The American Retirement Nightmare

Megan Leonhardt of CNBC reports that according to one economist, the system is ‘flawed’ when most Americans have little or no retirement savings:
It’s no secret that Americans are falling short when it comes to saving enough for retirement. But as a new report shows, many are disastrously unprepared — and that may point to flaws in the system.

Progressive think tank the Economic Policy Institute found that Americans 56 to 61 had a median balance of $21,000 in their 401(k) accounts in 2016, which is the most up-to-date data on file. That total reflects almost 30 years of savings.

Younger generations do not fare much better. Older millennials (ages 32 to 37) have about $1,000 saved in their 401(k)s.

The problem is that while 401(k) plans are meant to supplement Social Security, the benefits distributed by the government agency are modest. Currently, the average Social Security retirement benefit is about $1,470 a month, or about $17,640 a year, according to the Center on Budget and Policy Priorities.

Meanwhile, the typical American spent about $3,900 a month last year on basics such as food, housing, utilities, transportation and health care, according to the latest consumer spending data from the Bureau of Labor Statistics. Retirement accounts, ranging from pensions to 401(k)s to individual retirement accounts, are expected to fill the gap.

But when it comes to 401(k)s, that’s not happening.

At least one economist says that the problem lies primarily with the plans, not with Americans’ savings habits. “The system is designed to make people feel bad about themselves — everyone privately thinks that they’re screwing up. And yet if everyone is screwing up, then it’s clearly a system flaw,” Monique Morrissey, economist at the Economic Policy Institute and author of the report, tells CNBC Make It.

Problems with the current system

As more and more American employers move away from offering pensions, 401(k)s and similarly structured retirement plans have risen in popularity. But the biggest problem with relying on 401(k) plans to supplement Social Security benefits is that many people simply don’t have access to employer-based retirement plans.

“The No. 1 problem is a coverage problem,” Morrissey says. Nearly 40 million private-sector employees do not have access to a retirement plan through their employer, according to a 2018 study by the U.S. Bureau of Labor Statistics.

Most people without any 401(k) savings are in that position because they don’t have access to a plan at work, often because their employer doesn’t have a plan at all, they’re part-time or they haven’t been at the company long enough to qualify.

Even if people are covered and participating in their retirement plan, Morrissey says “401(k) plans were not well designed to serve in lieu of a real pension.”

First, 401(k) plans can be difficult for employees to navigate, even with changes lawmakers have put in place to make it easier for consumers to get started. Last year, 65% of companies with more than 5,000 employees automatically enrolled workers in 401(k) plans at a small set deferral rate, according to data from Vanguard. Many times, these programs will start employees off at a 3% contribution rate and gradually increase it to 6%.

Yet even though these auto-enroll programs get consumers started, the projections and assumptions that they need to make can be difficult to navigate. To determine how much you should invest to retire comfortably, you need to broadly estimate your lifetime earnings, as well as make some assumptions on what market returns will look like.

As Morrissey points out, small variations in those assumptions can make a huge difference. If you slightly tweak your expectations to be more pessimistic or more conservative, you could get results that specify you need to be saving close to half of your income.

If millennials want to retire at 65 and have enough to live off even half of their final salary in retirement, for example, they would need to save 40% of their income over the next 30 years if investments return less than 3%, according to recent academic research from Olivia S. Mitchell, a professor and executive director of Wharton’s Pension Research Council at the University of Pennsylvania.

That type of savings goal becomes “overwhelmingly impossible to do and people give up,” Morrissey says.

Additionally, 401(k) contributions are voluntary and you can tap your funds for a variety of purposes before retirement, a situation that makes these types of retirement savings accounts more “vulnerable” than traditional pension benefits to economic downturns.

How to boost your savings

For millennials, the good news is that it’s not too late to jump-start retirement savings. Juggling saving for retirement with covering rising day-to-day housing, health care and living expenses and working to wipe out existing debt can feel overwhelming, but it’s possible.

