The future of retirement is changing rapidly.
Just last week, the Pension Benefit Guaranty Corporation (PBGC) published a troubling report. In short, the agency reported that to stay solvent through 2025, they need to come up with an extra money to fund their projected deficit — $53.4 billion to be exact.
This means the Corporation will need to increase premium fees between 59% to 85% to avoid fund insolvency over the next 10 years, and 363% to 552% to avoid insolvency in 20 years.
Keep in mind, the PBGC funding shortfall is only the tip of the iceberg. While the PBGC is charged with backstopping pensions that fail, their projections show underfunded pensions under pressure system wide. In fact, whether you view data from the Social Security Administration, NerdWallet, or John Mauldin, underfunded pension deficits are most likely in the trillions of dollars.
To get a sense of the trends graphically, take a look at two summary charts from the PBGC report.
Figure 2 on page 7 shows that the “financial assistance to insolvent plans has grown since 1981.” While the chart indeed shows an increase of insolvent plans since 1981, the graph title severely understates the curve of the trend line. Insolvent plans trickled in from 1981 to 2005, but from 2005 forward, assistance needs have skyrocketed. Compounding this issue, Figure 4 on page 10 shows the macro funding picture, noting that the “PBGC ME Fund (becomes) exhausted during FY 2024.”
The fund is currently using reserve funds and premiums to stem the rising tide of assistance needs but in 2024, the fund will be fully depleted. At this point, future premiums do not keep pace with liabilities as no reserve would be present to pull from.
Social Security Background
Today, Social Security benefit holders over the age of 70 rely on Social Security for over 50% of their income. However, the Social Security system was not designed to act as a full-on retirement plan or pension.
In fact, when the Social Security Act was signed into law by President Roosevelt in 1935, it created a “social insurance program designed to pay retired workers age 65 or older a continuing income after retirement.” In 1935, life expectancy was 60 years for men and 63 years for women. Doing some quick math, it is easy to see that the system was designed to take care of those few individuals who lived significantly past their expected drop dead date.
Unfortunately, the Act has not been adjusted to accommodate for the increase in life expectancy over the years. In 2010, male life expectancy was 76 years and female life expectancy was 81 years. The massive increase in life expectancy means that the system is making years of payouts to millions of benefit holders that it was never designed to support.
As fund benefits have continued to flow out well past the designed limits, the system now faces a crisis. The Social Security OASI Trust Fund has a projected reserve depletion date of 2035.
Could this issue be corrected via federal funding mechanisms or higher taxes on workers? Absolutely. But workers would certainly mount a political opposition to such measures.
Converging Trends Are Creating the Perfect Storm
The crisis in the Social Security System and defined pension plans could manifest in a few ways.
First, political pressure could be brought to bear and the systems could be funded by workers and taxpayers.
Second, system adjustments could be made which balance the funding burden between benefit holders and workers. The retirement age could be adjusted nearer to life expectancy, benefit distributions could be reduced, and workers could contribute slightly higher taxes. Extraordinary political capital would be expended in either of those scenarios.
Third, U.S. based companies could continue their march to move corporate treasuries to offshore tax havens in order to shield themselves from tax and pension liabilities, leaving pension holders in the dust.
Take a Deep Breath
The collapse of social safety nets is certainly scary. Most retirees depend on Social Security and pension income streams and rightly expect the return of their contributed. Solving the problem for current retirees is not easy or politically expedient. However, math is math and the writing is on the wall. These programs need to change significantly to survive. Current workers should not expect to see full Social Security or pension benefits and instead should plan for a world without safety nets. In that world, what does the future of retirement look like? And, how can current workers plan to get there?
The Future of Retirement: A Scenario
In a world without safety nets, careful planning and preparation can help reduce risks and overall retirement funding requirements. Take a tip from the Boy Scouts and Always Be Prepared.
Let’s examine some basic needs in retirement:
- Housing – Housing cost is a huge retirement variable. If you don’t own your home, rental expenses will drive your retirement costs through the roof. Paying off your home now fixes your return on investment and eliminates the need to pay rental expenses during retirement. Take care of your home investment and make sure that it will provide you shelter well beyond your desired retirement date.
- Taxes and Utilities – Taxes and utilities are a consistent burden in retirement. Plan accordingly for property tax increases, or move to an area with lower tax rates. Plan ahead for taxes on investment withdrawals. Plan ahead for utilities in one of two ways. First, if all of your utilities come from the grid, expect price increases over time as infrastructure ages. However, it is possible to mitigate utility expenses by purchasing technologies that provide off grid utilities such as solar electric, solar hot water, wind powered pumping, wind powered electricity, geothermal heating, cooling and electric, well water and filtering, and natural sewage treatment. While these options may have a high up-front cost, most provide long term returns which exceed the initial investment.
- Health Care – Health care cost is a huge retirement variable. While Medicare and Medicaid may provide some assistance, it is possible that those funds could be strained when you get to retirement age. To plan for a retirement with limited safety nets, it is prudent to invest in your health now. Invest time and money in a gym membership, an active lifestyle and healthy dietary changes. While you can’t plan for every eventuality, the best way to eliminate future health care costs is to reduce the need for future health care. In addition to taking positive steps to care for your health, it is always wise to hedge for catastrophic events. A single negative health event can wipe out one’s entire net worth. Therefore weigh the risks and costs of catastrophic health care insurance. While this is certainly a safety net, the risk of not having coverage might be too great to ignore.
- Food, Travel, Clothing, and Incidentals – No matter how well you plan and how many retirement costs you can eliminate through home ownership, utility mitigation, and a healthy lifestyle, you will still most likely need some kind of monetary savings to exchange for goods and services when you retire. You may have caught John Oliver’s show this weekend where he discussed retirement plans and the role of fiduciaries and financial advisors. His criticisms of 401k’s and certain types of financial advisory services were basic but well founded. The take aways: Many 401k plans charge high fees and underperform the market, and many people offering financial advisory services may not have your fiduciary interests at heart. However, not all is lost. There are many savings and investment plans available which have low fees and broadly diversified investments which can net investors higher returns over time. Consult a fiduciary for advice on how to structure such a savings and investment portfolio. When you make your budget, determine your expected length of retirement and expected expenses over that time, and plan an income stream that supports those expectations.
This scenario covers a few basic considerations on how to plan for retirement if social safety nets fail. The take away is this: take responsibility for yourself, your family, and your community. The government may not always be able to provide for you. Careful planning and design can eliminate many retirement costs (and fears). Keep in mind, before 1935 most people lived without social financial safety nets. The current experiment may simply be at the end, or may require new design.
In the meantime, take the reins, invest in yourself, and save for the future.
For more on how banks and credit unions can educate account holders on how to be financially strong, check out FinStrong.com — a program that financial institutions can offer their users to build brand loyalty and help users save for retirement.
Header image from American Advisors Group.