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What if your pension runs out of money?

March 8, 2013 9:35 amLeave a Comment

The zero-interest-rate policy in the U.S. continues to wreak havoc on those saving for retirement.

Case in point: Many companies are pouring cash into their defined benefit pension plans because of the low interest rates, according to a report this week in The Wall Street Journal. According to the report, companies are required to calculate the present value of the future pension liabilities—how much they need to pay out to retirees—by using a so-called discount rate, which based on corporate bond yields. As those rates fall, the liabilities rise. And as those liabilities increase, companies make up the difference by pouring cash into their plans.

So what does this trend portend for workers at the firms that have traditional defined benefit plans? What should workers do at firms where this might be happening or could happen? And what might small employers who have defined benefit plans consider doing to avoid problems?

Prepare for the worst

Not surprisingly, some experts say there’s plenty to worry about, others say this trend is much ado about nothing, and still others say workers with a defined benefit plan—funded or not—should be thankful for what they have.

At one extreme is Ary Rosenbaum, an ERISA/retirement plan attorney for his firm, The Rosenbaum Law Firm. He says workers ought to prepare for the possibility that their employer will freeze their pension benefit or terminate the plan.

And if that should happen, consider, at a minimum, increasing the amount of money you contribute to other retirement accounts, such as an IRA or 401(k) to make up for what you might lose in pension payments.

Others, meanwhile, say that workers whose employers have a well-funded pension plan need not worry as much about their plans being frozen or terminated. “Workers at healthy firms shouldn’t worry, because the company stands behind the promise,” said Ron Surz, president of Target Date Solutions. “That said, I don’t think there are many defined benefit corporate plans left. Defined benefit plans are now mostly union and government plans.”

Companies are pouring cash into pension plans

Some of America’s biggest companies are shifting cash that could be used for development or expansion into pension funds as low interest rates designed to spur the economy push up pension liabilities.

And still others remind us that there’s not much a worker can do whether a plan is funded or underfunded. “First, workers have very little influence over the actual funding requirements of true pension plans,” said Christine Russell, a retirement strategist for Christine Russell Retirement Consulting. “The amount a company must fund is determined through complicated formulas calculated by actuaries.”

So what can employee today do if they are covered by a pension? “Thank their employer for continuing the pension plan,” she said. “Many companies no longer offer such plans, so an employee covered by a pension is a lucky person, indeed.”

What’s more, she said employees should let the human resources/employee benefit department know that they value this benefit. “Often, it can seem like this substantial and important benefit is ignored by employees,” she said.

By way of background, there are more than 27,500 private-sector defined benefit plans covering more than 44 million American workers, according to the Pension Benefit Guaranty Corporation.

You can learn more about how employers can terminate a pension plan or how to check if your plan is underfunded at General FAQs about PBGC.

To be fair, it’s possible that this trend where firms pour cash into defined benefit plans may not continue, or at least it won’t at some of the country’s largest companies.

The aggregate deficit in pension plans sponsored by S&P 1500 companies decreased by $74 billion to $482 billion as of the end of January 2013, according to report released this week by Mercer. What’s more, Mercer said in its release that the funded ratio (assets divided by liabilities) improved 3%, up from 74% to 77% during the month. This deficit compares to an aggregate pension deficit of $557 billion on Dec. 31, 2012 and is a slight improvement over the $484 billion deficit and funded ratio of 75% at the end of 2011, the company said.

According to Mercer, the improvement of the past month was driven by strong equity markets, which gained more than 5% in the period, and an increase in interest rates of about 15 to 20 basis points, which reduces liabilities, the company said.

Still, the company cautioned defined-benefit pension watchers: “Before sponsors celebrate too much, it is important to realize we have had numerous examples over the past few years of funded status improvements quickly being wiped out by adverse market movements,” Jonathan Barry, a partner in Mercer’s retirement business, said in a release. “In both 2011 and 2012 there were monthly improvements in funded status early in the year, only to experience market conditions that saw year-end funding levels below the start of the year.”

Russell noted, for instance, that while funding amounts today seem substantial, during good performing years companies are permitted to fund less. “The market performance of the pension investments reduces the amount of cash the company needs to contribute to the pension,” she said. “And there are even some years where the company may not have to fund the plan at all.”

In addition, even during the best of times, some companies didn’t fund all of the pension contribution required, Russell said. “When that lack of full contribution is followed by a few years of market underperformance the required contribution to the pension goes up substantially,” she said. “As we know, there is usually a cost to procrastination; this is true especially where pension contributions are concerned.”

So what’s a worker with a defined benefit plan to do? Keep a close eye on the funded status of your plan, consult with a qualified expert about the health of your defined benefit, prepare for the possibility of your employer freezing or dropping your defined benefit plan, consider—regardless of the funded status of your plan—upping the amount you contribute to other retirement plans such as a 401(k) or IRA.

