In 2016, Social Security old age and disability benefits recipients will likely see no cost-of-living adjustment for only the third time in the last 40 years. The reason: low inflation. Each year, the level of the annual COLA for the following year is determined after the end of the third quarter by comparing the inflation rate (the CPI-W, to be precise) with the prior year’s inflation rate. The CPI in 2015′s third quarter is, so far, below 2014′s third-quarter inflation, and thus no COLA.
However, for higher-income Social Security recipients, there will be an unintended consequence beyond simply not getting a “raise” in their Social Security checks. Because of the way the law works regarding Medicare Part B, higher-income retirees will see sharp increases in the premiums they pay for Medicare Part B premiums (lower-income recipients are “held harmless” from such increases).
This development reflects how economics and the tax code and market performance and retirement and health care planning — all of great interest to advisors — are intertwined. It also reflects how advisors’ clients, even the higher-net-worth ones, can feel the effects of economic and demographic change.
As part of Investment Advisor‘s 35th anniversary issue, we decided to take a look at the changes that will occur in that large group of people known as the American population over the next 35 years.
If the popular, and mostly accurate, image of an advisor in 2015 is that of a white man in his 50s whose average clients are white married couples in their upper 50s, get ready for an iconoclasm.
And if you picture a typical independent advisor as a lone wolf entrepreneur who found his calling only after trying another line of work, your picture will need some serious Photoshopping as well. For one thing, he might well be a she. For another, the person (or persons) running this hypothetical firm may not be entrepreneurs but people with financial planning degrees who chose to be advisors as their first career. It makes sense that the ethnic and racial and gender makeup of advisors will change along with the changing demographics of the larger population, though most industry observers would agree that change has yet to happen (see “The Changing Demographics of Advisors”).
The Client of the Future
Your typical client will likely change as well, if demographic trends already in play continue (see “What if the Projections Are Wrong?”). It’s a mistake to think that in the United States a typical family comprises a couple that marries while young and stays together until death, raising their natural-born children in their home until said children reach a launchable (post-college?) age.
Such families — and such couples — are becoming more the exception than the rule. A 2013 Census Bureau report noted that “it is difficult to talk about a single kind of family or one predominant living arrangement in the United States,” wrote Jonathan Vespa, Jamie Lewis and Rose Kreider in “America’s Families and Living Arrangements: 2012.”
Here are some highlights from that report:
Between 1970 and 2012, the share of households that were married couples with children under 18 halved from 40% to 20%.
The proportion of one-person households increased by 10 percentage points between 1970 and 2012, from 17% to 27%.
Between 1970 and 2012, the average number of people per household declined from 3.1 to 2.6.
Households with five or more people decreased by half, from 21% to 10% of all households, between 1970 and 2012, while the share of households with only one or two people increased from 46% to 61%.
Households where a single male or female lived alone increased over those same years from 5.6% to 12.3% for men, and from 11.5% to 15.2% for women.
The population of the United States is growing older every day, the percentage of foreign-born residents is getting bigger every day and white, non-Hispanic people are on track to become a minority in this country.
How the Population Will Change
A report issued in March 2015 by the Census Bureau with a typically long-winded title — “Projections of the Size and Composition of the U.S. Population: 2014 to 2060” — sums up how the makeup of the U.S. population will change over the next 35 years.
“By 2030, one in five Americans is projected to be 65 and over,” wrote Sandra Colby and Jennifer Ortman in the Census Bureau paper. “By 2044, more than half of all Americans are projected to belong to a minority group (any group other than non-Hispanic White alone); and by 2060, nearly one in five of the nation’s total population is projected to be foreign born.”
We’ll get to the reasons why an older population will affect advisors and their clients and the U.S. economy and markets a little further on, but let’s first discuss the issue of the changing ethnic makeup of the country.
First, a little history. We like to call ourselves a “nation of immigrants,” but the truth is that America has had a love-hate relationship with foreigners coming to our shores well before immigration policy became an issue among the current crop of Republican presidential candidates. Among the earliest “immigrants” to this country were the Pilgrims, seeking religious freedom, but also Africans, mostly West Africans, who came to the 13 colonies as slaves — in fact, 20 Africans arrived in Virginia as indentured servants in 1619, a year before the Pilgrims arrived, and 4 million were set free by President Abraham Lincoln in 1865.
