Ah… retirement. That time in life when you’ve worked hard for long enough to “deserve” time to sit back and relax – maybe play some golf, or take classes to reignite an old hobby, or travel the world. Today retirement is so engrained in our culture as a natural phase of life that it’s easy to forget that it is a very modern concept.
In 1881, Otto von Bismark, a conservative minister president of Prussia, came up with an idea to have older adults not have to work to the very last second of their lives. Eight years later the German government started to provide a retirement system for anyone over the age of 70. At the time, not many people made it that long.
Across the Atlantic in the US, retirement was a fledgling idea. Municipal employees started to receipt public pensions in the mid 1800s and in 1975 American Express started to offer private pensions. It wasn’t until 1935 when the Social Security act passed and the official retirement age in the US was 65. (Life expectancy for men was 58 at the time.)
The 1960s and The Extended Retirement
The government never intended for retirement to be a prolonged period when adults didn’t work. It was more a social safety net for older adults who no longer could work. In the 1960s people were living to 70 years on average in the US and people started to stop working when they were still relatively healthy and enjoy their old age.
It’s incredible to think that in the last 100 years or so we as a society went from not having a retirement to expecting this to be a significant phase of our lives. Today, the average retirement age is 63 and the average length of retirement is 18 years.
Having 18 years to enjoy life before you kick the bucket and after you’re handcuffed to a desk for the majority of your free life is a wonderful gift. However, retirement is still out of reach for most people. The average savings of a 50 year old is just $42,797. Thirty-six percent of Americans over 65 rely completely on social Security. And 6,100 Americans turn 65 per day (see these and more stats on retirement here.)
Social Security Is Screwed
Many Americans expect they will be able to live off Social Security through their retirement, but Social Security was never meant to cover all costs. It’s a safety net, but not an income. And Social Security is RUNNING OUT OF MONEY. It will only be able to cover 77% of promised benefits beginning in 2037.
Retirement is expensive and may no longer be feasible. The good news is that we’re staying healthy longer. The bad news is that people still want to retire at 65 or 70, and people still do die in their 60s and 70s so waiting longer could mean working through till your last breath.
The government knows something must be done to either pay for Social Security or shift America’s idea of retirement, but it’s going to be a big challenge. As far as our presidential candidates plans, Hillary would pay for the gap by raising taxes on people making more than $250,000, while Trump thinks that creating more jobs and “getting rid of government deficits, waste, fraud and abuse” will cover the deficit (though he has no clear plan on how this will actually do that.)
The Big Problem With Retirement Savings
Do you have access to a 401k? The 401k is a very new invention. As companies stopped providing for their employees’ retirement via pension plans and pushed risk onto the employee via this new investment vehicle. In 1978, Congress passed the “Revenue Act of 1978” which allowed employees to avoid being taxed on a portion of their income to receive as deferred compensation (also known as the “Internal Revenue Code Sec. 401(k).
In 1984 the government realized that 401k plans were possibly benefiting only the very wealthy, and passed an act to ensure that these 401k plans weren’t discriminating rank-and-file workers. That appeared to work, as by 1996 assets in 401(k) plans surpassed $1 trillion.
Despite the growth of the 401(k) and its benefits (specifically, allowing employees to change jobs whenever they want versus being locked into one company to obtain their pension – and, for companies, the cost to manage these funds is a lot less than managing pension funds), many financial pundits claim they are a massive failure. They have a lot of issues:
- A 401(k) account does not guarantee anything. It’s simply an account to put investments in. The stock market often goes up over time. It also goes down. Once you move your 401k to an IRA you can invest in most types of funds and stocks. You can lose all your money. You can take too many risks. Even if you don’t take “risks” the stock market could crash towards the end of your 50s / early 60s and you could suddenly be out of that cushy retirement you worked for your entire life.
- 401(k) fees eat up a lot of the supposed savings they offer. They are so expensive because there is a lot of administrative overhead to make sure the funds meet compliance requirements – and because banks need to make money offering these funds or – what would be the point?