Small employers may have to freeze plans too

Meanwhile, small employers should consider freezing their plans at one extreme or, if nothing else, investing the assets in the plan differently.

Rosenbaum, for instance, said small employers that have a defined benefit pension may need to consider freezing their plans if they still accrue a benefit or develop a plan to terminate the plan. He noted that employers can amortize their underfunding over a seven-year period.

Others, meanwhile, suggest that small employers ought to consider shutting down their defined benefit plan and establishing a 401(k) plan. “Small corporate employers who have not yet established a defined contribution may want to do so, and if they do, they should plan on providing serious employee education,” said Surz.

By contrast, Russell doesn’t think small employers should shut down their pension plans. But they should make every effort to diversify their pool of pension assets appropriately. “When performance of the investments is greatly reduced, the company has to make up for it in larger out-of-pocket pension contributions,” Russell said. Relying on just a few asset classes in the plan might cause the pension portfolio to be too closely correlated with the stock market.”

The pension portfolio is then subject, she said, to the stock market‘s lack of performance. “Using some asset classes uncorrelated to the stock market, to broaden diversification can help with this problem,” Russell said.

In addition, some small employers may want to talk to their actuary about changing their funding formula, Russell said. “There are restrictions on what can be done, so keeping in communication with the actuary and exploring all options is important, especially if the portfolio has not performing as expected,” she said.

In addition, Russell said small employers should review their pension portfolio performance regularly to catch a problem early, and possibly save them some out-of pocket pension contributions.

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Employee Benefits, Featured Contributors, Retirement Planning, Robert PowellTagged

4 ways to stay young like those Taco Bell seniors

March 6, 2013 8:34 amLeave a Comment

It makes for a good commercial but is it in line with reality?

The good commercial, for those who didn’t see it during the Super Bowl on Sunday or on YouTube, was the Taco Bell ad in which Bernie Goldblatt and his buddies sneak out of their retirement home for a wild night on the town.

Over the course of their spree that night, they sneak into a swimming pool; they go disco dancing; one elderly woman has a dalliance in a bathroom stall with a much younger man; and Bernie gets his last name tattooed across his back. The old fogies finish off the night, much like my teenage sons, at Taco Bell before heading back to the Glencobrooke Retirement Home.

You can watch the ad, titled “Viva Young” – 2013 Taco Bell Game Day Commercial here. (Of note, it was Grandparents.com’s favorite commercial from the Super Bowl.)

Now the truth of the matter is that this commercial is far from the truth, or at least far from the truth I know. When my father lived in an assisted living facility several years ago few, if any, of the residents had wild nights on the town such as that in the Taco Bell commercial. In fact, most of the residents were in bed by 7 p.m.

It is true that the residents did take road trips. However, all of these road trips were sponsored events. They would shuffle onto a bus to go on a whale watch, or watch the Pawtucket Red Sox, or grab a quick lunch at Hooters. And no one that I ever met there ever ate spicy food.

Still, the Taco Bell commercial strikes a chord. Who among us doesn’t want to be young at heart? Who among us doesn’t want to recapture a piece of the past, even if only for an evening? Who among us doesn’t want to throw caution to the wind and go wild every now and then?

Well, the answer is that all of us would like go on a spree like Bernie and his friends every now and then. Unfortunately some (or is it many?) of us don’t know what it would take be youthful again, even if means getting heartburn or throwing out your back.

What would it take? Who has the permission slips? Well, here’s what experts say you have to do to stay young in deed and thought.

Change your perspective

Annarose Ingarra-Milch has the main character in her novel, “Lunch with Lucille,” address the concept of youthfulness. Lucille, the nonagenarian, breaks it down to four diamonds or four valuable lessons. Learn more about the book, “Lunch with Lucille,” here.

The first diamond, said Ingarra-Milch, is all about changing our perspective. “If we see ourselves as old, we will act old,” she said. “We will focus on what we can’t do. What we have lost. And as a terrible consequence people will treat us as old folk, stick us in a corner, and ignore us.”

If, however, you change your perspective and see your age as something valuable, then it makes sense that the more years, the more value, Ingarra-Milch said. “The knowledge we have learned over our lifetime, our crystallized intelligence, is a priceless commodity and only gifted to a select few.”


Taco Bell Enlarge Image

Bernie takes a joy ride around the football field on a souped-up scooter.

In other words, how you see yourself is key to how others see and treat you. “If we see ourselves as fun-loving and adventurous, then others will too,” said Ingarra-Milch. “Going forward, think how the nurse will relate to Goldblatt and his crew should she become privy to their nighttime antics?”

