Category Archives: Pension

The Importance of 401(k)s.

Pensions are fading fast.  If you work for a private company the chances are good that your retirement plan is a 401(k), not a pension plan.   Even if you work for the government, the chances are that the entity you work for will resemble Illinois eventually.

That leaves you with the responsibility for your retirement.  There are two problems with the 401(k).

The first is that too many people do not participate.  Even when employers match their employee’s contribution, not everyone takes advantage of this “free money.”

The second problem is that most people don’t have enough information on the investment choices they are given in their 401(k).    Investing is complicated.  Most plans offer dozens of choices and few people know enough about investing to use them to create an appropriate portfolio.

Employers are not equipped to provide the information.  Most do not want to assume the liability that giving investment advice exposes them to.  An RIA (Registered Investment Advisor) who is also a CFP™ can provide the guidance people need to make sense of the investment option in a 401(k).   Find a CFP™ in your area.

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Fixing the Public Employees’ pension crisis

Public employee pensions are time bombs set to explode.  The State of Illinois finances are in such a state of crisis that its comptroller, Susana Mendoza, has told the legislature that over 90% of its monthly revenue is now being commandeered for court-ordered payments, primarily to pay current pensioners.  If Illinois does not pass a new budget within a few days there will be a financial crisis.

According to Forbes:

Public employee pension plans around the country are facing a shortfall of at least $1 trillion, and some of the largest plans are beginning to radically cut promised benefits because they have not stashed away enough to meet their obligations.

There is only so much money to go around.  Promises that can’t be kept won’t be kept … and that includes pensions.

One sign of things to come is a bill signed by Pennsylvania Governor Tom Wolf.  It reforms the state pension system that makes it more sustainable.

 “Let’s be clear: This plan addresses our liability in the only real and responsible way possible, by changing the structure of pension benefits,” said Mr. Wolf. “The fact is, we cannot accelerate the shrinking of our liability on the backs of our current employees, and this bill recognizes this in a real, concrete way.”

The bill moves new workers not in high-risk jobs such as state police and corrections officers into a hybrid retirement system.   Half of their retirement benefits will come from pensions paid for by the taxpayer and the other half will come from a 401(a) defined contribution plan.  A 401(a) is similar to a 401(k) but for public employees.  There are differences, but both transfer responsibility for retirement income to the employee and away from the employer.

The law is projected to save more than $5 billion and shield taxpayers from $20 billion or more in additional liabilities if state investments fail to meet projections, said a news release issued from the office of Republican Sen. Jake Corman, the bill’s chief sponsor.

We suspect that Pennsylvania is just the first state to adopt a system that transfers the responsibility for public employees’ retirement income away from the taxpayer and toward the employee.  It levels the playing field between public and private employees.

It will also make financial planning increasingly important for everyone.

Click HERE for questions about financial planning.

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What is the difference between a 401(k) and a pension plan?

Both plans are designed to provide income for retirement.  There are some very important differences.

A 401(k) is a type of retirement plan known as a “defined contribution plans.”  That means that you know how much you are saving but not how much it is worth when you are ready to retire.  That depends on your ability to invest your savings wisely.  The benefit is that your savings grow tax deferred.  Many employers match your contribution with a contribution of their own, encouraging you to participate.

A pension plan is known as a “defined benefit plan.”  That means that you are guaranteed a certain amount of income by the plan when you retire.  The responsibility of funding the plan and investing the plan assets are your employer’s.

Because your employer is liable for anything that goes wrong with the pension they have promised their employees, many employers have discontinued pension plans and replace them with 401(k) type plans.  This shift the responsibility for your retirement income from the company to you.

If you have a 401(k) for your retirement and are unsure about the best investment options available to you, get the advice of a financial planner who is experienced in this field.

For more information, contact us.

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Is your retirement plan a ticking time bomb?

In your mind’s eye, how do you see yourself living retirement?  Does it include the activities that you enjoy now … without the time you spend at work?  When you have the time, do you see yourself seeing the world?  Retirement presents an opportunity for some life-changing experiences.

