There is no magic wand that will instantly create a secure retirement for everyone. The fact of the matter is that Americans are responsible for creating their own financially stable retirement. Though Social Security keeps most seniors out of poverty, it provides a bare minimum of retirement income. And experts expect some changes to the program in the not-too-distant future.
Most Americans have to develop a siege mentality to retire securely. The battle to secure consistent retirement income involves a two-pronged attack: Save a lot and work a long time. Individuals are not entirely cast to the wolves, though: Regulators and lawmakers, with the help of employers, are constantly working to help Americans prepare for retirement.
Everything is in a flux, though. Some sources of retirement income are vanishing while others are gaining strength.
The traditional pension plan, also called a defined benefit plan, was the gold standard of retirement benefits. It provided workers with a steady stream of retirement income after putting in a number of years on the job. With promised pension benefits, a retiree could coast on easy street.
To protect retirement benefits, the Employee Retirement Income Security Act of 1974, or ERISA, set some minimum standards for the retirement plans established by employers. It basically forced employers to provide protections for the benefits promised to workers.
ERISA is a big piece of legislation. One provision created the Pension Benefit Guaranty Corp., or PBGC, which insures pension plans. Employers offering defined benefit plans must buy insurance to guarantee that a minimum level of benefits can be paid in case the business goes bust.
Some of the pension plans insured by the PBGC are single employer plans, provided by individual companies, and others are multi-employer plans. The latter are collectively bargained plans that are generally maintained by labor unions or several employers within an industry, such as trucking or coal mining.
Unfortunately, some multi-employer plans have become seriously underfunded in recent years. The problem: Some companies in these plans have gone out of business or their revenues have markedly decreased. In fact, the plans are so underfunded that the multi-employer program would have risked going bankrupt by 2025 if it had to pay out benefits.
To save the plans, changes had to be made, including the unthinkable: the ability to cut back existing pension benefits. In December, Congress approved such a change to ERISA affecting multi-employer pension plans. Many people say it sets a negative precedent.
“The rules changes were in certain respects a concern to some because they allowed suspension of benefits in some circumstances when the plan was very underfunded and risked becoming insolvent,” says Diann Howland, vice president of legislative affairs for the American Benefits Council.
“It’s easy to agree with those people; it is a terrible precedent. But there’s not enough money,” says Donald Fuerst, senior pension fellow at the American Academy of Actuaries. “How do you pay the benefits if you don’t want to cut them? No one has a real good answer for that.”
In any case, the number of workers in private industry who are covered by a defined benefit plan is shrinking all the time. Nearly 1 in 5 workers, 19 percent, had access to a defined benefit plan, according to the March 2014 National Compensation Survey by the Department of Labor.
There were nearly 10.4 million plan participants in multi-employer plans as of 2013, according to the PBGC. The underfunded plans covered nearly 1.5 million participants as of 2011.
It’s a relatively small slice of the populace, but if benefits can be cut for these people, even moderately, could they be cut for other defined benefit participants in the future?
Most workers don’t have to worry about the funding status of their pension because they simply don’t have one. Instead, 60 percent of the employed population has access to a defined contribution plan, typically a 401(k).
Unfortunately, the burden for saving in a 401(k) rests mostly with the employee. That has necessitated a little bit of behavioral finance jiujitsu from employers, enabled by regulatory agencies and lawmakers.
“The law has changed to allow employers to automatically enroll people in their 401(k) plans, if the employer chooses, and to auto-escalate contributions,” says Fuerst.
Workers can thank the Pension Protection Act of 2006 for making auto-enrollment and auto-escalation in retirement plans less of a liability for employers.
“People might be enrolled at 3 percent and might have an auto-escalation feature to go up (a percentage point) each year, to 10 percent. Those types of provisions are very effective at increasing the number of people participating in these plans,” Fuerst says.
There’s just one problem: “There are a lot of plans that don’t have those provisions,” he says.
Many have added automatic enrollment, though. A recent survey by Aon Hewitt found that 7 in 10 plans polled offered automatic enrollment at the end of 2014.
Once people retire with their sizable nest egg, decisions must be made about how to extract the money in a tax-smart, sustainable way. One recent rule change by regulators makes it easier for individuals to buy longevity annuities in their 401(k)s and IRAs.
Longevity insurance is a type of financial instrument that insures against running out of money in retirement. Income can be deferred until age 85.
“The reason the guidance was so important was one factor: the (required minimum distribution) rule,” says Steve Shepherd, partner and head of Institutional Annuities and Life Insurance Solutions at Aon Hewitt Investment Consulting.
For instance, if you buy a longevity annuity in a retirement plan, how do you get around the fact that you have to start taking distributions at age 70 1/2? You really couldn’t, since distributions had to begin at age 70 1/2.
Before the guidance, participants could buy the annuities in their 401(k) plans but could not take full advantage of longevity insurance, Shepherd says.
Regulatory agencies are doing other good things, as well.
“They are talking about rules to help (retirement) plan fiduciaries vet and do due diligence on some of these options from insurance companies and other providers. The government is providing a very easy way for plan sponsors to put these products in plans and to understand how to do it efficiently,” says Shepherd.
For those who aren’t crazy about annuity products, there’s the daunting task of converting a nest egg into a regular income stream. The government is trying to help plan participants predict their future income while they’re saving.
In 2013, the Department of Labor issued an advance notice of proposed rulemaking that would have retirement plan sponsors illustrate the amount of lifetime income a participant in a defined contribution plan could expect based on their savings. The lifetime income illustration would appear on 401(k) statements to give savers a clear measurement of how their savings will finance retirement. The estimated date of a proposed rule is July 2015.
In the 2014 retirement confidence survey conducted by the Employee Benefit Research Institute, a few questions were posed to survey respondents asking how they would respond to lifetime income illustrations. The survey found that 17 percent of respondents said that seeing the retirement income projection would cause them to increase the amount they contributed.
“That is so important because if I have my 401(k) plan and see that I have $500,000, I could have my plan sponsor project out for me what that $500,000 may be in terms of periodic income starting at a particular age,” Shepherd says.
Basically it would answer the question, “Do I have enough money budgeted so that I can live in retirement?” says Shepherd.
That is the eternal question. If the answer is “no,” spend less today in order to save for tomorrow.