Let go of the past

The second diamond is about letting go of the past, said Ingarra-Milch. “It is no secret that we live in a youth-centered culture,” she said. “Hell, we created it. Hide the gray. Get rid of the wrinkles. Look younger and be happy.”

You can certainly try and keep up with that to-do list, but it will be a losing battle. And that in turn will create stress.

The antidote, said Ingarra-Milch, is self-acceptance. “Enjoy where we are now,” she said. “Where ever we are on the adulthood spectrum, carpe diem.”

Her advice: Do new things, learn new ways of doing old things, taste different foods, sip different drinks, and read different genres of books. “We still need to stay open to the smorgasbord of people and their ideas, no matter how kooky they may seem,” she said. “And of course, we must make an effort to be actively involved in what goes on around us—in our own health, our family, our community, and our world.”

Have goals

The third diamond, meanwhile, keeps us looking forward and into the future. “Having goals gives us a target,” said Ingarra-Milch.

To be fair, you don’t have to look down the road 10, 20 or 30 years as you once did. Your goals can be as short term as deciding what you will have for dinner tonight, what shoes you will wear tomorrow, what movie you will see next week, or in Goldblatt’s case, how you will sneak past the nurse’s station when it’s go-time. “Looking to the future allows us to continue moving,” she said. “We keep from getting stagnant. We keep questioning, ‘what else, where else, how else?’”

In the novel, for instance, the main character, Lucille, raises her glass each day at lunch and toasts “Cent’anni,” 100 years in Italian. “It is a goal she wishes for herself and each of her lunch companions,” said Ingarra-Milch. “Well, I figure that if we are looking to live to be 100 years old, there must be a lot of things we want to do before we get there.”

Others, by the way, are of the same opinion. Consider, for instance, the advice of Jim Stovall, author of the best-selling novel “The Ultimate Gift.” “People stay young as long as they have something to do, someone to love, and something to look forward to,” he said. “We stay young as long as we believe our best days are still ahead.”

George Kinder of the Kinder Institute of Life Planning also thinks it’s wise to ask yourself the following questions: What would you do if you had all the money you needed or all the time? What would you do if you had only five to 10 years to live? And, what would you regret not having done if you learned you only had one day left to live?

You might not head out to Taco Bell after asking yourself those questions, but odds are high the answers will help you focus on what’s important to you in your golden years.

Develop a gratitude attitude

In Ingarra-Milch’s novel, Lucille recommends developing a gratitude attitude. The advice is this: Be thankful for what you have no matter how minor, for what you can do or still do, for the people in your life or the people you had in your life, or for whatever goes on in your day. “Each and every day we must look to find what it is we appreciate and then remind ourselves of our good fortune,” said Ingarra-Milch.” This positive outlook, as the song goes, keeps us on the “sunny side of the street” and makes every day a celebration. It is no secret that people are attracted to positive, upbeat people. It is an easy way to keep our old friends close as well as attract new ones.”

Ingarra-Milch said Lucille’s four diamonds are fundamental best practices for keeping a youthful presence. And, she acknowledges that they do take effort and persistence to master. “But we know that, we have lived long enough to know that everything worthwhile takes effort and persistence,” she said. “Changing our perspective, letting go of the past, making new goals, and choosing a positive attitude can turn anyone into a ‘Goldblatt.’”

Hats off to Taco Bell

And for what it’s worth, Ingarra-Milch also praised Taco Bell for airing the Bernie Goldblatt commercial. “Unfortunately, I, like many I suppose, have become accustomed to only seeing seniors in commercials hawking how to pay for their own funeral expenses, discreetly manage their incontinence, and yelling for help after they’ve fallen and can’t get up,” she said.

In fact, Ingarra-Milch said the commercial reminded her of her youth. “I thought back to when I was a teenager and right after Johnny Carson signed off, I would creep past my sleeping mother and out the back door to hang with my friends and be up to ‘no good,’” she said “Way to go Taco Bell for recognizing that age has nothing to do with wanting to have fun, laughing, smiling, playing, sharing time with friends, taking risks, and (still) bucking the system.”

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Current Events, Featured Contributors, Lifestyle, Robert Powell

Retirees and stocks: Sell now or hold on?

March 1, 2013 8:16 amLeave a Comment

If you haven’t asked this question, you will. Is it time to take your chips off the table? With the major stock market indexes close to all-time highs, now seems as good a time as any to walk away from the table, especially if you are back to where you were in 2008.

The answer truly depends on your personal circumstances, but also on who you ask. To be fair, it’s not quite like the old joke about asking five economists for an opinion and getting six answers, but it’s pretty darn close. In fact, the experts we spoke with offered up recommendations ranging from sell everything to do nothing. Here’s a recap of their advice.