First, take some time to prioritize your financial goals. “Millennials will need to have a clear idea of what is most important to them in the long-term. Kids? House? Life experiences?” says Bart Brewer, a certified financial planner with California-based Global Financial Advisory Services. Trade-offs may need to happen, he adds.

It can also help to create a written monthly budget and carefully manage your credit. Young people need to be very careful about dramatically raising their standard of living, Brewer says. “It’s much harder to ratchet down after you’ve ratcheted up.”

And while they’re not perfect, it’s worth enrolling in your employer’s retirement plan if you’re eligible. Once you have your 401(k) account set up and your contributions flowing in, it’s important that you select how to invest your funds — otherwise your retirement money will essentially act like a savings account.

Also, make sure to contribute enough to take advantage of any match your company may offer. Some companies offer to match the amount of money you put your 401(k), up to a certain point: If you put 5% of your salary into your 401(k), your employer may also contribute 5%, depending on the type of program. The median matching level is 4% among Vanguard 401(k) plans.

Last, you may need to consider working longer and waiting to claim Social Security until later. “Benefits from Social Security are 76% higher if you claim at age 70 versus 62, which can substitute for a lot of extra savings,” Mitchell says.

If you’re able, don’t retire, Mitchell says. “If you can keep working, do so. If you can’t work full-time, work part-time. Every little bit helps.”
The way things are headed, I reckon a lot of Americans are going to try to put off retirement till they reach the age of 70. Problem is only a lucky few will be able to do this.

For the rest of them, what awaits them is pension poverty, the new normal when it comes to retiring with little to no savings.

Just do the math, the typical American spent about $3,900 a month last year on basics such as food, housing, utilities, transportation and health care, and the average Social Security retirement benefit is about $1,470 a month, or about $17,640 a year, according to the Center on Budget and Policy Priorities. That basically translates into a shortfall of $2,430 a month or $29,160 a year.

[Note: Boston College's Center for Retirement Research publishes a bit more favorable data on the median 401(k)/ IRA balances which is available here. It still demonstrates most Americans aren't saving enough for retirement.]

How is an older American suppose to get by? Either they need to drastically curb their expenses, which often means choosing between medication or paying the rent, or if they're lucky, they'll find a job at Walmart or somewhere else paying them a pittance to supplement their Social Security benefits.

Or they can do what most Americans are doing, jack up their credit card debt at the top of the economic cycle:

All this to say, it's a grim situation, the American dream has been exposed for what it has become for the restless masses, the American retirement nightmare.

Of course, the prosperous few will tell you all is fine with the American capitalist system but the disenchanted masses are catching on, they realize they're screwed and will ultimately retire in poverty.

Even the young millennials see the writing on the wall, and they too are facing a very grim retirement.

This is why hedge fund billionaire Ray Dalio, founder of Bridgewater, the largest hedge fund in the world with over $150 billion in assets under management, thinks the capitalist system is broken and needs to be fixed or else major social upheaval is coming.

But as I explained here and here, the capitalist system isn't broken, hedge fund and private equity billionaires (and other billionaires) have never had it so good, the system is working just fine when it comes to their self interests. They might publicly deride rising inequality, but privately they're just fine with it as long as they're growing richer relative to the masses and their peers every year.

Yesterday, I had a long discussion with Ed Harrison on Real Vision going over these issues. Our discussion is available here for subscribers and I have asked them to make it public for my readers or at least have excerpts made public.

Anyway, Ed and I discussed the US public pension crisis. I alluded to The Pew Charitable Trusts 2017 study on state funding gaps (click here to read it) and said for many chronically underfunded state plans, they simply cannot afford another crisis, it will place them in an untenable situation where their funded status drops below 30% or worse.

