
Planning for life events
Planning for life events is tough to do off the cuff. This area is something that quality wealth advisors (knowledgeable in federal retirement income benefits) can offer a huge advantage since (due to their daily exposure) they are often able to uncover potential events and solutions that most wouldn’t know how to plan for.
Example: Jim’s father passed away from heart disease when he was only 61. Jim said his mother struggled financially after he passed. She even took on part-time work as a seamstress well into her 70’s. Jim wanted to ensure his wife wouldn’t be subjected to this type of hardship if an early demise was in store for Jim as well.
His initial strategy was to take the smallest payout from both his federal pension and SSA income benefits when he retired. This was a caring approach that would provide his wife with the highest payout from each in case he passed early in retirement. However, during the planning process, we discovered that this would put too much of a strain on their early retirement income needs, ultimately causing the couple to put off their long dreamed about retirement years.
Instead, Jim took the higher payouts but, with extra income, was able to fund a significant life insurance policy…and add to their savings.
This move allowed them to:
- Enjoy a larger income now.
- Let both retire younger.
- Not hurt Mrs. Enlighten, if Jim passes early in their retirement.
Distribution plan
They now have a focused distribution plan that should carry them from Jim’s federal retirement date (at 58 years old) throughout their lives. He will:
- Start taking his federal pension (annuity) and SRS (bridge payment) immediately.
- Take $1,100 dollars per month from his TSP at 62 until he reaches full SSA benefit age of 66 (+).
- Not touch his TSP again until he reaches 70 ½.
- Begin taking Social Security at age 66 (+), and his wife will start hers 6 months later. Their plan estimates that this will give them an excess of $3,100 per month (at 66).
- Take Required Minimum Distributions (RMD) from his TSP and IRA at 70 ½; the extra income will help offset inflation by adding an anticipated $2,200 per month.
They estimated that their monthly expenses in early retirement would be $4,300. They also said they want to take two trips per year, such as a cruise to Australia. This is obviously expensive. But, because they created a plan (not to fail), which included proper retirement distributions, we were able to construct a map that will allow them to achieve their goal to travel.
Thanks to these new plans, they were not only able to retire securely, but two years earlier than they had originally hoped.
Jim’s plan will not work for everybody since each federal employee has his own financial goals, life events, and investment risk tolerance. However, you can create your own retirement plan that meets your needs and puts you on the path towards a prosperous retirement.
If you would like to learn how to create your own retirement map, I invite you to sign up for my free online workshop “Treasure Map to Early Federal Retirement” on September 22 at 3 PM EST (Length: 40 minutes)
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Securities offered through LPL Financial, member FINRA/SIPC.
© 2015 Randy Silvey. All rights reserved. This article may not be reproduced without express written consent from Randy Silvey.
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Fed ends 'too big to fail' lending to collapsing banks.
The Federal Reserve is cutting its lifeline to big banks in financial trouble.
The Fed officially adopted a new rule Monday that limits its ability to lend emergency money to banks.
In theory, the new rule should quash the notion that Wall Street banks are "too big to fail." Translation: the government has to save them during a crisis.
The Fed's new restrictions come from the Dodd-Frank Act of 2010, which brought in a wave of reforms after the financial crisis.
Under the new rule, banks that are going bankrupt -- or appear to be going bankrupt -- can no longer receive emergency funds from the Fed under any circumstances.
If the rule had been in place during the financial crisis, it would have prevented the Fed from lending to insurance giant AIG (AIG) and Bear Stearns, Fed chair Janet Yellen points out.
Politicians like Senator Elizabeth Warren have pushed the Fed to end such emergency lending to banks that are going under.
She does not think the Fed's new rule goes far enough.
"There are still loopholes that the Fed could exploit to provide another back-door bailout to giant financial institutions," Warren, a Democrat, told CNNMoney.
At first glance, the new rule sounds like a common sense change. If a bank is going under, American taxpayers shouldn't be bailing it out.
However, it's important to note that the new rule allows the Fed to judge by its own measures whether a firm qualifies for its emergency aid.
The idea is the Fed can still lend to banks during times of emergency, but the bank must be able to pay it back. Yet the true health of a bank in turmoil can be very difficult to assess.
"It's very hard to judge in real time whether a firm is insolvent or just having liquidity problems because it becomes impossible to price assets," says Paul Ashworth, chief U.S. economist at Capital Economics, a research firm.
That's why Warren wants clearer guidelines.
"It's up to Congress to close those loopholes and ensure that Fed emergency lending is limited to protecting the economy and not to saving a few favored banks," Warren says.
The rule is the latest in a series of reforms the Fed has put on the biggest banks in an effort to prevent the next crisis.