Sell, sell, sell

Stephen Chen, the founder of NewRetirement.com, thinks now might be the time for retirees to consider selling. “If someone has remained invested through the downturn, then it probably makes sense for them to sell some of their stocks into this rally and rebalance according to their needs, especially someone around retirement age who has less time to ride market ups and downs,” said Chen.

The caveat, however, is this: Ideally retirees have a good understanding of their minimum retirement income needs and have identified the sources that will guarantee that income (Social Security, pension, annuity, bonds, dividends, drawdown strategy, and the like). “Once retirees have a plan for their core income needs, they can take more risk with their remaining assets,” Chen said. “Investors should be rebalancing their portfolios annually so that if they have a run-up in one portion (equities, for example) they can rebalance to maximize their risk adjusted returns.” Read more at NewRetirement.com.

What the heck are you doing the stock market anyway?

You might not call it the sell-everything approach, but one camp suggests that no matter what the stock market is doing or has done, you shouldn’t be investing in risky assets to fund your retirement, unless of course you’ve already got your future expenses covered with safe, reliable streams of income.

Instead of investing in stocks, this camp suggests that you invest in Treasury Inflation Protected Securities (TIPS), or zero coupon bonds, or income annuities as way to fund your desired standard of living.

To be sure, selling all your stocks all at once to follow this strategy might be a shock to the system. So consider ways to ease into it. Reduce, over time and steadily, the percentage you have in stocks while increasing the percent you have in, best case, inflation-adjusted income-producing assets. Consider, too, reading “Risk Less and Prosper” by Zvi Bodie and Rachelle Taqqu if this approach appeals to you.

See related video: Don’t Risk Your Retirement in the Stock Market.

Try product allocation

Others, meanwhile, say that just because the stock market is at all-time highs doesn’t mean you should take your chips off the table. But they do recommend allocating your assets across products and investments, not just risky assets.

“My fundamental belief is that retirees and pre-retirees should pursue a preset allocation strategy rather than take some chips off the table,” said Garth Bernard of Sharper Financial Group. “Taking chips off the table or changing the asset allocation mix in response to the market situation is de facto ‘market timing’ and it has been demonstrated to be one of the least productive and riskiest approaches to retirement investing.”

Because of the potential length of time spent in retirement and because there is a tendency to drawdown the assets, retirees and near retirees show use a balanced produce allocation with perhaps as much as 40% to 50% in a diversified holding of stocks, said Bernard.

The key to managing assets in or near retirement, according to Bernard, is what he calls the “tossed-salad approach.”

Allocate a portion of the assets to a balanced investment approach, allocate a portion of the assets to an insured-withdrawal approach, and allocate some to insured future guaranteed income such as long dated annuitized payments. “Like a tossed salad with a mix of vegetables of various colors, some that grow above the ground and some that grow below the ground, plus a dash of fruit, such an approach will be good for one’s financial health in retirement,” said Bernard.

Set aside up to three years of living expenses

Others also say the recent gains in the stock market does provide a good excuse for revisiting and rejiggering your investments. But Ross Levin, the founding principal and president Accredited Investors, advocates using what some might call a two-bucket or a best-of-two worlds approach. His recommends setting aside up to three years’ worth of cash in an online saving accounts and then investing the rest in a portfolio where stocks might represent anywhere from 40% to 80% of assets.

This approach, which Levin uses with his clients, “allows us to not be forced to sell during bad markets,” he said.

Levin readily admits that studies have shown that this strategy can be a drag on returns. “But studies don’t consider the client’s emotional responses to selling for cash needs during down markets,” he said.

Not two, but four buckets

Others agree that retirees and pre-retirees ought to consider putting their money into different buckets. In the case of Jason Branning of Branning Wealth Management, it would be four buckets, however.

“Pre-retirees and retirees should be sure they are planning strategically,” he said. “They need to have or create a disciplined retirement plan that carefully divides their goals with solutions that can actually deliver as needed and in expected ways—base expenses matched with base income; discretionary expenses need to be covered by discretionary income sources.”

And retirees should manage various risks in retirement with up to four goal-segmented prioritized funds or buckets, which Branning refers to as “modern retirement theory.”

With that theory, you would have a base fund that covers basic expenses. Social Security, part-time work, an immunized bond portfolio, lifetime annuity stream, and, though least preferred, a reverse mortgage are examples of the sort of income produced from that fund.

You’d also have a contingency fund that would cover potentially catastrophic expenses, a discretionary fund that would cover nonessential expenses, and a legacy fund.

Branning, for the record, is opposed to selling stocks now just because they are up. He noted that the annualized five-year returns for the S&P 500 (SNC:SPX)   (4.37%) and the Dow Jones Industrial Average (DJI:DJIA)   (5.24%) have not been anything to write home about. But pre-retirees and retirees should write this down for future reference.

