A recent survey on retirement readiness from the American Academy of Actuaries concluded that only one third of respondents between 18 and 64 know how long their assets will last post-employment. Still, more than half of them are confident in their retirement plans.
Should they be?
Using recent mortality estimates, the average 65-year-old man can expect to live until 84, while a woman of the same age should live until about 86. If we average these numbers, we’re looking at about 20 years of retirement to fund. And the mean American household income for those aged 60 to 64 is $50,000 according to the Bureau of Labor Statistics. So, funding roughly 20 years of $50,000 is the challenge.
For years, many advisers have implemented what is often referred to as the “three-legged stool” approach to retirement planning — a pension, Social Security, and personal savings. Let’s take a quick look at each leg.
U.S. retirement assets hit $26.6 trillion in the second quarter of this year, according to the most recent research from the Investment Company Institute. Two decades ago, defined benefit assets exceeded defined contribution assets. That’s no longer the case — pension assets today total around $8.7 trillion, while IRA and 401(k) assets combined are $15.9 trillion.
In 1975, 55 percent of American workers had a pension. By 2017, this number had fallen to roughly 25 percent. For those 25 percent, the average annual benefit is somewhere around $20,000. However, it’s estimated that defined benefit plans — public and private combined — are underfunded by $3 trillion dollars. The first leg of the stool might not be there for many Americans 20 or 30 years down the road.
Despite similar concerns about the sustainability of Social Security, millions of retirees rely heavily on it today. Last year, the Social Security Administration paid benefits of nearly $900 billion to over 53 million Americans, an average annual income just under $17,000. Estimates of how underfunded the system is vary, but many projections show Social Security funds running dry by 2035.
Happily, defined contribution assets have been growing steadily. Among those families that have managed to save using vehicles like a 401(k), the average account balance is around $93,000. The median account balance, however, is just $26,700.
Worse, one in every three eligible participants has saved nothing. According to the U.S. Bureau of Economic Analysis, in July 1967 the personal savings rate was 12.5 percent. In June 2017, it fell to 3.8 percent — the exact inverse of what has happened with Social Security contributions. Many people may not be saving enough, particularly those without a pension.
Defined contribution plans present another problem in that they place a large onus on participants to do everything themselves. In my experience, plan participants don’t want to do it themselves. They want answers to four questions: 1. How much do I save? 2. How long should I save? 3. How should I invest? 4. What income will I get? But they want someone to do it for them.
Fortunately, many innovations in the defined-contribution-plan space assist with these problems; for example, auto-enrollment and auto-escalation for choosing the contribution rate. Qualified default investment alternatives (QDIAs) — such as picking an appropriate target date fund to automatically invest in —or managed account options help to ease the burden of investment decision-making as well.
Unfortunately, most research shows that the returns in defined contribution plans have not kept up with the performance of professionally managed pensions, trailing by 0.5 percent to 1.0 percent per year.
The average 401(k) account balance for those in the 60-to-65 age bracket is $197,000. While double the overall average account, even if fully annuitized this balance would only generate an income of $8,000 a year. Defined contribution savings will not match the retirement income generated through traditional defined benefit plans or Social Security for most participants.
Hybrid plans, which share some elements of defined contribution and defined benefit structures, can solve some of these problems, although they have not been widely adopted. For beneficiaries, these plans provide a lifetime monthly check in retirement instead of a pool of assets and the benefits of professional investment management, such as low fees, economies of scale, and access to the illiquidity premium. For plan sponsors, they have the advantage of some sharing of market risk across stakeholders, and improved cost predictability.
Blackstone Group president Tony James and labor economist Teresa Ghilarducci recently published a book titled Rescuing Retirement, which introduces a federal proposal that has many of these features. But a similar model has already existed in the public sector for nearly 70 years. Although I’m clearly talking my own book, this model is the Texas Municipal Retirement System, and perhaps, for once, the sleepy public sector can serve as prototype for the private sector, helping to prop up an otherwise wobbly stool before its other legs come off.