With the first of the Baby Boom generation having reached the traditional retirement age of sixty-five in 2011, the number of retirement age individuals is expected to grow by 10,000 each day for the next fifteen years.
By 2030, when the last of the Baby Boomers will have turned sixty-five, an estimated 18% of the US population, or sixty-five million Americans, will have reached retirement age.
Up In Smoke provides a startling examination of the status of each of our nation’s retirement systems and explores how a pending retirement crisis could threaten the US economy. Those nearing retirement, as well as generations to follow will increasingly be seeking an understanding of how we arrived at this difficult place and what hope lies ahead. Up In Smoke provides those insights.
Richard DeProspo is an investment professional with over 30 years’ experience advising state and local governments throughout the country. An expert on public employee pension management, he has lectured widely on the topic and advised numerous municipalities and public pension funds on the proper management of employee retirement liabilities.
Mr. DeProspo holds B. A. and M.B.A. degrees from the State University of New York. Up In Smoke in his first non-fiction work.
With the leading edge of the baby boom generation reaching 65, we are just now beginning to see the effect of America's transition from traditional corporate sponsored retirement plans, to defined contribution savings accounts. Today, of those eligible for 401(k) and IRA savings accounts, only 50% have actually funded them. Of those that have and are now approaching retirement (age 55-64) the median balance is just $111,000. But the question that now arises is could the 401(k), even under the best of circumstances, produce the savings necessary to fund a comfortable retirement? The answer might surprise you.
Up in Smoke
Delaying participation in a 401(k) is one of the most likely reasons why the median balance of those approaching retirement age with 401(k) accounts is only $111,000191, rather than the hypothetical optimal balance of one million dollars discussed above. In our modelling, the employee who delayed funding his or her 401(k) account for ten years, even if funding thereafter was at the maximum allowed by law, was consistent throughout the remaining term, with optimal investment of the balances, would still see the balance of this retirement account fall by half and provide funding at the median income level to only age seventy-four. Missing the first ten years of investment has about the same impact on retirement funding as having contributed just one-half of the IRS maximum over the entire 30-year period.
All too similar is the effect of having changed investment elections following the devastating losses following the 2007–2008 financial crisis. Investors who moved their investments to cash or money market funds in early 2008, will have seen the accumulations of their accounts suffer greatly, compared to our base case. In this instance our retiree, drawing median income would see his retirement account last until age seventy-five, nearly ten years earlier than if he had remained fully invested.
These results exclude any amounts funded under 401(k) plans by way of employer match, as well as those few extraordinary investors who may have “beaten the market” by individual stock selection, by timing the market or by investing in company stock of those select companies that were takeover candidates or otherwise outperformed the market. Leaving these outliers aside, however, the modelling of the hypothetical 401(k) accounts above tells us much about why actual investor balances in 401(k), 403(b), 457 and IRA accounts differ so dramatically from the theoretical possibilities of these accounts. It also helps us address the troubling question of why only half of people to whom a 401(k) is available have opted to fund it. And why for those who have funded 401(k) accounts, the median balance is only $59,000.
But it also helps answer the question of whether the 401(k) account, as designed under the Revenue Act of 1978 could ever have worked, given its seemingly obvious design flaws of voluntary participation, employee self-directed investment and the lack of a prudent employer default option. But more importantly, did it require nothing less than optimal performance under all variables and conditions that could influence its results? Dual-income households will certainly improve on the results over households with one working member and one retirement account, but is it really reasonable to design a retirement system that requires a dual-income household to produce adequate retirement savings? This is especially of concern, given that the percentage of American households reporting as dual-income, despite gains over the past thirty years, make up only about one-third of total households192.
Here’s what we do know. First, failing to participate in the funding of a 401(k) from the earliest possible age is devastating in its impact on the ultimate funding of the account, as is failing to fund the account in each and every year or at the maximum level. Second, 401(k) retirement funding is highly subject to investment selection, something that by its very nature cannot be known with forethought. Third, during retirement, inflation and the return on unexpended balances, two other uncertainties, can have a dramatic impact on the account’s ability to fund retirement expenses.
We have also learned, though, that even under the best of all possible circumstances with optimal foresight and dedication, the 401(k) by itself can only sustain an income of moderate means, roughly $3,000 per month, and then, to a point of only twenty years into a typical retirement. That would argue that the 401(k), by all measures, is a dismal failure as a retirement plan of broad application for Americans.