“Market directions cannot be controlled, and even the best money managers aren’t always correct,” he said. “No one can predict the future; there are simply too many factors outside a retiree’s control. Pre-retirees and retirees should, however, exercise their control through a retirement plan that can navigate the unknowns of market and life.”

For starters, just because the market rises to an all-time high should not automatically signal sell all stocks. “This rise in values does offer retirees the opportunity to rebalance their portfolios and reaffirm or shift their investment policy statements in light of specific income needs but only in the context of their whole retirement plan,” said Branning.

No need to sell

And then there are those who advocate not for two or four buckets or allocating your money across products, but for traditional investment management practices.

“As with many asset allocation decisions, it really depends upon both your ability and willingness to bear risk,” said Bob Johnson, a finance professor at Creighton University. “If you have the ability to bear the risk of equities (that is, if you have a margin of safety in terms of your asset base) and the willingness to bear risk (that is, the mind-set to be able to mentally bear a 20% decline in the market), then given yields in the fixed income market, I wouldn’t significantly change my asset allocation.”

Now when one talks about near retirees, Johnson said people often make the mistake of thinking they have a short time horizon. “But, if someone is 65 years of age, life expectancy for a male is an additional 19 years,” he said. “That is not a short time horizon and moving assets all into a very conservative asset allocation, an investors runs a significant shortfall risk—that they will outlive their assets.”

Johnson is also quick to question whether the stock market has indeed advanced a great deal in the past five years. By some accounts it has, he said. But, a little historical perspective may help.

For instance, the following are the returns on the S&P 500 for the five-, 10-, and 20-year periods ending Dec. 31, 2012:

  • Five-year compound annual growth rate is 1.63%
  • 10-year compound annual growth rate is 7.06%
  • 20-year compound annual growth rate is 8.22%

“Now, the above returns don’t take into account the near 7% the S&P has advanced this January,” Johnson said. “But, I think the lesson is immediacy. It is a behavioral finance tenet that investors tend to overweight the near term past. They see the past month and believe that the market has advanced a great deal—and, for the month it certainly has. But the returns for the past five years on stocks have been abysmal.”

For Johnson, the bottom is this: “I would not dramatically change my asset allocation due to short term moves in the market. An investor should have a target allocation and that allocation shouldn’t change from the target unless life circumstances change. Trying to outguess the market in the short-run is, I believe, a losing proposition for individual investors. In fact, I think it is a losing proposition for most professional investors.”

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Featured Contributors, Investments, Robert Powell

How you can save your Social Security

February 28, 2013 8:29 amLeave a Comment

Lawmakers don’t have a monopoly on how to solve the Social Security crisis. In fact, average Americans also have plenty of creative ways to increase revenue and/or reduce outlays to the Social Security Trust Fund, which come 2033 will be able to pay out about three-quarters of scheduled benefits through 2086.

Case in point is a reader who recently suggested that he would gladly forego his Social Security benefit if in return the government didn’t tax his IRA/401(k) distributions. Absent crunching the numbers, it’s hard to say whether this tactic would have any meaningful effect on the Social Security Trust Fund.

But the suggestion—along with a similar one from a financial adviser (what if annuity investors could get their annuity benefits/payout tax free if they forgo Social Security?)—inspires this thought: Maybe it’s time to create a national suggestion box where Americans can submit their ideas to fix Social Security crisis.

And to jump-start things a bit, I asked some of the nation’s top financial advisers for their in- and out-of-the box ideas. Consider this the start of our national suggestion box.

Disconnect Social Security and Medicare

Diahann Lassus, president of Lassus Wherley, has clients who don’t need the income from Social Security, but do need access to Medicare. “If we disconnected the two systems totally in terms of qualifying maybe some folks who needed access to Medicare but really didn’t need Social Security could make that choice,” she said.

Another option, she said, would be a means test for Social Security that would not automatically disqualify them from Medicare. “Creating a system that wasn’t quite so automatic in terms of how we look at the sign-ups might help but not sure how to quantify how much,” she said.

Having some level of means testing could help in other ways too. “Some people, including myself, view Social Security as insurance,” she said. “Like many types of insurance we pay into over the years (other than life) we don’t necessarily expect to need it or use it in some cases. That isn’t out-of-the box but certainly something we need to consider.”

Another idea: Instead of disconnecting Social Security and Medicare, connect them. Let’s line up Medicare eligibility and Social Security eligibility ages to encourage people to work longer, said Lisa A.K. Kirchenbauer, president of Omega Wealth Management.

