The inadequacy of Americans' financial preparations for retirement has been documented in countless studies. We save too little, too late. We fail to do the homework to understand the financial products we already own. As a consequence, we often make poor investment decisions.
We don't fully appreciate the new rules of longevity. When you got the gold watch at age 65 a generation or two ago, the watch wasn't expected to last very long, and neither were you. Today, retirement is a period lasting 25 to 30 years for many. Making nest eggs last this long takes a lot of work. It takes an appreciation for unspectacular but dependable investment products that can be counted on to pay out money every month, year after year.
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The stock-market decline and recession provided a prolonged shock to an already shaky retirement system. It highlighted in dramatic fashion that the 25-year sustained shift from defined benefit pension plans to defined contribution plans had left many employees holding the bag. That's no knock on the investment companies and mutual fund firms that manage the alphabet soup of 401(k)s, 403(b)s, IRAs, and the like. I can give them a sharp rap on the knuckles for burying their fee structures and making it very hard to understand exactly how much of my retirement money goes into their pockets each year.
But their retirement advice generally is sound. Their funds are professionally managed. Many of them have very strong investor education programs. It's just not clear that we've been paying attention. As a result, we have a retirement system that is providing very little security to tens of millions of people who are nearing retirement age.
The Obama Administration and Congress are debating what to do about this problem. It's not been a center-stage drama but one that occurs in subcommittee hearings, studies, and the often arcane regulatory rule-making process. A Government Accountability Office (GAO) report this week laid out the statistical realities of retirement.
Social Security provides half or more of all income of nearly two-thirds of U.S. households containing at least one person aged 65 or older. One-third of all such households depend on Social Security for 90 percent of their income.
That's hardly enough money to provide a secure retirement. However, given the choice of taking Social Security right away at the age of 62, or waiting a few years until benefits are much higher, most people opt to take the smaller amount of money right away. The benefits of waiting can be substantial. "Social Security provides an average of about $11,786 annually if begun at age 62, $15,715 if begun at full-retirement age, and $19,487 at age 69," the GAO report said. "A big advantage to postponing Social Security benefits is that unlike most annuities provided by insurers, Social Security benefits are annually adjusted for inflation."
Turning to private retirement funds, the GAO cited studies that found nearly 40 percent of households had no such plan at all. The median value of the accounts for people who did have the plans was $98,000. Now, it you took $98,000 and invested it in an annuity contract, you would be able to receive a little more than $5,000 a year in income for the rest of your life. That's a woefully inadequate amount. And the problem is that people often do not take wise steps to convert their nest eggs into streams of retirement income.
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When given the choice of converting their retirement account holdings into a lump sum payment or into an annuity, nearly everyone prefers the lump sum. And it's not clear that this sum is properly managed to produce secure retirement income.
So, what's the government to do when people won't take the steps to act in their own best interest? Some experts have suggested we start another retirement program that uses an employee's own money -- like a 401(k) -- but forces people to place the funds in an annuity or similar guaranteed income product -- like Social Security. Business generally hates this idea, or anything else that smacks of a mandate with a "one size fits all" mentality. It's also a tough go in an era of rising complaints about government interference with private behavior.
Another possible response is to require investment companies and the employers who offer retirement plans to really step it up in terms of investor education. That might be a big improvement and wouldn't be very expensive to do. There also are regulatory and legislative proposals to make retirement investment programs much more transparent to consumers -- more complete disclosure of fees, more easily understood retirement-plan statements, and the like. Some version of these proposals is expected to be adopted.
"Although, retirement savings may be larger in the future as more workers have opportunities to save over longer periods through strategies such as automatic enrollment, many will likely continue to face little margin for error," the GAO concludes. "Poor or imprudent investment decisions may mean the difference between a secure retirement and poverty, which highlights the need for improving financial literacy. How we address this issue for the already large segment of the population depending on limited retirement savings to ensure income adequacy throughout retirement continues to be one of the key policy challenges facing the Congress and the nation."
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