Alicia Munnell has spent the bulk of her career looking at the retirement situation in the United States, and she believes the traditional notions of retirement don’t work in today’s world. Longer life expectancy, rising health care costs, and a shift away from defined benefit plans should be forcing a rethink of the various steps individuals and policymakers can take to avoid a potential retirement crisis, she says.
The scholar, author, and former economic adviser to President Bill Clinton recently sat down with REIT magazine to discuss what she sees as the coming retirement crisis and how investors should prepare.
In your book “Falling Short, The Coming Retirement Crisis and What to Do About It,” you imply that many of us won’t be able to retire as comfortably as previous generations. So, how did we get here over the last 30 years?
A number of things have changed in the last 30 years. Mostly, it’s the need for money. By that I mean people are living longer, and health care costs are high and rising rapidly. On the supply side of money, social security is going to replace less of pre-retirement earnings than it has in the past because the full retirement age is rising from 65 to 67, and so people who retire at 65 will see a cut in their social security benefits.
We’ve also had a shift from defined benefit plans where people get a payment for life via pensions and their retirement investment decisions that are being made by their employer; to 401(k) plans, where people are basically on their own and have to decide whether or not to join the plan, how much to put in, how to invest their money, and what to do when they move from one job to another. And, unfortunately, the balances in these plans are really quite modest. So, we’ve had an increase in the need for retirement income and at the same time, we’ve had a decrease in conventional sources of retirement income.
How big is the problem today?
Here at Boston College’s Retirement Research Center, we put out something called the retirement risk index. It measures the percent of today’s working households that are not going to be able to maintain their standard of living in retirement. This index currently shows that roughly half of those households will fall short in retirement.What are some things we can do as individuals right now to get on track and stay on track in our retirement planning?
As individuals, the basic goal is that we should be working longer and saving more. In terms of working longer, I think people should know that the point at which they get their highest benefit from social security is at 70 years old. And social security is just wonderful money when you’re planning for retirement because it’s an annuity that comes in every month and is also adjusted for inflation. So as prices go up, so does your social security benefit.
If you can retire at 70 instead of 62, then your monthly benefit will be 76 percent higher. If you’re fortunate enough to have a 401(k) plan, which frankly not everyone is, then the best thing to do is to join it right away and contribute at least up to the match and more if you can every year.
Alternatively, with many pension and profit sharing plans disappearing, what can businesses do in order to assist their employees in building a solid retirement savings?
The best thing businesses can do is offer plans. Even if they can’t offer their own plan, they should encourage their employees to set up an IRA of some sort. Basically, the best thing they could do is offer a 401(k) to their employees with automatic enrollment and then make sure employees contribute at an adequate level by having automatic increases at the default contribution rate from auto enrollment. If employers do that and encourage their employees to keep working, then their employees will be fairly well-off at retirement age.
In your book “Social Security and the Stock Market,” you cite that the U.K., Australia and Canada are countries that have retirement systems similar to the U.S. by having equities in their retirement plans. What are some of the risks and rewards of equity investments in retirement plans?
I’m a big fan of having social security assets invested in equities—but at arm’s length, and only a portion of the funds, and not in a way that interferes with the stock market—as it’s a way to reduce the costs of the programs, which is where we really need help. It’s not a crazy idea. It works very well. Canada has been quite successful at this.
You’ve recently written about how DB plan performance has been more likely to be driven by asset performance than by asset allocations. Given this and the well documented outperformance of listed REITs versus private real estate, should DB pensions consider greater allocations to REITs?
Defined benefit plans should always search for the highest after-fee, risk-adjusted return. To the extent that listed REITs are a viable competitor according to this standard, they should certainly be considered by investment managers.
You’ve suggested that the retirement income landscape has been changing in a way that systematically threatens the retirement security of millions of Americans. What are some changes that policymakers could undertake now to begin to alleviate and perhaps avoid a pending retirement crisis in the U.S.?
Policymakers could do quite a lot. Basically, the game today is work longer and save more. The first thing we need to do is fix social security so that there’s not a long-run deficit in the program, as it’s the backbone of the retirement system and it’s important it works well in terms of 401(k) plans too. Policymakers should pass a law that says if you’re going to have a 401(k) plan, that it has to be fully automatic: automatic enrollment; automatic increases to the default contribution rate; and automatic provisioning so that some of the money that people get when they leave their 401(k) plan is provided in the form of lifetime income and not just a lump sum. Generally, most people have no way of figuring out what to do with a lump sum distribution. So, those things would improve 401(k)s a lot.
We need to “cover the uncovered” as a part of a truly comprehensive national retirement plan. We also need to consider homes as a retirement asset. We need to encourage people to feel free to use their home equity to support themselves in retirement. And they could do that by downsizing or through a reverse mortgage. We’re also very enthusiastic about a property tax deferral program for seniors here in Massachusetts where the deferred tax amount is repaid when the individual dies or sells the property.
As I mentioned, we also need to work longer. I think we need a national PR campaign to tell people that if you’re healthy and you have a job, that you should stay in that job until you are at least 70 so that you can maximize your social security benefits and give your 401(k)s assets a chance to mature as much as possible. People with more education will live longer, so it’s a perfectly reasonable thing that somebody with a college degree is going to live 30 years or more after they retire. It’s just simple arithmetic.