Simply Junior

Retirement Risks

If you’re one of the “Baby Boomers,” you’re probably giving serious thought to retiring, if you haven’t already retired – and if you have already retired, you may be wondering if you’re going to be able to afford to stay retired.

Today’s economic crisis complicates the situation considerably by increasing the following retirement related risks:

1. Average Life Expectancy Has Increased

People are living longer than their parents’ generation. For example, in 1970 a 60 year old white male had a life expectancy of an additional 16.2 years; however, by 2008 his life expectancy had grown to 20 years.

So how is the Boomer going to afford retirement during those bonus 3.8 years? There are only a few likely answers to that question:

Increase current savings Work longer Move in with children or other family members Get by with a lower standard of living
2. Health Care Costs Keep Rising

Predicting and planning for ways to cover one’s health care costs are some of the most difficult, largely because requirements are so individualistic with requirements varying substantially from one person to another. Long-term care needs are even more difficult to predict and arrange adequate funding.

Health care costs have grown at a rate greater than 5% (inflation adjusted) for the past 15 years – and that is higher than the growth in family income. Medicare costs are expected to rise at a comparable rate.

3. Government Actions May Impact Retirement Benefits & Benefit Programs

It is well known that the costs associated with the major social programs (e.g., Social Security, Medicare, and Medicaid) are growing faster than other parts of the economy, and some experts question their long-term viability because of the combined effects of increased longevity, size of the Boomer population, and rising health care costs in general.

Further, immediate questions regarding ongoing health insurance in retirement, and at what benefit levels, are rampant in today’s economy – and these questions are given even more fuel by the reorganizations occurring, especially among the auto industry.

There is currently a lot of discussion about a national health care program – but such conversations have been ongoing for decades, with few benefits to show for those efforts. Although President Obama will be leading such efforts this year, most people expect a lot of opposition from Congress (although maybe it will be a bit easier now that the Senate will soon be welcoming its 60th Democratic Senator).

Most people expect that seniors over age 55 will be protected from cuts in these social programs, but maintaining full coverage for them is a two-edged sword – doing so increases the likelihood of a new value-added tax, which would likely add to the tax burden for retirees.

4. Sometimes One’s Retirement Date is Dictated, and not a Free Choice

According to a 2004 Health and Retirement Survey (HRS), 37% are forced to retire. This can occur due to poor health or economic downturns, etc.

5. 401Ks Became 201Ks

Did your 401k and other retirement savings take a major hit with the stock market meltdown last year? Mine did. Many people saw their 401k and other stock market accounts take a 50% hit, which has led many comedians to rename them “201k”. For many people, their 401k was the bulk of their retirement savings, so this stock market meltdown has really damaged their retirement plans.

Humpty Dumpty Had It Wrong

But, the news is not all bad. You can fix a broken egg – a broken retirement “Nest Egg,” that is. You can work longer, semi-retire and take a part-time job, work from home, start your own business, etc. A study by Butrica, Smith and Steuerle (2006) indicated that working just one (1) extra year can increase annual retirement income by 9%, while working a total of five (5) extra years results in an extra 56% annual retirement income.

A defined contribution retirement plan offers an individual retirement account to each of the participants in the plan. The benefits from such a retirement plan are based on how much is contributed to the account. It is also affected by the retirement plan owners’ income, their expenses, as well as the losses and the gains of the investment vehicles used by the plan.

There are various types of defined contribution retirement plans. A 401(k) is probably the best known, as it’s the most widely participated in of the defined contribution plans. Others are 403(b) plans, employee profit sharing plans, and stock ownership plans for workers.

A defined benefit retirement plan makes a commitment to the participant to provide a specified monthly benefit at the time of retirement. This might or might not be stated as an exact dollar figure. The monthly benefits of such a retirement plan might also be calculated by a formula that includes calculations for the particular participant’s years of service and salary. While a private sector fund does not usually require contributions from the participants most public sector funds do. Unlike defined contribution plans, the defined benefit retirement plan participant does not need to have a hand in investment decisions – and in fact is generally restricted from doing so.

With defined benefit plans, the retirement income is guaranteed, there is no investment risk, there are adjustments for cost of living and the retirement savings is tax deferred.

In defined contribution plans the retirement savings are tax deferred as well, but participants have some control over how much they will save, and it can be paid through deductions from payroll. Lump sum distributions to a defined contribution retirement plan might be eligible for 10 year tax averaging, and the investment results have no ceiling.