Pension defaults have pushed seniors back to work.
This is an excerpt from the February 2010 issue of Global Asset Strategist.
In the US, most workers no longer have a pension, so they are herded into company sponsored retirement arrangements. These usually consist of a few, equally terrible options. The majority of workers can choose between a couple of different stock funds, or maybe a bond option. Plans that offer both are considered “diversified,” as if these are the only two asset classes.
These arrangements are “one-size-fits all,” which means they fit most workers poorly. Ideally, consumers would consult a competent financial advisor who could tailor an individual retirement plan. Unfortunately, it can be difficult to get this level of personal service unless you have a large amount of money to invest.
Rarely are employees given the opportunity to buy emerging market shares, precious metals, or other types of investments. This omission is no accident. Bloomberg TV’s June 2008 exposé found that mutual funds “pay to play,” meaning that they give kickbacks to companies who enroll employees in their retirement plans. These funds are often below-average performers that savvy investors would never choose for themselves. Bloomberg found that many 401(k) plans have punitive, hidden fees that can eat up half the balance over 30 years. It turns out there is a “miracle” of compounding, but the mutual funds are the ones benefiting, not you.
Even more egregious, many companies have opt-out policies, where workers are automatically enrolled in retirement plans. Once started, these arrangements are rarely liquidated since there is a steep tax penalty for selling early. My husband was briefly ensnared by his employer’s default plan, and he had to call customer service in India repeatedly in order to stop unwanted deductions from his paycheck.
Opt-out plans are often lauded in the US media as a necessary step to protect people from insufficient savings in old age. Since this was originally the function of Social Security, I wonder if this is a tacit admission that SS will disappear or become grossly inadequate in the next decade. It’s definitely part of the trend toward a “nanny state” where adults give up large chunks of freedom in order to be shielded from the consequences of their own behavior.
I doubt politicians are pushing this policy due to their concern with the well-being of their constituents. I believe this is a ploy to prop up the stock market to make the economy look good, and curry favor with their masters on Wall Street. As the Baby Boomers retire and start liquidating their stock plans, the demand for stocks must be replaced or the market will fall.
Your country may also allow you to invest money for retirement and defer paying taxes until later. This seems beneficial, unless tax rates rise sharply, inflation skyrockets or you are simply financially successful, pushing you into a higher tax bracket.
In addition, putting your money into a government plan locks you into a set of rules – things like limits, maximum investments, and permissible investment classes. Lose track of changing regulations, and fees, fines, and other negative consequences can result. Once you give control of your money to another, you may not like the results.
I agree that it’s smart to build your own nest egg, and not trust that a government or company pension will support you. After all, institutions frequently renege on promises, as United Airlines did during its bankruptcy reorganization in 2005.
Personally, I am fearful that one of my elderly relatives will have his General Motors pension reduced or eliminated in the future, if the US government is unwilling or unable to bail out the plan. This situation was unthinkable when he retired over 20 years ago.
Government defaults are even more devastating, as workers rarely expect them. During the Russian crisis of 1998, the Yeltsin Administration stopped paying pensions and people were forced to scrounge for potatoes or barter for necessities.
While short term emergencies like this pass, in Western countries, there is a demographic problem with all pension plans. Kotlikoff and Burns wrote an excellent, yet scary book on this subject called The Coming Generational Storm: What You Need to Know about America’s Economic Future. The trend toward smaller families means not only fewer children to support parents in their senior years, but that a tiny crop of current workers will be forced to support a much larger group of retirees. Like an inverted pyramid, the scheme will eventually collapse of its own weight.
With pensions looking more shaky by the day, How can you protect yourself?
1. Invest in yourself - Take care of your health, learn valuable skills and put money into your business, if you have one.
2. Pay down debt – This has a guaranteed return on investment. If your credit card has a 15% interest rate, your payments yield 15%. In addition, if your house or other assets are paid for, you won’t lose them to foreclosure.
3. Live below your means - This will give you a savings cushion in case your pension is cut.
4. Avoid most real estate – Unless you are assured of an income stream through renting the property, it’s probably a bad deal.
5. Diversify, diversify, diversify - Realize that most investments today are risky or don’t keep up with the real inflation rate. If you must buy paper instruments like stocks, diversify by geographic area, industry, size, dividend payout, etc. Don’t buy any assets you don’t understand, either.
6. Be skeptical of your financial advisor - While most are well meaning, many will be pressured by their firm to sell certain products that benefit their bottom line more than your portfolio. (Bret has a great post on his experience here.) Ask questions and decline anything that doesn’t make sense for your individual situation.
