The investment world is facing its biggest crisis ever, one that will harm millions of Americans if it’s not addressed head on, and soon. Such was the warning of Charles Ellis, about the retirement crisis to come, at this week’s Morningstar ETF conference in Chicago.
Many haven’t saved enough in their 401(k) plans nor will they receive enough in Social Security to live on during their lifetimes, which are growing longer because of improvements in health care. "The demography is undeniable,” said Ellis.
The median savings for American investors is $110,000, said Ellis, founder of financial consulting firm Greenwich Associates and co-author of the book “Falling Short: the Coming Retirement Crisis and What to Do About It.” That’s simply not enough for a retirement that could last 20, 25, 30 years or more. But, said Ellis, the problem can be solved if action is taken soon by employees, employers and the government.
Here’s what he recommends:
1. Workers should retire later
The preferable age is 70 — not 62, when retirees can begin to collect Social Security, or 66 or 67, the "full" retirement ages for baby boomers, depending on their birth year.
“Every year you continue working past 62 gets you 8% more in Social Security payments," Ellis said. By age 70, that's equivalent to 76% more in monthly payment than what would be collected at age 62, according to Ellis. “Putting in another 20% of time gets you 76% more in Social Security.”
Working longer also means more years to save for retirement at a time when many people can afford to save more because they likely won’t be supporting children anymore. Someone earning $60,000 a year, for example, could afford to save 12% of earnings, which after earning a moderate 6% annually would yield an additional $150,000 in retirement funds, Ellis said.
But working longer isn’t always easy. Employers often don’t want to hire older workers or keep them on the payroll, for a variety of reasons. To that point, Ellis suggested that employees “keep up to date with their skills, learn new skills, think ‘young’ and understand their choices.’’
Ellis recommended that employers use “best practices” for defined contribution plans, automatically enrolling employees from their first day of work but allowing them to opt out if they choose. The automatic enrollment rate should be the same as the employer match, Ellis said, implying that employers should make matching contributions.
BlackRock CEO Laurence Fink has made similar recommendations for employers and has also called the investment community to task. In a May 2013 talk with MBA students at the NYU Stern School of Business, Fink said the asset management industry needs to measure its performance against investors’ objectives and liabilities rather than against benchmarks.
“Investors don’t care if they’re holding a mid-cap stock or Mexican government bond, but whether an investment helps them achieve long-term outcomes like sending their kids to college, buying a house, and funding a decent retirement,” Fink said.
Employers should also make borrowing against 401(k) balances more difficult, Ellis said, because even though the borrower will pay back the money -- his or her own -- those funds will not be earning any returns while the loan is out. Such loans essentially reduce retirement savings. “Urge people to stay in their plan or roll it over into an IRA, but not to spend it,” Ellis said.
Finally, employers should also educate employees about the importance of saving for retirement and about how to invest. “Most people view their 401(k) plan as retirement security, but they haven’t had investment responsibility before,” Ellis said.
3. Government should reform Social Security.
Government has a choice, Ellis said, when it comes to shoring up Social Security: Put more money in the system or take less money out. Ellis prefers the latter. More specifically, he wants government to means test retirees like himself who don’t need the money.
Ellis does not favor raising the ceiling on income subject to Social Security taxes – currently set at $118,500 – or eliminating the ceiling altogether, which is the case for Medicare taxes. He also doesn't favor raising the Social Security or Medicare tax rate. These tax changes could help replenish the Social Security Trust Fund, which will be depleted by 2033, and the Medicare Hospital Insurance Trust Fund, depleted by 2030, according to the latest trustee reports.
There are precedents for such changes. Under the Affordable Care Act, the Medicare tax rate was raised to 2.35% from 1.45% for incomes over $200,000 for single taxpayers and over $250,000 for couples filing jointly.
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