In the 19th century and into the early 20th century, different waves of immigrants came to the United States. Between 1820 and 1930, some 4.5 million Irish immigrated, for instance. Between 1880 and 1920, 20 million immigrants arrived, including 4 million Italians and 2 million Jews, mostly from Eastern Europe. There were immigrants from Asia as well, but the biggest single group of immigrants over those decades came from Germany — some 5 million. The biggest year for immigration was 1907, when 1.3 million people entered the U.S. legally. The nation’s total population that year was only 87 million.
The country started tightening immigration with the Chinese Exclusion Act in 1882 and then the Immigration Act of 1924, which set quotas for immigrants of European origin (matching their percentages of the U.S. population in 1890) and essentially barred immigration from Asian countries. Japanese anger over that bar was just one of the ongoing issues between the U.S. and Japan in pre-World War II days.
In signing a new immigration law in 1965 — 50 years ago — President Lyndon Johnson said the 1924 law’s quota system “violates the basic principle of American democracy — the principle that values and rewards each man on the basis of his merit as a man. It has been un-American in the highest sense, because it has been untrue to the faith that brought thousands to these shores even before we were a country.”
That law, the Hart-Celler Immigration Bill of 1965, substituted an immigration system based primarily on family reunification and skills that the country needed rather than quotas.
According to the Census Bureau’s 2014 national projections, between 2014 and 2060, the native population is expected to increase by 62 million people, or 22%, while the foreign-born population is projected to increase by 36 million people, or 85%. The foreign-born population is expected to reach 19% of the total U.S. population by 2060.
Regardless of whether those changes fills you with excitement or dread, you — and your partners and successors — will be operating in that different America.
More Immigrants: Good or Bad?
So are immigrants good for an economy and for a society?
An April 2015 report from the Institute on Taxation and Economic Policy estimates that undocumented aliens in the U.S. paid $11.8 billion in state and local taxes in 2012. Overall, immigrant men are more likely to be employed (86%) than native-born Americans (81%). Immigrants also tend to be more entrepreneurial than native-born Americans. In a 2012 report, the bipartisan Partnership for a New American Economy used three different Census Bureau surveys that collectively found that in 2011, 28% of new businesses were founded by immigrants, even though they represented only 12.9% of the population. At the same time, entrepreneurialism among the native born declined.
Many of those new businesses are small businesses, which is where jobs (and eventual wealth, as advisors well know) are created. However, the Partnership, along with the Partnership for New York City in a May 2012 report, “Not Coming to America: Why the U.S. Is Falling Behind in the Global Race for Talent,” said that 40% of the Fortune 500 companies were founded by immigrants or the children of immigrants. As its title suggests, however, the report argued that current U.S. immigration policy based on that 1965 law is holding back the American economy, which already has a shortage of younger workers and has seen an overall decline in new business creation. It also argues that without a change in immigration policy, by 2018 the country will face a shortfall of 230,000 qualified advanced-degree STEM workers (science, technology, engineering and math), who are heavily involved in “innovation industries.”
The 2012 Partnership report says that immigrant-owned businesses “generate more than $775 billion in sales and pay more than $126 billion in payroll each year,” and that “immigrant-owned businesses are more than 60% more likely to export” than non-immigrant-founded businesses.
Since the immigrant population in the U.S. tends to skew younger than the native born, and since immigrants have a greater labor force participation, they are also supporting some key social insurance programs for all Americans. Using government data, a 2014 report from The Partnership for a New American Economy found that between 1996 and 2011, “immigrants contributed $182.4 billion more to Medicare’s Hospital Insurance Trust Fund than was expended on their benefits.”
It’s not a stretch to suggest that the American business owners of the next 35 years will more likely be foreign born, and that regardless of how the tax code changes, or the immigration laws, they will need the kind of advice that you’ve been providing to native-born business owners.
How Wealth — and Retirees — Are Changing
Advisors’ client rolls are filled with retirees and those approaching retirement. With boomers continuing to reach retirement age in big numbers, advisors may need to change how and what they offer their retired clients based on the expressed — and sometimes unvoiced — desires of those older Americans.
Even without major medical advances (which seems unlikely), life expectancy for Americans continues to increase, even if at a slower rate than previously, and even though the gap between men’s life expectancy and women’s has narrowed slightly.
Using 2010 data, the Tax Foundation reported that there were 268,000 tax returns reporting more than $1 million in income. Millionaires tend to be married (86%) and tend to be older (80% are over age 45, with 33% aged 45 to 55). Including Americans at a lower income level — $200,000 in AGI and more — 73% have two or more earners in their households and 78% have a bachelor’s degree or higher education. And those higher earners tend to pay more in taxes: 22% of the total paid in 2010.