7. Save in metals not just currency – I recommend having an emergency fund of 3 months of expenses, minimum. However, most currencies around the world are losing value at a scary rate as governments print too much. Instead of keeping a lot of cash, I have much of my savings in bullion form. As silver has more than tripled over the past 9 years and gold has increased more than 5 times, my savings are vastly outpacing price inflation. If I need cash in the future, I can always sell my precious metals back to coin dealers.
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My mom invests in gold jewelries, does that count? She said, it feels good wearing them and at the same time when you need money you can sell them anytime. Am getting older, I havent thought about these stuff, well better later than never. Thanks for sharing.
Hi Kathrynne, that depends on a couple of things. If this is high carat jewelry (high percentage of gold vs. fillers like copper) and she didn’t pay a high markup then it can be a good investment. In the US, too many people buy “gold” jewelry with little gold in it and pay two or three times what it’s worth. Then when they go to sell it back they are disappointed. I know in India women often wear the family’s savings account as jewelry though, so it’s different in other countries. I’m glad you found it helpful!
The idea that pension plans, Social Security, and maybe even 401 (k)’s (or (b)’s may not be there in the future is really scary. However, I like how you listed some good points about diversifying, especially investing in bullion. It’s something I’m not invested in, but my husband and I have kept an eye on the price of silver and gold and we have seen a huge inflation in their price. This year is the year I get serious about saving for retirement and opening up a 403 (b), however I need to also look into other options rather than just investing in paper.
Hi Little House, it is very scary about the pensions and Social Security. I think it’s very unlikely that 401(k) plans will be seized by the government. However, I fear that US stock market gains will not keep up with inflation, so retirement plans may buy very little in the future.
I’m glad you have an open mind about bullion. I recommend making sure you are actually buying metal though. Precious metal ETFs may not actually hold the bullion they claim to. Certificate programs are generally unallocated, which means that you have a claim against the financial institution for the worth of your certificate. An allocated investment means the institution is holding actual bars of metal for you.
[...] out Retirement Pitfalls over at [...]
I think taking care of your health is key. What good is being reitired if you can’t enjoy it? And, what good is saving for retirement if you don’t live to see it?
Another key, which you covered well, is owning real assets. Financial assets, such as stocks, bonds and money markets, aren’t protected from inflation. I like real estate much better than precious metals, because it can produce cash flow. The problem is that people made some wacky investments and screwed up the market. As you said, if it doesn’t produce cash flow, it’s a bad investment.
Hi Bret, I totally agree about health. All the money in the world will do you no good if you are too sick to enjoy it.
As far as real estate goes, there is plenty of blame to go around. Builders put up too many houses, borrowers lied on their loan applications, assessors inflated values, banks gave out crazy mortgages to anyone with a pulse even illegal immigrants, and of course, the Fed kept interest rates too low for too long which created the fuel for the whole thing.
I agree that real estate can create cash flow while metals don’t. However, you have to be careful that your real estate asset isn’t losing value because you may need to sell it unexpectedly. On the other hand, precious metals have increased in price almost every year for the last decade, so if I need money, I can sell some at a hefty profit.
[...] promises, so you need to make alternative retirement plans. I discussed this subject recently in Retirement Pitfalls. AKPC_IDS += "850,";Popularity: unranked [...]
[...] In the area of more general advice, Angela shares the wisdom she would give to her younger self if she could. Karen tipped me off to a great video by Steve Jobs where he reminds us to avoid the trap of thinking we have something to lose, and never taking a chance on our dreams. Len grounds us by pointing out that college can be a waste of money if you don’t have a plan, which I expand on in Is College Worth It? Little House (her super secret identity) gives us a wake up call about planning for retirement, which dovetails well with my ideas to protect yourself in Retirement Pitfalls. [...]
Unemployed older Americans who’re unhappily accepting early retirement usually start drawing on their Social Security advantages early, which affects both their income and the rest of the economy. The later retirees wait to draw Social Security, the higher their monthly income checks will probably be, usually in the range of an extra 6-7% for each year between ages 62-70 that they wait.
Welcome to Live Richly, SSH! While it’s true that you make more by waiting, as I understand it, you have to collect SS into your 90s for it to matter. That’s why my parents started taking it earlier.
Also, the system is insolvent even if the US government doesn’t admit it. We are already seeing denial of inflation so that seniors don’t get a cost of living adjustment. Since I expect SS to disappear or be inflated to be worth almost nothing, I encourage people to take it now while they still get something.