Reframing the discussion

Lassus also thinks the nation needs to reframe the discussion about Social Security. “I think the biggest challenge we have is that many who pay into Social Security believe they have a right to get their money back,” she said. “When, in fact, it was designed to help those lower income individuals who didn’t have pensions or other assets. So, we need to reframe expectations around what Social Security really is and what the objective should be for individuals. If we really believe it needs to be for those who don’t have other significant means that creates a very different paradigm than the expectation that we will all receive it regardless of whether we need it.”

Time to change the paradigm

Help people save more so they won’t have to be so dependent on Social Security is another idea. Lassus once testified before the House Subcommittee on Social Security in 1999 and discuss the issue of small businesses having no pensions for their employers. “There are many challenges with Social Security today including the fact that so many corporations have eliminated pensions or converted them to 401(k) plans where individuals are responsible for their own savings,” she said.

Another part of this challenge is in the area of small business. “We still have many small businesses that have no pension plan for their employees even though we have successfully passed legislation to make it more cost effective to do so,” Lassus said. “The bottom line is that I think more people are becoming dependent on Social Security today because of many of these other issues. How can we change this paradigm?”

Get a tax credit

Marc Freedman, president and CEO of Freedman Financial, proposed this tactic. A retirement benefit at full retirement age is $2,513 per month this year or $30,156 year. “If you assume that the spouse gets half that amount or $15,000, that’s $45,000 per year,” he said. “If someone were to elect giving up a $45,000 income stream for life; you’d essentially be asking them to give up about $1.2 million in income benefit. That’s the amount of money you would need to give to an insurance company to produce a $45,000 income stream for two people.”

Now, assume that a $45,000 income stream creates at $10,000 tax liability. “If someone were willing to give up their Social Security income; how about offering a $10,000 tax credit to the individual,” he said. “The Government makes net $35,000 per year on the deal and the tax payer gets to save $10,000 against other taxable income.”

Education required

Part of the problem with Social Security is that more people than ever before are collecting and many of those beneficiaries are living longer than ever before. And Louis Barajas, a financial adviser and author of five books, thinks a little education about this fact could go a long way. “Educate the public around the original historical reasons and demographics of the times for establishing Social Security,” he said. “Life expectancy, birthrates, health-care costs are dramatically different and Social Security needs to be adjusted to reflect these changes.”

For instance, in 1940, the average life expectancy at age 65 (i.e., the number of years a person could be expected to receive unreduced Social Security retirement benefits) was 12.7 for men and 14.7. By contrast, the average life expectancy at age 65 was 17.6 for men and 20.3 for women in 2009. Not only are older Americans living longer, there are more of them since Social Security became the law of the land. In 1940, for instance, there were just 9 million Americans age 65 and older. In 2010, there were 40 million Americans age 65 and older.

Read about life expectancy for Social Security from the SSA.

And read about life expectancy from the Centers for Disease Control.

Mostly inside-the-box suggestions

Right now, Uncle Sam limits the amount of earnings subject to taxation at $113,700. But some, including Theodore Sarenski of Blue Ocean Strategic Capital, recommend removing what’s called the contribution and benefit base. “I, for one, would not mind paying on a higher limit than the 113,700 while I am still working and have the ability to pay,” he said. “This would fix most of the problem. A rise (in the full retirement age, or FRA) to 68 and 69 for those turning that age 45 years from now would fix the rest.”

Others also think the FRA must be raised.

“Mostly I’m focused on increasing the age of full retirement, as that has been the biggest flaw in the stability of the plan in my opinion,” said Sheryl Garrett, the founder of The Garrett Planning Network. ‘However, unless we convert the current retirement income stream from Social Security back to the “what if I live too long” social insurance backstop it was when enacted, the tax (income generation) burden is too much for our demographics to absorb.”

Her suggestion: The FRA must be extended for all those workers currently age 40 to age 60. “FRA would be age 70, with drastically reduced benefits available at 62,” she said. “This will be hard on the older workers and those hoping to retire at an earlier age, but for the younger end of this cohort, they have the time to make adjustments and many likely sense that a change of some sort is coming and they would rather know what to count on.”

For workers who are current age 20 to 39, FRA would begin at 75, with drastically reduced benefits available at age 65, she said.

And third, for workers or people who are under 20, Garrett suggests that they not be in the current Social Security program. Rather, they would make a mandatory contribution to an IRA of exactly the amount the employee and employer both contribute to the Social Security retirement fund on behalf of the employee.

Other fixes? “Have 535 people in Washington (Senators and Representatives) be subject to Social Security and reduce their pensions,” said Sarenski said. “They might be more sensitive to the issue.”

Plus, Sarenski suggests eliminating Social Security’s COLA for future retirees. “Most other pension or annuity payments do not include COLA,” he said.

