Thursday, February 09, 2006
Will You Have Enough To Retire?
The last time the annual rate was this low was 1934 — during the Great Depression. As recently as 1994 the savings rate was nearly 5 percent, and double-digit savings rates were the norm 25 years ago.
The question is, where did all the savings go? The answer; home purchases. And since household real estate assets have risen by just over two-thirds since 1999, Americans now view their homes almost like ATM machines, using home equity loans and refinancing to pull out cash and support their spending.
In this materialistic and consumer driven society that America is today, people are actually spending more money than they make. So there's nothing left to save.
Every time there is a marginal uptick in incomes, there is a commensurate, or greater, increase in spending. Though this is the height of irresponsibility, it's been the engine for a growing U.S. economy.
In fact, Americans need to keep spending at this frenzied pace just to maintain our economy. Experts say that if everyone were to start saving, the economy would slow considerably — potentially to the point of recession. This is an obvious problem.
Yet, the savings rate will be driven down further when Baby Boomers start retiring and drawing on their retirement savings and the nation will need greater savings to fund the onslaught.
The report about the savings rate is particularly bad news news right now because, coupled with other developments, the retirement future of the average American doesn't look bright. For anyone who thought they could rely on a corporate pension, think again.
Corporate pensions appear to going the way of cassette players and rotary phones.
IBM just opted out, telling employees last month that their pension benefits will be frozen in 2008. And they aren't alone; lots of reasonably healthy companies — Verizon, NCR, Lockheed Martin, Hewlett-Packard, and Motorola, to name a few — already did the same.
It won't be long before most other American corporations follow suit and relieve themselves from their pension burdens. There's been widespread speculation that GM could be next.
As it stands, there have been a few dramatic cases of companies going bankrupt and defaulting on existing pension commitments, such as United Airlines. The problem has gotten lots of press, but that won't change a thing. It's a trend that's been underway for many years.
Defined-benefit pension plans, under which workers receive fixed monthly benefits based on their salaries and tenure, declined from 95,000 in 1980 to 30,000 in 2004 as companies either stopped offering plans or switched to 401(k)-type programs.
For the last two decades, more and more corporations have shifted to 401(k)s that automatically set contribution percentages and investment choices for employees.
Under the guidance of investment professionals (who aren't employed by for-profit mutual fund companies or brokerage firms), employees can determine how much money to set aside and how to invest it.
But while 401(k)s may be fine for younger workers, they don't work for older workers nearing retirement.
That said, we are entering a period in which workers and corporations will battle over the demise of pensions, long the primary source of retirement income for many Americans. But the fight will also involve governments at all levels, regulators, accountants and taxpayers. And these battles will be heated because everyone involved has so much to lose.
The primary problem is an aging population that is living ever longer. Pension costs have sky rocketed due to millions of longer-living retirees, and the problem will only worsen in coming years.
In 1950, when pensions first became common, American life expectancy was just 68. But it has now grown by an additional ten years. Meanwhile, American workers, many of whom are union members, are watching as employers dump or cut their pensions at a time when there's reasonable concern about the future of Social Security. For these workers, retirement security is non-negotiable.
But the pension problem is even worse than most American realize.
Public-employee pensions have never been accounted for like those run by private employers. Governments aren't required to reveal their pension liabilities the way a corporation is, on the theory that governments can simply raise taxes to pay retirees.
But the Governmental Accounting Standards Board, which sets the rules for the public sector, has finally decided to change its regulations. State and local governments will now have to reveal their pension liabilities, which may be underfunded by $1 trillion or more. Gulp.
And the private sector has a mess on its hands as well. Its pension funds are underfunded by $450 billion. Right now, 44 million Americans are relying on these private pensions and they have reason for genuine concern.
The Pension Benefit Guaranty Corporation, which insures the defined-benefit plans for all those people and takes over the plans of bankrupt companies, reported a deficit of $22.8 billion at the end of the 2005 fiscal year. It was the fourth consecutive year that a shortfall had been reported. And the PGBC predicted that its troubles would continue well into the future.
The PBGC had to assume responsibility for the pension benefits of an additional 235,000 workers and retirees in 2005, raising the total to 1.3 million. It also paid benefits of $3.7 billion last year, up from $3 billion in 2004.
When United Airlines and US Airways filed for bankruptcy last year, they forced a combined $9.6 billion in pension liabilities onto the PBGC. Delta Airlines and Northwest Airlines , which both filed for Chapter 11 bankruptcy protection in September, could follow suit.
And then there's the greatest pension crisis of all: Social Security. The hard truth has been hidden by the so-called trust fund, where the plan's annual surpluses are sent to be invested until future need. But since those surpluses are required to be invested in government bonds, they've simply been handed over to the U.S. Treasury and spent by Congress.
The trust fund is a myth. When Social Security's annual surpluses are exhausted in just six or seven years, there will be a panicked struggle over how to cover the plan's obligations.
And the ugly truth about pensions has also remained undisclosed for decades. Now, as the first baby-boomers turn 60, that reality must finally be confronted — and it will get ugly.
Many financial experts see pensions as an inherently unstable, unfair and economically unrealistic means of providing for retirement.
Though they've existed since the 19th century, the corporate pension became a retirement staple in the United States following World War II. But American corporations didn't foresee pension commitments becoming such a heavy burden for companies dealing with stiff foreign competition and longer living retirees.
Many economists argue that if companies had invested in individual retirement accounts for their employees in previous decades, instead of putting that money into pension plans, they wouldn't be facing this problem. Though IRAs and 410(k)s didn't exist until the 1970's, the general point is true.
The problem with pension plans is that they promise a specific benefit in the future without knowing the affordability of those benefits at that time. In essence, pensions are a contract between current and future generations, much like Social Security. And, as with Social Security, those future generations aren't represented at the bargaining table.
As a result, the current generation of workers are guaranteeing the retirement income of older Americans with no guarantee of anything in return.
When succeeding generations are smaller than the ones whose retirements they are helping to fund, they face tremendous and unfair burdens. As a result, the Social Security system and American corporations are facing similar difficulties.
But there are many more Americans with no pension, no 401(k) and no savings to speak of. And without that additional support, no one will survive on Social Security alone. The American retirement system is crumbling, and not nearly enough is being done to rectify it.