January 6, 2010

Funded Floors for Retirement

Yes, things are bad and perhaps even worse than we know. Yet, we can do something about it.

This online series marks a change for me and Research, where I've been writing columns in the print magazine that are about one-third longer.

The shorter format changes the content possibilities. Arguments with three or five part articulations have to give way to shorter narratives. And, please, let me know about the topics that you would like to read in this new format.

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Using recent statistics, almost 116 million U.S. households have an average income of about $68 thousand dollars per year. Also, the U.S. economy supports about $52 trillion (and climbing) dollars in total debt.

This means that the average U.S. household earning $68,000 per year is supporting an average of $450,000 in promises to pay back creditors.

Trillions, billions and millions can confuse the best of us. Don't take my word, look at the math: $52 followed by 12 zeros divided by 116 households followed by 6 zeros returns $448,275.86 per household: about $450,000 per household.

[Sources of information on this topic can be found online at websites managed by author Michael Hodges, blogs and government sites.]

These numbers do not include contingent liabilities such as Social Security, Medicare and public pension promises made by the various levels of government.

One of the important difference between now and the First Great Depression is the size of government. Government was very small then. It is very large now.

Depending upon what is included and how it is reduced to a present value, government promises may add-up to a number between $50 and $100 trillion dollars. This means that the average U.S. household earning $68,000 per year is also supporting another $450,000 - and perhaps as much as $900,000 - in un-funded promises to give money to others.

How can clients fund these million dollar liabilities per household as well as their own retirement liability?

In our lifetime, the common wisdom about retirement funding for the average household changed several times:

- Defined Benefits: First the average household believed retirement would come in the form of a pension plan, the proverbial gold watch.

- Defined Contributions: Then, it gradually put more and more of its faith - and retirement savings - into defined contribution plans.

- Social Security: Most household members thought normal retirement age would be 65, but then it changed to 67 and beyond.

- Home Equity: More recently, the average household hoped to sell the house in time for retirement.

These retirement funding plans are disappointing many households because they share a major flaw: They work as long as there are only a few who benefit from the payments made by others.

Floors that work are funded. Benefits paid by others fail then these others show up for their own benefits.

Yes, things are bad and perhaps even worse than we know. Yet, we can do something about it.

In addition to what we know about asset allocation, we can use all of our clients' sources of capital (human, social and financial) to focus our planning practices on "First Build a Floor, Then Expose to Upside" in order to create funded retirement plans.

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Francois Gadenne is chairman and executive director of the Retirement Income Industry Association. He can be reached at fg@riia-usa.org.

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