A Generation In Peril: Helping Boomers With Their Biggest Challenge--Retirement

By: Terry Donahe

Baby Boomers are in denial. They face an array of challenges that threaten their very quality of life. Yet many are woefully unprepared to meet those challenges. With life expectancy increasing significantly, their retirement years could last much longer than they think and their money could run out. Yet, instead of taking crucial steps to help themselves, many are throwing prudence to the wind. A good example is their inclination to tap into home equity to pay for miscellaneous expenses, thereby further eroding their chances for a golden retirement. Their attitude seems to be: What? Me worry?

What will it take to change the mindset and savings habits of Boomers? They need cold, hard facts. This is where you may be able to help them. Let’s first look at where the problems lie.

Boomers Will Live Longer
Because of advances in nutrition, medical care, and work safety, the Boomer generation will live longer than any generation before it. The current estimates for life expectancy are dramatic. Until the early twentieth century, life expectancy was twenty to thirty years. In the year 1900, with the arrival of the Industrial Revolution, the average life expectancy in the United States was forty-seven. Today, it is seventy-eight. Boomers who retire in three years at age sixty-five can expect to live another nineteen years on average. This means that over half of the Boomers will live longer than age eighty-five. Many will even live into their nineties and beyond.

Many also will have to continue working instead of being able to retire at sixty-five. This scenario is reminiscent of the days before pensions and Social Security, when people worked their entire lives. Before the twentieth century, few people were able to accumulate enough resources to stop working and rely on savings to pay for their needs in old age. In fact, most did not experience “old age.” In response to organized labor, large corporations began to provide employees with benefits, such as health care, vacations, and retirement benefits. Workers who were no longer productive and performed manual labor were “retired” from the work force and replaced by younger employees. They typically lived only a few additional years.

Social Security’s Heyday
The Great Depression created tremendous social anxiety as people realized the catastrophic collapse of the economy could threaten their security. The federal government, under the leadership of President Franklin D. Roosevelt, moved to create a system to provide economic security for all citizens. The Social Security Act was signed into law August 14, 1935, and retirement as we know it was born.

Over the past seven decades, employer-provided pensions and Social Security have been critical to maintaining a minimum quality of life for millions of retirees. Many entered retirement with modest personal savings. These generations learned to save because of their experiences with storing crops, struggling through the Great Depression of the 1930s, and rationing during World War II. They had learned to live frugally to survive those hard times.

Boomers cannot rely on company pension plans and Social Security to the extent their parents did. In the good old days, corporate “defined benefit” pension plans were funded by the company with little or no employee participation. These pensions typically provided employees with a steady stream of income, starting at retirement and ending at death.

The Demise of the Defined Benefit Pension Plan
Traditional defined-benefit plans reached the height of popularity in the late 1970s, when more than 60 percent of Americans participated. Since then, use of these plans has steadily eroded.

Employers have abandoned these plans for several reasons. As retired employees live longer, the cost to fund pensions has increased proportionately. Some companies have been mismanaged, and efforts to prevent them from failure have involved terminating fixed obligations such as pensions. Other companies have been forced to abandon pension plans in an attempt to remain competitive in the global economy. During the leveraged buyout frenzy of the 1990s, the integrity of many corporate pensions was jeopardized as numerous debt-laden companies failed. As of 2006, fewer than 13 percent of American workers could expect to rely on a pension as their primary retirement plan.

Social Security Headed toward Insolvency
Boomers also will not be able to count on Social Security to provide the level of benefits that prior generations experienced. In fact, the Social Security system is critically underfunded and in jeopardy of failure unless the federal government acts.

Social Security is a “pay-as-yougo” system. Current workers pay taxes that, in turn, the government uses to provide benefits to retirees. This is about to change, as the numbers of Boomers who will receive Social Security benefits will overwhelm the ability of active workers to fund the system’s obligations. According to the Congressional Budget Office, in 2018, Social Security will begin paying out more in benefits than it collects in payroll taxes, and in 2041, Social Security will have become insolvent.

In 1945, twenty workers supported each Social Security beneficiary. In 1999, only three workers supported each Social Security beneficiary. By 2020, roughly two workers will support each retiree. According to the 2008 Social Security Trustee Report, the unfunded liability is $15.8 trillion. It is not clear how Americans will address this looming crisis. What is certain is there will be a major restructuring of the Social Security system.

Most likely, this will result in extending the age further at which individuals are eligible for benefits, as well as a reduction in benefits for those whose income and/or assets exceed a means threshold and a significant increase in payroll taxes for both employers and employees. The government may also introduce an entirely new form of retirement savings, which would shift some or all of the responsibility for accumulating and managing retirement funds to individuals.

Already, the benefits of recipients with “other” income above certain modest thresholds are subject to taxation. Up to 85 percent of a retiree’s benefits are taxed if the person is single and receives other income in excess of $34,000; or is married, files jointly, and has other income in excess of $44,000. While these limits may be indexed for inflation, Boomers can expect that such increases likely will be nullified by other changes as the federal government attempts to avoid insolvency of the entire program.

So, Boomers will not be able to count on employer-provided pensions or Social Security to provide their adequate financial protection during retirement. In fact, unless they significantly change their lifestyle, they may not be able to rely on the traditional retirement income source—personal savings—to see them through the rest of their lives.

A Generation That Disdains Saving
Boomers are not savers. Unlike their parents, who learned to ration, conserve, and save during the Depression and World War II, in general Boomers have not learned to plan for their future. This is a generation of spenders and consumers, not accumulators. They have enjoyed the highest standard of living in world history, and they have done so by purchasing a vast array of discretionary items, including larger and larger homes, multiple vehicles, expensive electronic gadgets, vacations, entertainment … the list goes on.