But there are a few things that can cause those retirement dreams to become nightmares.

If your retirement plan includes a pension, you may want to consider the risk.  It is a fact that many private and public pension plans are sadly underfunded.  Some public pension plans are the worst offenders.  As an extreme example, the Illinois General Assembly Retirement System is only 13.5% funded.

A long period of very low interest rates means that pension plans with large bond investments have generated low returns.  It has caused others to take greater risk.  At some point that can affect the pensions of those who believed their Golden Years were paid for.

Living longer than you expected is another risk.  In 1950 the average life expectancy was 68.  That meant that the average worker retired at age 65 and died three years later.

Sixty years later, in 2010, the average life expectancy was 79 and many people are living longer.  In 2010 there were 1.9 million people over age 90 and three quarters of those were women.  One of the biggest concerns that retired people have is running out of money as savings are eroded by inflation.    How would living past age 90 affect your retirement plans?

The third thing that is causing the average worker concern about retiring is insufficient savings.  Fewer people are covered by pension plans.  Many employers have replaced guaranteed pensions called “Define Benefit Plans” with 401(k)s and 403(b)s known as “Defined Contribution Plans.”  This transfers the responsibility for retirement from the employer to the employee.  Too few people are taking advantage of these programs, not saving enough, and making unwise investment choices.  This can result in insufficient savings when the time comes to actually retire.  One result is that more and more people continue to work well past the traditional retirement age of 65.

What is to be done?

We have to accept a greater responsibility for our own retirement.  We have to be honest about how safe those pension promises are, whether we work of a large corporation or for a government entity.  We have to start saving early and make wise investment choices.  One of the wisest things people do as they prepare for retirement is get the services of a competent retirement professional who will guide them to a safe haven at the end of the road.

 

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Effective Retirement Plans Do Not End at Retirement

There are those fortunate individuals who, because of wise planning, are able to retire without having to worry about how much money they can spend after their paychecks stop.  These people can afford their needs and wants from sources like pensions and social security that adjust for inflation.  They have probably been saving all of their lives and have always lived below their means.  Others are not so fortunate.

Most middle class retirees fund their retirement spending from Social Security, a pension (perhaps), and income from investments.  Because people often live several decades after retirement, it’s vitally important to make estimates and projections about the future.

Here are just a few of the things that factor into how much it will cost to live once you retire:

  • Your basic living expenses; your “needs.”
  • The cost of your “wants” and “wishes” above your basic expenses
  • The age at which you want to retire.
  • The number of years in retirement.
  • Spousal income and, in two income families, the age at which each spouse retires.
  • Your pension benefits.
  • Life, disability and long-term-care needs.
  • The age at which you apply for Social Security.
  • The value of your investment assets at retirement.
  • The estimated return on your investment assets.
  • Your risk tolerance.
  • The rate of inflation during retirement.

Putting all these factors together is a complicated process that’s beyond the capability of most individuals who don’t work in finance.  Complex planning programs have been developed that can provide answers.  These answers typically provide a probability of success or failure via a procedure called “Monte Carlo” analysis.

We have found that people who begin planning early can make appropriate mid-course corrections while they still have time.  It also provides them with the peace of mind.  Having a well-thought-out plan for the future removes a great deal of worry an uncertainly.

If you are approaching retirement without a plan, give us a call for more information.  We would be happy to meet with you to discuss your needs.

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Even the “rich” can’t afford retirement.

Investment Approach

Registered Investment Advisors (RIAs) deal with people at all wealth levels but most are upper income even if they are not billionaires.  There is a retirement crisis and it’s not just hitting the working class.

The typical median wage earner making $50,000 a year and retiring at 67 can expect Social Security to pay him and his wife about $2400 per month.  To maintain their previous spending levels this leaves a gap of about $1000 a month that has to be made up from savings. But many of these middle income people have not saved for their retirement.  Which means working longer or reducing their lifestyle.