And Sarenski recommends taxing high income retirees at a greater amount and use that excess tax for Social Security benefits only. Plus, he wants Uncle Sam to encourage more savings by not taxing any interest or dividends below a limit such as 2,000 per year of unearned income.

The box we’re in

The other point of view, however, is this: The reader who volunteered to forego Social Security to get tax-free distributions from a 401(k) or IRA may be thinking out of the box. “But the box we’re in is of our own making, and (the reader’s suggestion) exposes this reality,” said Don St. Clair, a financial adviser. “He’s essentially suggesting that one part of government (Social Security) balance its budget by forcing the other part into greater deficit (or smaller surplus) at that time.”

 

 

“Have 535 people in Washington be subject to Social Security and reduce their pensions. They might be more sensitive to the issue.”

 

 

Theodore SarenskiBlue Ocean Strategic Capital

From his perspective, St. Clair said the only reason we’re even having this Social Security-needs-saving-conversation is “because we’ve tied our shoes together before running the race.”

According to St. Clair, the real issue is this: There are fewer working-age people today (three) than there were in 1950 (16), and there will be fewer still (two) working-age people in 2030 supporting each Social Security recipient.

“This is a real economic constraint, but it is not a monetary constraint,” he said. “It’s absolutely the case that we’re headed from a world of three workers for every one recipient to a world of two workers for every one recipient.”

How real, limited resources (goods and services) get divided up in the future will be, as it is now, determined by some political process at that time—facilitated by taxing and government spending decisions at that time.

“If at that time we decide that more resources should go to the working, and fewer to the non-working—or vice versa—then we will decide at that time based on the real resources available to be divvied up at that time,” he said. “The irony is that because we think this is a monetary issue, subject to some imaginary and arbitrary monetary constraint, we’ve got policies today that take away from that future generation of producers’ ability to produce in that future.”

We are, said St. Clair, literally starving our future working-age population by not investing in them, and the infrastructure that will be ever more necessary as there become fewer and fewer of them providing for themselves, their children, and their parents.

Said St. Clair: “Twenty-two million people looking for full time work, $2.2 trillion of crumbling infrastructure, and we’re unwilling to untie our shoes because we mistake limited—human and real—resources for unlimited—monetary—resources. The carpenter can run out of 2x4s (timber), he cannot run out of inches. Somebody needs to save Social Security from its saviors. You don’t need a healthy and productive trust fund, you need a healthy and productive workforce.”

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Featured Contributors, Robert Powell, Social Security

Four simple steps to the complete retirement

February 18, 2013 5:32 pmLeave a Comment

Sometimes, it’s what the teacher learns from his students, rather than the other way around.

I’ll explain. I’m currently teaching an online course at Boston University about retirement. The students are working professionals from around the world, including Australia. Some are researchers, some financial advisers and some are working in the home office of big financial firms.

More often than not, I’m finding that I learn a thing or two about retirement that can be more than a little helpful to my readers. Here’s an example: Four simple but essential steps to creating the complete retirement plan.

Getting the right mix of assets, products and withdrawal strategy

Advisers are increasingly using software programs such as MoneyGuidePro and Income Discovery rather than pencil, paper and calculator to build retirement-income plans. And with good reason. These and other sophisticated software programs are taking much of the guesswork out of retirement planning.

With Income Discovery, for instance, advisers such as Rick Fine of Sensible Financial Planning will enter information about your three main types of capital: human (your earnings from work), social (Social Security) and financial capital (your taxable and tax-deferred accounts) into the program. In addition, advisers will enter information about your current and future expenses.

Fine also enters guidelines about what’s called a maturity-matched portfolio, a portfolio typically made up of bonds—in many cases Treasury Inflation Protected Securities or TIPS—that mature to meet future expenses. (In other, words they are using bond ladders, a way to make sure that you are matching certain assets against certain future liabilities.)

Part of this exercise also involves assessing whether you are willing to purchase income annuities to make sure your future expenses are covered, as well as getting a handle on your tolerance for risk, expected rates of return and the like.

Add that all together and the software will figure out the optimal combination of annuities for you to buy, how much to invest in your maturity-matched portfolio, and a systematic withdrawal plan (SWP) that will lead to a successful outcome, said Fine.

According to Fine, the cash flows generated are for the least successful of all possible successful outcomes. What’s more, the program also shows the failure rate, annuity purchases as percent of total assets, and maturity-matched portfolio as a percent of income.

For the maturity-matched portion of your portfolio, the Income Discovery program actually shows specific bond purchases right down to the individual CUSIP number of the security, the month and year of maturity, the number of bonds purchased, and total value, “so that we can actually implement the plan by requesting specific bonds through YieldQuest, or some similar company,” Fine said.