Those clients of yours who are nearing or in retirement are the first truly tech-savvy retirees, and they’re spending money on upgrading their home, according to survey results released in February 2015 by Merrill Lynch and Age Wave. The survey found that by age 61, the majority of respondents said that by that point, they “feel free to choose where they most want to live,” compared to younger cohorts who choose where they live based on family and work responsibilities.
One of the surprising findings from the survey: Of those retirees who have moved since retiring, 30% bought a larger home (19% bought the same sized home and 51% said they downsized). One of the reasons cited for upsizing: 16% reported they had a “boomerang” adult child living with them. Another trend among the older U.S. population: roughly 373,000 retired Americans lived abroad in 2013.
As homeowners age, the emotional value of their homes becomes more important to them, the Merrill-AgeWave survey found. While those aged 55 to 64 gave an equal weighting to their home for its emotional and financial value, 56% of 65- to 74-year-olds more heavily valued the emotional value of their home, while by age 75 and over, 63% said the emotional value of their home was more important to them.
While some advisors may help clients budget for home renovations as they age, recommending a good technology contractor may be even more important than finding a good carpenter, plumber or electrician. According to the Merrill-AgeWave study, retirees are particularly interested in technologies to:
Cut home expenses, e.g., smart thermostats or apps to control appliances: 80%
Monitor their health, such as sensors, alerts or medication reminder apps: 76%
Help optimize their health, such as with air purification or other devices to improve their sleep: 67%
Connect with their family and friends, such as video chat and interactive devices: 64%
Help maintain their home, such as cleaning robots or heated driveways: 58%
Greater overall life expectancy presents financial planning and life planning changes. Figures 4 and 5 (below) show how life expectancy has changed over the past 110 years, and also shows how the gap between men and women has narrowed.
In an interview with ThinkAdvisor.com’s Gil Weinreich in February, attorney Marcia Wagner argued that advisors should be “having frank discussions with their clients regarding ‘longevity risk’ and the resulting need to save even more, spend less, invest wisely and also potentially work longer — not just for the resulting increased benefit under defined benefit pension plans, but in order to earn money longer and stave off spending retirement savings.”
Wagner pointed out that if the IRS adopts even higher life expectancy assumptions from the Society of Actuaries, it may well require plan sponsors to increase plan contributions to raise pension plans’ funding ratios.
For the Social Security old age trust fund, higher life expectancy, lower birth rates and stagnant immigration together pose a serious threat to Social Security’s own long-term health, as seen in Figure 6 (below).
The problem, simply stated, is that there won’t be enough workers paying into the Social Security old age trust fund to support the increasing number of recipients. In 1950, there were 16 workers per Social Security beneficiary; in 1960, there were five workers per beneficiary; in 2015, the ratio is three workers to every beneficiary, and by 2025, the Social Security trustees estimate, there will be just 2.3 workers per beneficiary.
While nearly everyone knows what must be done to “save” Social Security — some combination of increasing the full retirement age, increasing the taxable maximum salary (now at $106,800) and trimming benefits — Chris Brightman, chief investment officer of Research Affiliates and a former pension fund official, puts the demographic issue into the broader economic context. He says there are essentially three drivers of economic growth for any country: population growth, increase in workforce participation rates and increases in productivity.
In light of the U.S. demographic picture, Brightman says, “our economic headwinds will continue for the next few decades.” Why? Because those three big drivers of growth are under pressure. U.S. population growth will decrease, he says. As for workforce participation rates, he admits that from 1960 to 2000, there was “big growth in employment participation — because of women entering the workforce. The rate for males has been dropping,” he says, “since before the financial crisis — it’s the baby boomers aging.”
Then comes productivity, which he says increases among workers up to age 50 when “you’re at your peak” productivity-wise and decreases as you age beyond that point. As the U.S. population becomes older, led by the baby boomers, productivity increases from workers won’t get higher. Unfortunately, “75-year-olds don’t produce anything; they consume,” Brightman says.
“This will be a political problem,” he argues. How to fix the problem? “We need to restructure pension plans” for one thing. While pension funds have seen a historical return of 8%, which they need to meet their liabilities, “you won’t be getting that now.” But since “we’re a rich country, we can afford to fix this” as long as we have the political will.
So how should advisors counsel their clients nearing retirement? “Work a little longer, save more and live more frugally in retirement,” Brightman suggests.