This problem is also hitting the higher income people.  How well is the person earning over $200,000 a year going to do in retirement?  The issues that even these so-called “rich” face are the same:  increased longevity, medical care, debts and an expensive lifestyle are all issues that have to be considered.

“The $200,000+ executive expects a fine house, two cars, two holidays a year, private schools, to pay for his kid’s university tuition, and so it goes on. And this is not to mention the tax bill he’s paying on his earned income. A bunch of all this was really debt-funded, so effectively the executive spent chunks of his retirement money during his working days.”

When high income people are working, they usually don’t watch their pennies or budget.  But once retired, that salary stops.  That’s when savings are required to bridge the gap between their lifestyle and income from Social Security and (if they’re lucky) pension payments.  At that point the need for advance planning becomes important.

Before the retirement date is set, the affluent need to create a retirement plan.  He or she needs to know what their basic income needs are; the cost of utilities, food, clothing, insurance, transportation and other basic needs.  Once the basics are determined, they can plan for their “wants.”  This includes things such as replacing cars, the cost of vacation travel, charitable gifts, club dues, and all the other expenses that are lifestyle issues.  Finally, there are “wishes” which may include a vacation home, a boat, a wedding, a legacy.  The list can be a long one but it should be part of a financial plan.

If the plan tells us that the chances of success are low, we can move out our retirement date, increase our savings rate or reduce our retirement spending plans.

This kind of planning will reduce the anxiety that is typically associated with the retirement decision making.

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The Retirement Dilemma Facing American Workers

illustrated-financial-roadmap-750

The way Americans fund their retirement has undergone a fundamental transformation in the last 30 years. According to the Bureau of Labor Statistics, the percentage of private-sector employees with a traditional defined benefit pension plan has dropped from about 45% in 1980 to a little over 20% in 2011. A defined benefit pension plan is one that provides the retiree with a guaranteed income for the rest of his or her life.

The guaranteed pension has been replaced by a defined contribution plan. Today, about 50% of the private workforce participates in one of these plans, which include 401(k) plans and 403(b) plans and allow the worker to set money from their paycheck aside to grow tax-deferred until they retire, at which point they can start pulling from it to fund their retirement. However, there is no guarantee that the amount saved will be adequate to meet their income needs once they retire.

Most government workers still have access to traditional defined benefit pension plans. However, most of these plans are severely underfunded and questions are being raised about cities and states being able to pay the benefits that were promised. A recent poll of people 25 years and older concluded that “Americans are united in their anxiety about their economic security in retirement.” Over 75% of those surveyed worry that economic conditions might hurt their chances for a secure retirement. (For related reading from this author, see: How Retirees Should Think About Retirement Income.)

Social Security and Medicare Concerns

The federal government provides a basic level of retirement income via Social Security, and provides a basic level of health insurance via Medicare and Medicaid. However, these programs are on shaky ground according to most actuaries. The Social Security Trust Fund will run out of money around 2034 unless it is reformed. That does not mean that checks will not go out to retirees, but it does mean that the amount going out will decrease.

Medicare is in even worse shape and, with the continued rapid rise in medical costs, may face a crisis even sooner. The costs of health care and increasing life spans are major issues for retirees, which explains the reason that so many Americans think they are facing a retirement crisis in the first place. Given the level of debt at the federal level and the rhetoric of the current administration, we do not see the government jumping in to fund the American worker’s retirement at levels above what it does now.

Even Denmark, an icon of the Welfare State, is proposing tax cuts, reducing welfare benefits and raising the retirement age.

“We want to promote a society in which it is easier to support yourself and your family before you hand over a large share of your income to fund the costs of society.”

Funding Your Own Retirement

If the government is not going to come to the rescue, and if corporations are going to continue to unload the financial risks and burdens associated with pension plans, what is the answer? Look to the old saying, “If you want something done, do it yourself.” Going forward, it’s increasingly going to be up to the individual American worker to fund his or her own retirement.