Manish Malhotra, the brainchild behind Income Discovery and a MarketWatch RetireMentor , said the maturity-matched portfolio can be used to create a cash flow to match any type of expenses in retirement. “Its simplest use is to fill in for the cash flow that Social Security could have provided, if not deferred. By building a TIPS based ladder in such a case, one would be able to get the U.S. Government guaranteed cash flow for part of one’s income, while still taking advantage of the higher Social Security benefit amount obtained on deferral of the claim.

Another use of the ladder, he said, is to provide cash flow to cover either all expenses or essential expenses if the investor is willing to reduce nonessential expenses under unfavorable market conditions. “The period of coverage would depend on the investor’s age, risk attitude and current bond yields,” he said. “A conservative investor may decide to lock in 10 to 15 years of expenses, while an investor with higher risk profile may lock in only three years of expenses. Low yields, like current yields, will further reduce the period length. “

Read “Bond Ladder—A Source of Certain Cash Flow,” an article on Income Discovery’s website which explains the bond ladder and its advantages over holding a bond-based mutual fund for generating the desired cash flow.

The lesson? Gone are the days when you can just wing it in retirement. Today, more than ever before, you have an opportunity to create the most optimized stream of income in retirement. Don’t leave your precious hard-earned money on the table. Take advantage of the software available and the experts who get retirement-income planning.

Getting retirement expenses right

Getting a handle on what your expenses will be in retirement is a big part of getting your retirement-income plan right. But according to Fine that is sometimes harder than it sounds.

“We sometimes have difficulty obtaining a ‘current’ consumption budget from clients who do not track their expenses very well (or not at all),” he said. “Since we do consumption-based planning, we need to know what clients spend in a typical year. It’s not so much that they don’t want to give us the information, it is more that they are unable to account for a lot of their expenses, so whatever they give us will most likely be wildly off.”

In some cases, Fine reports having to “back into” annual consumption spending. “Although not as accurate as we would like, we do this by asking them how much they earned last year, and how much they saved to various accounts,” he said. “But if we have a base level knowledge of what came in and what was saved, we can form a rough estimate of what was spent.”

In the main, however, Fine said, more people than he would have expected are able to account for a year’s worth of spending. “Often, they do the brute force method of poring over their credit card and checking account statements, but they get it done,” he said. “Others are more sophisticated, using Quicken or mint.com to track spending.

Whatever you do or don’t do, the lesson here is clear: If you don’t know what your expenses are or will be in retirement, how will you ever know how much income you’ll need in retirement?

Maximize your income

Besides getting a handle on your expenses, you’ll need to figure out ways to maximize and optimize your income in retirement. Now, the most common ways to do this are well known: You can, for instance, keep working, get another job at a higher salary, or ask your non-working spouse to re-enter the workforce.

But in some cases, if you have this option, consider buying a higher pension benefit while you are still employed. Public employees who have a defined benefit pension plan might have this option, for instance. “If you live long enough, it eventually pays off,” said Fine.

Others agree. “I think purchasing pension credit is the best way—besides delaying Social Security until age 70—to immunize your income to cover fixed expenses if between Social Security and pension more lifetime income is needed,” said Betty Meredith, the director of education and research for the International Foundation for Retirement Education.

According to Meredith, buying pension credit provides funds managed by the same level of professionals who manage insurance and mutual fund companies and an institutionally priced annuity with a savings of probably at least one-third since marketing costs are nonexistent which means more income in their pocket over time.

The lesson? In retirement, when every bit of income is precious, look for ways to create the most amount of income where and when possible.

Reaching an agreement

One of the big problems awaiting couples on the verge of or even in retirement is this: They seldom have talked about what they want to do in retirement, about their goals, travel plans, and the like. So to solve this problem, David Evensky of Evensky & Katz uses MoneyGuidePro (MGP), which is a goals-based capital needs analysis software.

“MGP is quite savvy in understanding human behavior and the problems advisers must deal with in truly assessing our client’s objectives,” Evensky said.

For instance, MGP has created some cards that advisers use with their clients. The cards have certain goals listed on them and pictures to help those who visualize concepts easier than hearing them. These cards have typical retirement goals such as travel, gifts/donations, college, home improvement, major purchase, and basic living expenses.

“We have each spouse take their cards and prioritize them,” Evensky said. “We then help each one discuss together why they made a choice and what that means to them. Very often just having this conversation honestly and openly really speeds up or planning process and helps each adviser and team understand the goals and objectives most important.”

“Maximizing returns is not always the priority,” said Evensky.

Rather, he said the lesson is this: Giving people the peace of mind that they are on the path to what’s most important to them in retirement and maximizing the probability that they will be able to realize these goals is the priority.

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Featured Contributors, Financial Planning, Investments, Retirement Income, Retirement Planning, Robert Powell