Well-known financial columnist Robert Powell has a recent article in MarketWatch titled, “Retirement in America is ‘Endangered.” The motivation for this piece, he writes, is that retirement preparedness is a crucially important topic that was missed in the recent State of The Union address by President Obama.

Powell goes on to list the key problems with the current ‘state of retirement’ in the United States:

  1. Under-funding of Social Security
  2. Low savings rates
  3. Poor market returns over recent years
  4. Inadequate levels of financial literacy
  5. Half of American workers have no employer-sponsored retirement plan

All of these issues are critically important. In just one or two generations, we have shifted from a society in which employers provided lifetime retirement income via traditional pension plans, to one in which individuals now must manage every aspect of their financial futures, including how much to save and how to invest their retirement savings. The good news is that each of these five issues can be solved if we have the will to solve them.

Social Security

Regarding Social Security, it seems almost inevitable that the maximum income which is used to determine social security contributions will be raised and that the age at which workers are eligible to draw benefits from Social Security will be increased. Both of these solutions are discussed in Powell’s article, and these changes are likely to be unavoidable. The only alternatives would be to reduce benefits for current retirees, or to increase the Social Security tax rate itself, which would have a number of negative outcomes. First, Social Security would become a more regressive tax if the rates were simply increased, with lower earners paying even more and wealthier earners largely shielded from increased contributions. Reducing benefits for current retirees would surely be the most politically suicidal stance for any elected official to take. The shortfall in funding is most likely to be further shifted forward onto current workers and future workers.

Savings Rates and Financial Literacy

Dealing with inadequate savings rates is the largest long-term retirement planning problem that we face as a nation. There is no way around the fact that Americans must save a higher fraction of what they earn. Savings rates can be increased somewhat with automatic enrollment into employer-sponsored 401(k) plans, but the majority of the savings increase will need to come from voluntary or mandatory increases in deferral of income into long-term savings plans. Personally, I would strongly support the idea of a mandatory contribution rate into a 401(k) plan, or IRA for those who do not have an employer-sponsored plan.

It is not uncommon to encounter articles that cite recent poor performance of the stock market as a key source of problems in retirement preparation. It is certainly true that the stock market has broadly under-performed many expectations, with an average annual return of 3.7% over the past ten years and 0.47% over the past five years.

However, this period of low returns is not, in fact, the real problem. The real problem is that many investors believed that the stock market would consistently deliver the kinds of high returns that prevailed over much of the 1990s, and there was no solid reason to believe that stocks would always deliver high returns. The fundamental issue may have been that investors do not really understand the balance of risk and return that risky asset classes such as stocks and real estate offer. Even over long holding periods, there is a real chance that an equity-heavy portfolio will substantially under-perform. We should not be making plans on the basis of the bet that stocks will perform well for us in our required time horizon.

Ultimately, low savings rates and lack of understanding of the real risks associated with many asset classes, result in investors betting their future retirements on asset allocations that may be too risky for them. Low savings rates and inappropriate risk choices ultimately come down to a combination of financial literacy (our fourth item in the list above) and behavioral issues.

Financial literacy means that investors understand what they need to do, but understanding does not mean that people will do what they should. Taking a class on nutrition does not make you healthy. In other words, I totally agree that we need better vehicles for financial education but we, as a society, need to figure out how to motivate better financial decisions. As a society, we need to encourage frugality rather than overwhelmingly glorifying consumption.

Lack of Employer-Sponsored Retirement Plans

The fifth item in the list above identifies the problem that half of all American workers have no employer-provide retirement plan at all. This population is crucially important and does not get sufficient attention. We know that personal savings rates are very low, but it is a reasonable assumption that savings are lower for those people without retirement plans at work.

Powell makes a more pessimistic assertion:

…the 75 million workers who don’t have a retirement plan at work aren’t saving anything at all for their golden years.

The article discusses one proposal for the creating of “automatic” or “universal” IRAs that would allow any person to have a specific portion of their wages diverted to a retirement savings account. Simply creating accounts does not mean that people will, in fact, actually save.

So, what does all of this mean?

First, I think that it is clear that a traditional retirement in which retirees quit work at age 65 and enjoy something close to their pre-retirement income from a combination of Social Security and private pensions (either traditional pensions or 401(k)’s and similar plans) is increasingly unlikely for most Americans. The reality is that many (and perhaps a majority) of people will retire later and live in substantially reduced circumstances once they do retire. There will, of course, be a population of people who plan to work later in life but who cannot, due to poor health or bad economic conditions. For people who can secure employment, working longer will help to overcome lower saving rates or poor investment returns earlier in life. Having a substantial portion of the aging populace planning to work longer has implications for the broader economy, of course, and these implications are not well understood.

[Editor’s Note: The Council of Economic Advisers just released, “Supporting Retirement for American Families 2012” which sheds additional light on the problems Americans face when saving for retirement. We think it’s worth a read.]


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