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Retirement Savings Crisis

I hate to be the bearer of even more bad news but we have a serious crisis that started years ago and is only getting worse and that is the level of retirement savings in this country.  The current economic crisis is making a bad situation extremely worse.  Retirement savings are contracting as a result of people living longer, destruction of wealth (401ks and home values), and never ending increases in health care costs.  The condition of the social security system does not even enter into this crisis.

Retirees have relied on a three-legged stool for retirement savings: 1) private pensions; 2) social security and 3) personal savings.  This three-legged stool has become very unstable for near retirees and future generations.  The National Retirement Risk Index (NRRI), developed by the Center of Retirement Research at Boston College,  measures the percentage of working-age households that are at risk of being unable to maintain their pre-retirement standard of living in retirement.  The NRRI has determined that almost 45% of households are “at risk” of not having enough retirement savings to maintain their living standards in retirement.  The percentage of households “at risk” jumped to 61% when the health care costs were included in the NRRI.

Private Pensions

Less than half of the private sector workforce, ages 25-64, participates in an employee-sponsored retirement plan.  Those who do participate in employee-sponsored plans encounter much different coverage than in the past.  In the 1980’s, employers started to move away from the traditional defined benefit pensions that paid an retirement annuity based on years of service and age.  Today, most workers who participate in employer-sponsored plans have what are known as defined contribution plans – typically a 401k.  This change in pension coverage has shifted the burden of investment risk from the employer to the worker.

This sounded good: employers can lower the costs and workers can increase their wealth in the market.  But the reality is that the stock and bond markets don’t always increase and are prone to fluctuations and periods of great volatility – as we are finding out today.  People have lost $2 trillion of retirement savings and the market situation is not getting any better.  It will take many years to recoup these losses and many people don’t have the time to “ride out the storm”.

But even before the financial crisis, people had not saved enough money for retirement.  In 2004, Federal Reserve’s Survey of Consumer Finance reported that a typical household close to retirement (age 55-64) had on average $60,000 in a 401k or IRA.  The situation for younger generations is no better and is probably worse.

Social Security

Social security benefits “leg” will become shorter and not because of the condition of the social security system:

Link

At any given retirement age, Social Security benefits will replace a smaller fraction of pre-retirement earnings than in the past for three reasons.  First, the increase in the Full Retirement Age from 65 to 67 is equivalent to an across-the-board cut.  Second, premiums for Medicare Part B and for the new Part D drug benefit, which are automatically deducted from Social Security benefits, are slated to increase sharply due to rising health care costs.  Finally, Social Security benefits will be taxed more under the personal income tax, as the exemption amounts in the tax code are not indexed to inflation, so taxation will move further down the income distribution [meaning more fixed income people will be paying income tax on social security benefits].

Personal Savings

Today’s news sounded promising because households have saved more over last several month.  But are people really socking money away or are people just paying off more debt (which is good).  Household wealth, for most people, has not increased significantly over past five years and in fact may have declined rapidly as a result of the collapse in home values.  Many people had large portions of retirement savings tied up in the equity of their homes but this source of savings has been devastated by this crisis.  Personal savings for retirement may be non-existent for most people.

So, where does this leave us?  The situation is very bleak.  Our retirement savings system has assumed too much investment risk.  Many families’ standard of living will be dramatically reduced as a result of this increased risk.  But this risk is only part of the problem.  The other major problem is health care costs.  Health care costs will continue to drain retirement savings and tarnish our “golden years”.

The questions for us are: is the decrease in the standard of living for many retired families acceptable to us and if not acceptable, what are we going to do about it?