America has a retirement problem. Over the past decades, macroeconomic trends and shifts in corporate thinking have made the process of planning for retirement harder to navigate for the average worker. A drift from defined benefit pension plans in favor of employer-sponsored 401(k) plans has impacted the current generation of pre-retirees.
The change has introduced variables to retirement planning that were never part of the equation for the retirees of yesteryear. With a population older than it has been at any point in history, some experts are predicting a "retirement crisis," wherein tens of millions of Americans become simultaneously unable to work and unable to afford to retire.
It has never been more important for workers to understand how the landscape has changed — and how to adjust their planning in order to meet individual retirement goals.
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Yesterday's pension is today's 401(k)
Pension plans make retirement planning straightforward for two reasons. First, employers are responsible for regular contributions to the plan during an employee's working years. Second, converting that lump sum into a stream of income to meet living expenses during retirement isn't a step for which retirees themselves are responsible.
This system largely automates the process of building a nest egg and drawing it down once they retire. Unfortunately, few companies offer pension programs anymore, opting instead to provide workers individualized 401(k) account access.
Quantifying the extent to which pension plans have vanished from the corporate environment is easier than you might think. Last year, 16% of companies in the Fortune 500 offered pension programs, a drop from 59% that did in 1998.
This generational shift has made today's pre-retirees more responsible for their own retirement planning.
401(k) plans are dependent on the capital markets
Another challenging variable associated with 401(k) plans is their level of exposure to stock and bond markets. Though the risk associated with these securities varies greatly from asset to asset, there's always uncertainty.
Particularly in equities, sharp short-term corrections can wipe out significant amounts of paper wealth in short timespans. An ill-timed market crash devastated many retirement portfolios when investors panicked and sold low.
Retirement savers’ 401(k)s are universally involved in these markets. They depend on them for solid investment returns. A 2017 study found that over two-thirds of all 401(k) plans feature stocks in their portfolios. It's highly unlikely that anyone considering retirement is entirely immune to market downturns, given more 401(k) plan participants hold stocks today than at the height of the pre-recession bull market in 2007.
That makes these new retirement accounts inherently less reliable at any given point in time than more old-fashioned pension plans.
Market volatility in dollar terms has risen
In addition to increased exposure to the stock and bond markets, today's retirement investors are likely to see more turbulence than earlier generations. Two accounts with identical asset allocations, one from 1995 and one from 2018, would have significantly different risk profiles.
The reason is simple: The market itself is larger. The same phenomenon that makes the stock market an excellent long-term play makes it increasingly uncomfortable for investors who crave stability.
As the market has expanded over the past 100 years, a change of 1% in either direction has become increasingly extreme in real terms. A 1% rise worth 8.25 points on the Dow Jones Industrial Average in 1980, for instance, would have represented a 250-point swing earlier this summer.
The amount of dollar value that can be gained or loss in a short amount of time has increased, making volatility feel greater and increasing the psychological difficulty of retirement planning.
Fixed income investments are a way to recapture long-lost stability
All this is not to suggest retirement is impossible for people today — far from it. It is more complex and requires a more thoughtful approach to plan and execute. Fortunately, there are options available to workers looking for the stability of the pension plans of old.
These options include:
- Short term bond strategies: Adding short-term bonds to your portfolio can provide stability and even income to a portfolio, while minimizing risk, based on the limited volatility of bonds of short duration.
- Dividend-producing stock strategies: Choosing stocks with a stable history of dividends is another way of producing stable income. These stocks are generally less volatile than the market as a whole because of the dividend component.
- And annuities: These financial products pay a fixed amount to an individual over time.
Annuities can provide a steady stream of income for a predetermined interval of time, and in some cases for life. They're highly customizable to suit any time horizon and income flow desired. Selecting annuities depends on several factors, including risk tolerance, the timing of payments and tax efficiency. There are a lot of choices out there, including single premium immediate annuities, fixed index annuities and variable annuities. Although they are complex investment choices and should be thoroughly understood before investing, the annuity marketplace is wide open today, offering consumers a lot of options.
It is important to have annuities as part of an overall income plan, to provide safe, stable income, which is guaranteed by the insurance company. These annuities are designed to simulate a pension of yesteryear. This strategy has a similar type of benefit and will reduce the overall risk of a portfolio.
Securities and advisory services are offered through, USA Financial Securities Corp., Member FINRA/SIPC. www.finra.org A Registered Investment Adviser located at 6020 E. Fulton St., Ada, MI 49301. Informed Family Financial Services, Inc. is not affiliated with USA Financial Securities.
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