Ed asked me why should Americans care if most of them are not part of these state plans? I again referred to the Pew study which states this:
Kentucky, New Jersey, and Illinois have the worst-funded retirement systems in the nation in part because policymakers did not consistently set aside the amount their own actuaries said was necessary to cover the cost of promised benefits to retirees. As a result, the pension funds in those three states had less than half of the assets needed to cover liabilities in 2017. Underfunding pensions also increases pension costs significantly over time. Pension contributions went up 424 percent in Illinois, 267 percent in Kentucky, and more than 100 percent in New Jersey from 2007 to 2017, reducing resources available for other important public priorities. Despite these increases in contributions, the three states collectively fell $11.5 billion short of the amount needed to keep pension debt from growing.
Those massive increases in pension contributions affect everyone. People which live in states where plans are chronically underfunded can expect higher property taxes to make up for the shortfall as more and more of state budgets go to contribute to these woefully underfunded plans.

So, yes, you'd better pay attention to the public pension crisis because it will impact you regardless of whether you're part of a plan or not.

What will happen to many state plans teetering on the edge of insolvency? As I told Ed, if we get a really bad crisis where asset prices and interest rates plunge and stay low for years, there will be no political will to raise taxes and nobody in their right mind will be buying pension obligation bonds.

At that point, Congress, the Fed and the Treasury department will step in to bail out many US state plans but there will be a heavy price paid for such a bailout, there will be a haircut on benefits and increase in contribution rates.

Those of you who think no bailout is coming, I refer you to two older comments of mine, The Mother of all US pension bailouts and a multibillion Thanksgiving pension bailout which took place a year ago.

If things get very bad, there will be a bailout, it won't be pretty, unions will scream bloody murder but they will bow down to creditors and accept whatever is offered to them.

Of course, as I explained in the $16 trillion global pension crisis, Congress, the Fed and the Treasury won't be bailing out public pensions for the hell of it, they will be doing so to bail out Wall Street and its large hedge fund and private equity clients, all of which benefit massively as long as they can keep milking the US public pension cow in perpetuity.

A lot of people will dismiss such a statement as "absurd" but I tell them to read C. Wright Mills' The Power Elite, to really understand the past, present and future of capitalism.

Just look at the 2008 crisis. Who really benefited the most a decade later and why? (answer: elite hedge funds and private equity funds and the big banks that serve them).

Anyway, I told Ed Harrison, the US public sector pension crisis will only get worse. Why? Because pensions are all about managing assets and liabilities and I foresee low to negative rates being with us for a very long time, especially if deflation strikes the US, which means liabilities will soar to unprecedented levels and assets will not deliver anywhere close to the requisite returns pensions need.

Ed and I got into a discussion of duration of assets versus liabilities. I told him the duration of liabilities is a lot bigger than the duration of assets (typical pension liabilities go out 75+ years) which means when rates fall, pension liabilities mushroom, especially when rates are already at ultra low levels and asset inflation, if there is any, won't make up for the shortfall.

[See a comment Zero Hedge posted, US Stock Markets Up 200%, Yet Illinois Pension Hole Deepens 75%, and more importantly, my comment from the end of August where I discussed why the pension world is reeling from the plunge in yields.]

I also told Ed there is plenty of blame to go around for this dire situation. Bankrupt state governments and corrupt public-sector unions not wanting to abandon their 8% pipe dreams in order to keep the contribution rate low is just one of many structural flaws.

But in my opinion, the biggest problem of all with US public pensions is there are too many of them (need to be amalgamated at the state level) and more importantly, the governance is all wrong!

I told Ed, in Canada, our large public pensions got three things right:
  1. We got the discount rate right. Our large DB pensions use much lower discount rates that the assumed investment returns that US public pensions use to discount their future liabilities (anywhere between 7% to 8%; in Canada, they are discounted at 6% or lower).
  2. We got the governance right. In Canada, our large public pensions operate totally independently from government. This means, independent qualified board members are sought to oversee these large pensions and they hire a CEO who hires senior managers to run the day-to-day affairs of these pensions. They are compensated appropriately and run these pensions much like large businesses, investing across public and private markets all over the world.
  3. We got the risk sharing right. In Canada, large and some smaller public pensions (like CAAT Pension) are jointly governed and the risk of the plan is shared equally among all stakeholders, including retired members. Typically, this means adopting conditional inflation protection where indexation is partially or fully lifted if a pension is experiencing a deficit and restored retroactively once it reaches fully funded status again.
These are the three reasons why Canada's large public pensions are global leaders.

