Alicia H Munnell (Peter F. Drucker Professor of Management Sciences at Boston College, and director of the Center for Retirement Research at Boston College) gave a presentation with the title of this blog: The Big Picture. She has written extensively on income in retirement. Some of her major points include the following:
- More than one-half of today’s workers will not be able to maintain their current lifestyle in retirement. Why not?
- People will live longer.
- In spite of this increasing life span, people will work only a “little” longer before retiring—thus increasing their retirement life span.
- Health care costs are increasing. The increasing cost of care will be coupled with increased cost of health insurance—both private insurance through the Affordable Health Care Act and through Medicare Part B increases. In 1980, Part B Medicare premium was 6.8% of the Social Security benefit; in 2030 it is estimated to be 19.4%.
- Interest rates are at historic lows; lower rates reduce the amount of income generated from personal savings.\
- Retirement income has historically come from a combination of a) Social Security benefits, b) pension plans (either defined benefit or defined contribution), and c) individual savings. Let’s examine each separately.
- In 1985, Social Security benefits represented 42% of pre-retirement earnings. After Part B Medicare costs, the proportion decreased to 40%. Benefits were not taxable at that time so there was no further erosion due to income taxes. By 2030, those proportions are estimated to be 36% replacement before Medicare and income taxes; 32% after Part B Medicare expense, and 30% after Medicare and income taxes. Note that these percentages represent current replacement rates and do not include any potential changes to remedy the Medicare shortages currently under discussion.
- We live in a DC (defined contribution) or 401(k) world. The older DB (defined benefit) or pension plan is fast disappearing. 401(k)s limit the employer obligation only to offer contribution of funds to a retirement plan. The acceptance—and performance—of the plan is shifted to the employee from the employer. Here’s where we stand:
- Employees who don’t join the plan—21%
- Employees who contribute less than 6% of their pay—53%
- Plans with high asset fees—54%
- Plans losing assets through “leakage” (i.e. cash outs, hardship withdrawals, post 59 ½ penalty free withdrawals, loans, etc.)—25%Note: This leakage impact over the life of the plan can reduce the ending amount at retirement by as much as 25%.
- Retirees who don’t have a systematic plan for withdrawing assets in retirement—99% How much (and when) should withdrawals be made from a retirement plan? Too much too soon and the retiree can run out of money; too little too late and IRS required minimum distributions can have significant income tax and Medicare Part B premium impact.
- Individual savings (or the lack thereof) are a topic for a separate writing; they warrant a much greater discussion which we will examine later.
- So what should a pre-retiree do?
- Work longer. A longer working career has the dual advantage of allowing retirement savings to grow and reducing the time during which retirement assets are needed.
- Save more. Savings should be increased preferably through a systematic plan (such as a 401(k)) or a periodic contribution to a savings account.
- Consider non-traditional sources of retirement income. There are two primary assets for most employees today: their 401(k), and their home. Tapping the home asset is a complex topic—another one that will be addressed in a separate writing. Home assets should be used only after careful analysis and with a full understanding of all their ramifications.