- When you put private banks in charge of American’s retirement you inevitably run into corruption. Banks are focused on stockholder return first and foremost, not the retirement health of the general population. Even at those banks, employees spot this corruption from a mile away – case in point, a recent lawsuit against Morgan Stanley re: offering crappy 401(k) funds with high fees – and worse performance from market alternatives – from its very own employees.
- Your employer gets to pick what funds are available in your 401(k) – while you may have access to reasonably decent index funds (that will cost more because they’re in a 401(k) plan anyway, you also might not have access to decent investment options. You have to invest in options in your 401(k) plan if you want to invest in a 401(k), at least while you’re at the same employer…
- Employees actually benefit from leaving their company fairly frequently (though few employees realize this) as when you leave a company (and only when you leave a company) you can “rollover” your 401k into an IRA account where your investment options will be much broader and fees will be much lower.
- Pre-tax investing is not ideal for everyone. Does not paying taxes on $18k of your income now offset the risk of not being able to access that cash until you retire AND not being able to better diversify your portfolio? Capital gains tax is just 15% or 20%, which is lower than your income tax rate. However, when you invest in a 401k you are accepting that when you retire you will pay income tax on all of this money. Theoretically you don’t need to take that much out of your 401k in retirement to live, but if you’ve saved up that much maybe you want to splurge a bit — and then, instead of paying capital gains tax on your gains you are paying income tax on your gains and your basis after many years. So you put $9k in a taxable fund today or $18k in a pre-tax fund and wait 40 years:
- $9k in 40 years at 5% YoY interest = $66,225k. For simplicity, I’m ignoring dividends (payments made by companies to shareholders on a regular basis that are typically auto-invested back in the same fund) here and just looking at general growth. So you have to pay tax on $57,225 in gains. Say you are in a 30% tax bracket at retirement because you did well and you want to buy yourself a auto-piloted flying yacht complete with personal drone photographers (dream big people the future is going to be fancy) – so let’s say you pay 20% capital gains tax on this. You end up with $54780.
- $18k in 40 years pre-tax at 5% YoY interest rate = $132,451. But you have to pay income tax, so you end up with $66,225.
- Note, this is bad math with unrealistic variables and assumptions. Understand this concept using these numbers at your own risk. And understand that any assumptions made now will likely not be accurate in 40 years because the tax system can and probably will change by then. You can, for instance, move to a state with no state income tax, and suddenly your taxes are much lower in retirement – better to save pre-tax now. But if taxes go up, then you’re better of paying tax now and getting a lower capital gains tax rate – if that still exists in 40 years.
- But, the bigger problem here is – 45% of businesses with less than 100 employees offer 401ks. Employers don’t have to offer a 401k. Almost half of U.S. workers didn’t have a company-sponsored retirement plan in 2013, compared with 39 percent in 1999, according to an analysis of Census Bureau data by the Schwartz Center for Economic Policy Analysis. Few workers save anything outside of employer-sponsored plans. Only 8 percent of taxpayers eligible to set money aside in an IRA or Roth IRA did so in 2010.
- The general advice on 401ks is that they may or may not be a good investment vehicle, but ALWAYS invest up to the employer match. The match is also a generous benefit because if you can afford it you can invest more than $18k per year (the 401k limit) with the additional match funds. Otherwise you’re limited to the $18k.
- According to Aon Hewitt, 92 percent of employers with 401k plans match employees’ 401k contributions, with the most common scenario being one dollar for every dollar the employee contributes up to six percent of the employee’s annual salary. In my 11+ years in the workforce I’ve worked full-time only at companies with less than 100 employees. Not all of the employers offered a 401k. Not one of those employers has provided a “match.”
- Meanwhile, employees with access to a 401(k) match are often leaving it on the table. A 2015 report found that Americans leave $24 billion in unclaimed 401k company matches on the table each year.
Retirement is in Crisis
People just aren’t saving enough for retirement, and the social security system we have cannot provide enough for the rising costs of healthcare as people live longer – but not always healthier. Either we need to stop expected to retire until we absolutely have to (i.e. are on our death bed) we need collectively to have better retirement education, access to better investment options, and lower risk investments with more incentives to save. Otherwise, “Retirement” will become one of those concepts from the past, not something we can look forward to in our old age.