But things are far from perfect in Canada because too many of our citizens are not covered by large, well-governed defined benefit plans which is why Canada doesn't score at the top of the world's best pension systems.

It's always The Netherlands and Denmark which consistently score the highest and the biggest reason why is they offer great DB pensions to a large subset of their population.

The problem in these countries is their regulators are running amok, forcing pensions to do wonky things like buy more negative-yielding bonds at the wrong time. This is why some of the world's best run pensions are starting to worry (nothing like overzealous pension regulators to kill a perfectly great system).

Anyway, Ed Harrison and I also spoke about the ongoing retirement crisis in the United States and here I kept hammering away on the brutal truth on DC plans, they have failed miserably to help more and more people retire in dignity and security.

There are a lot of reasons why but I referred Ed and the Real Vision crowd to study the Healthcare of Ontario Pension Plan (HOOPP) put out on the value of a good pension.

I realize most people don't have time to read lengthy reports but take the time to read it or at least read the condensed report which is available here.

The point I was making to Ed is if we are looking at efficiency of outcomes, there's no question we need to bolster well-governed defined benefit plans throughout the world so more people can retire in dignity and security.

From the HOOPP study, look at the five value drivers in retirement arrangements:

This is why the study found for the same level of retirement security, the cost disparity between a Canada-model pension plan versus an individual approach amounts to a difference of about $890,000 over a lifetime.

Moreover, the study found for each dollar contributed, the retirement income from a Canada-model pension is $5.32 versus $1.70 from a typical individual approach.

These findings shouldn't surprise us. There are huge benefits to large well-governed DB plans which invest across public and private markets all over the world. They are better equipped to scale into asset classes and pool investment and longevity risks.

In Canada, we are definitely lucky to have the Canada Pension Plan Investment Board (CPPIB) managing the assets of the Canada Pension Plan but more needs to be done to cover many of our citizens that don't have access to a well-governed DB plan.

In the United States, the situation s critical and I foresee a looming retirement crisis which can last a decade or longer depending on how bad things get.

Two years ago, I wrote a comment on the pension storm cometh and so far, it hasn't come namely because central banks around the world are doing everything they can to reflate risk assets at all costs.

Can central banks save the day so we avoid another major crisis? Maybe they can buy us a lot of time but this will only ensure the Japanification of Western economies where zombie companies stay open for business longer than they should and asset inflation only exacerbates the wealth gap.

I don't know how this will all end, all I know is for far too many Americans looking to retire in dignity and security, it won't end well. Retirement dreams have vanished and the nightmare in only beginning.

Below, an older CBS MoneyWatch clip which goes over the problems with 401(k)s and DC plans in general. As the default retirement plan of the United States, the 401(k) falls short, argues CBS former editor-in-chief Eric Schurenberg. He tells Jill Schlesinger why the plans don't work.

Second, PBS Frontline takes us inside the multi-trillion dollar mismanagement and meltdown of public employees’ retirement savings, and how states and Wall Street paved the way to the road to ruin. Martin Smith discusses how dire the situation is and how we got here. The full PBS documentary is available here.

Third, in this clip from Real Vision special 'The Coming Baby Boomer Retirement Crisis' (released 9th May 2018) macroeconomist, Raoul Pal explains the impending pension crisis that not everyone is going to see coming.

For those of you who want to watch the full episode, I embedded Real Vision's full special on the coming retirement crisis (last clip below). Take the time to watch this, I'm not in full agreement with everything but it's definitely worth watching if you want to understand the scale of the problem and how we got here. Like me, Pal foresees a major bailout coming in the future but for most Americans, it will be too little, too late.