Crisis in Retirement - Are Aging Workers Heading for a Fiscal Cliff

Transcription

1 McCombs Knowledge To Go April 7, 2015

2 Crisis in Retirement Professor Michael H. Granof Ernst & Young Distinguished Centennial Professor in Accounting

3 Crisis in Retirement: Are Aging Workers Heading for a Fiscal Cliff? Michael H. Granof The University of Texas at Austin

4 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

5 Life Expectancy At Birth At Age 65 Calendar Year Male Female Male Female

6 Number of People Turning 65 Each Day 6

7 Social Security Population and Dependency Ratio (in thousands) 65 and "Workers" to Year Under Over Total Retirees ,902 92,382 12, , , ,000 35, , , ,124 43, , , ,463 56, , , ,598 65, , , ,831 85, , , ,679 99, , Source: Report of the Social Security Trustees, 2013, Table V.A.2 7

8 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

9 Of These, 60% Have Only a Defined Contribution Plan Source: The Continuing Retirement Savings Crisis The National Institute on Retirement Security, (March 2015

10 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.

11 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

12 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,

13 401(k) Balances By Income, Ages Source: 401 (K)/IRA Holdings in 2013, Center for Retirement Research, September 2014

14 State and Local Plans are only 76% funded 14

15 States Face $1 Trillion+ Gap 15

16 Source: Morningstar, The State of City Pension Plans,

17 Social Security is the Primary Source of Income for Most Retirees

18 Social Security is Not in Great Shape

19 The Federal Government Clearly Has a Long-term Deficit Problem

20 And a Long-term Debt Problem

21 There s Little Opportunity to Cut Expenditures

22 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

23 Median Income for Households Aged 65+

24 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

25 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.

26 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

27 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

28 Enhance Fiduciary Responsibilities of Brokers Handling Retirement Accounts

29 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)

30 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

31 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

32 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

33 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

34 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

35 Required Annual Savings To Achieve That Goal Years to Retirement Annual Savings 10 $56, $35, $25, $17, $13, $10, $ 8,642

36 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

37 Pay off Mortgages Share of Adults Ages 62 to 69 with Mortgages and the Median Value of the Mortgage, Source: Butrica and Karamcheva, Does Household Debt Influence the Labor Supply and Benefit Claijming Decisions of Older Americans

38 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).

39 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

40 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

41 Please Give Back to McCombs! This webinar has been brought to you by the McCombs MBA & BBA Alumni Advisory Boards, coordinated by alumni for the benefit of the Alumni Network. Please get involved with the Alumni Network! All alumni benefit when we work together to build the quality and value of the Alumni Network and the McCombs brand. Time: Talent: Treasure: Get involved in your local club Mentor another alumni or speak at a future webinar Make a donation to McCombs Suggested fund: MBA or BBA Alumni Excellence Funds Please use response code KTG Online survey link: Send me your feedback -- alumni@mccombs.utexas.edu