The Employee Benefit Research Institute recently reported that a mere 23 percent of Boomers age fiftyfive and over say they have $250,000 or more in savings and investments (not including primary residence or defined-benefit plans). This is consistent with the national savings rate, which has ranged from negative to slightly positive for several years running.

Very little in 401(k) plans: Although these plans were intended to help people save, according to a 2007 report by Fidelity Investments, one third of Boomers are not participating in employer 401(k) plans. The average contribution rate among those participating was 7.7 percent. The average balance held in a 401(k) was $38,000. The federal limit on annual 401(k) contributions in 2008 is $15,500. For Boomers over age fifty, it is $20,500.

Very little in IRAs: Funding IRAs (traditional IRAs and Roth IRAs) is no better. Research conducted by various sources over the past fifteen years indicates that less than a quarter of all Boomers are actively funding an IRA. This is consistent with a current report from the Investment Company Institute of America that only 14 percent of all U.S. households contributed to an IRA in 2006. The federal annual contribution limit to an IRA is $5,000. For people over fifty, the limit is $6,000.

Too much consumer debt: Boomers are actually spending well beyond their income, thereby reducing their net worth. They have done this by refinancing and draining their homes of equity, taking on additional consumer debt through auto loans and credit cards, and increasingly pulling money out of their retirement accounts for non-emergencies. The recent tightening in the credit markets is placing additional pressure on those who were already financially extended.

The Case of the Disappearing Inheritance
Are Boomers counting on inheritance from their parents? While those in their parents’ generation were more consistent savers, these seniors are generally living longer than they or their kids expected. As a result, they are finding themselves spending- down their savings and investments in order to pay for the basic necessities of life. In addition, they have been forced to pay for healthcare costs, including prescription drugs, which have risen significantly throughout their lives. When they finally pass away, many in this generation will leave little more than a home (that may or may not have debt against it) and personal effects.

A study done for AARP, using Federal Reserve data, indicated that the median inheritance amount received by Boomers in 2004, was $64,000. This number may grow; however, receiving a substantial inheritance is unlikely for most Boomers. The enormous wealth transfer that has been discussed for the past few decades likely will be very concentrated. Researchers at Boston University expect that about 80 percent of bequests will come from the wealthiest 10 percent of the generation.

According to AARP, 80 percent of Boomers have never received an inheritance and are not counting on one. Ironically, rather than receiving bequests from their parents, they are providing care and financial support to their parents in their final years.

As the Baby Boom generation marches toward retirement, dark storm clouds are gathering. There certainly are those within this generation who are prepared to enjoy their post-working years. However, they are in the minority. Unless this generation makes significant changes, many will find their retirement years are far from golden.

Helping Clients with Retirement Planning
Undoubtedly you have clients who are Baby Boomers. Perhaps you are a Boomer yourself. How many of your clients fit this profile? Are they prepared for, or at least on track for, a retirement that will resemble their current lifestyle? If they aren’t sure, here is an opportunity for you to add value to your relationships with them.

You have a couple of options. If you feel qualified to perform a retirement analysis and you have the tools (planning software) for it, you could offer to conduct the assessment for them. Alternatively, you could provide a referral to a financial advisor who has experience in retirement analysis.

To do the analysis yourself, start by evaluating their situation. Put together a balance sheet and a budget. Engage the client in a dialogue about their retirement. What are their expectations? When would they like to retire? What will be their lifestyle in retirement? Will they generate any earned income during retirement? How long do they expect to live? What kind of a return in investments do they anticipate? What would they like to estimate as a rate of inflation? Do they expect a change in tax rates? Do they anticipate any significant health-related expenditures?

Once you have all of the relevant data and estimates, and you have a general sense as to how the client would like to experience retirement, you can begin building a financial model for the retirement phase of life. The desired outcome is that the client will be able to live several years beyond life expectancy and not run out of financial resources.

Financial planners typically test the viability of a client’s financial readiness for retirement by using hypothetical trial runs. A technique called “Monte Carlo Simulation” involves running a client’s retirement scenario multiple times, and using randomized investment returns. This is done because investment returns, which are assumed to be fixed throughout the period of analysis, in reality are variable. The viability of a client’s retirement situation can be greatly affected by the manner in which actual investment returns impact the retirement accounts. Computers are used to run thousands of simulations. Most planners seek a success rate of at least 85 percent.

If clients’ current circumstances are not likely to lead to a successful retirement, you are in a position to help them explore many other options. They may elect to scale down their retirement lifestyle; such as by downsizing the home, reducing travel plans, or relocating to a less-expensive area. They may work longer than originally desired or planned. They may find ways to create additional income during retirement. They may tap into assets that were previously considered “off limits,” such as home equity or life-insurance policies. They may invest more aggressively during retirement years in an effort to grow their investments.

Boomers generally are not on track to enjoy the retirement they have envisioned. Many do not even realize how far off track they are. This presents an opportunity for you as a trusted professional advisor to draw their attention to this fact and encourage them to take action. Your clients will appreciate your valuable help and thoughtfulness.

Terry Donahe is a CERTIFIED FINANCIAL PLANNER™ who works with affluent individuals and families. His firm, Cascade Wealth Management, is a fee only Registered Investment Advisory firm located in Lake Oswego, Oregon. You may learn more about Terry and his firm at www.cascadewealth.com. Terry can be reached at (503)675-4381 or by email at terry@cascadewealth.com.

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