If people begin saving early, a large part of the retirement problem will be solved. The most valuable asset that people have when they are young is time. If workers begin putting money aside at an early age, it will grow and compound for 40 to 50 years until retirement, solving a large part of the problem. The compounding of returns is what makes so much of the difference.

Here is a little math exercise: assume you begin by saving $25 per month—much less than the cost of having one decent dinner at a restaurant—and invest it conservatively so that it grows at 5% per year. At the end of 45 years you will have $50,000. Now assume that you increase your savings by 10% each year—so that in year two you save $27.50 per month (still far less than the cost of just one dinner out)—at the end of 45 years you have $400,000 to use in retirement. These examples go to show that saving a modest sum for retirement does not require much cost or effort, just discipline, time and patience.

Financial Education is Key

The greatest asset that young workers have is time. Unfortunately, people rarely enter the workforce knowing much about saving or investing. That is one reason so many people live paycheck to paycheck. The solution to the retirement crisis is achievable by educating young people and raising awareness. Until schools and colleges begin having mandatory courses for our young people about managing money, parents should be doing this. If they are unsure, they can put their children in touch with a financial planner who will spend time to provide the education. Many financial planners are beginning to offer hourly rates to help people learn to plan and budget.

For most people, the retirement problem is the result of a lack of information. The solution is right in front of us, if we realize that times have changed and people must change with it.

(For more from this author, see: Are You Ready for the Retirement Challenge?)

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The Public Pension Crisis

Government workers at all levels are likely to have pension plans but there is a big question about the plans’ ability to pay.

According to the Bureau of Labor Statistics (BLS), 92% percent of full-time government employees like teachers and police officers are eligible for pensions, known as “defined benefit plans.”

According to the BLS about 22% of workers in the private sector have pensions, down from 42% in 1990.  In the private sector, retirement plans are much more likely to be 401(k) plans, known as “defined contribution plans.”  Part of the reason for this is that some large companies, like General Motors, accrued huge pension liabilities over the years that they were unable to pay.

Since the Federal Government can print money, federal employees are not worried.  However, states and municipalities depend on their tax base and can’t print money.  That’s where the problem comes in.  Some estimates claim the unfunded liability of public pension plans exceeded $3 trillion dollars.

According to Governing, the city of Chicago’s has an unfunded pension liability of almost $20,000 per capita.  Other cities are somewhat better off, but no big city has a fully funded pension account.  Dallas and Denver, for example are on the hook for between $8,000 and $9,000 per resident.  It’s difficult to even measure the amount of indebtedness because political leaders really don’t want to discuss it.

The problem has been exacerbated by rate-of-return assumptions that are unrealistic.  Most pension funds assume that their assets will grow at rates of seven to eight percent per year indefinitely, a virtual impossibility in this age of low interest rates and sluggish growth.

What does that mean for public employees?   They may want to cast a wary eye on Puerto Rico and some cities in California who have gone into default.  As a wise man once said, “something that can’t go on forever, won’t.”  A little planning ahead won’t hurt.

Whether you are a public employee or work in the private sector we welcome your inquiries.

 

 

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Retirement statistics

  • 65 – The age at which the average American expects to retire, up from 63 in 2002.
  • 26 – Percentage of baby boomers who expect to retire at age 70 or later.
  • $265,000 – the estimated amount a couple, both age 65, should expect to spend on health care.
  • 22 – Percentage of couples who factor health care costs into retirement.
  • 30 – Percentage of adults born in the 1940s and 1950s who have traditional pension plans.
  • 11 – Percentage of adults born in the 1980s who are expected to have a traditional pension plan.
  • 60 – Percentage of medical expenses that Medicare by itself covers.

If some of these statistics don’t scare you read them again.

For others, we may be able to help.

And read the first three chapters of Before I Go.

 

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How much annual retirement income will you have?

Most people believe that their home is their most expensive thing they’ll ever pay for.  They’re wrong.  The most expensive thing people ever pay for is retirement. And they’ll pay for it after they quit working.

That’s why it’s important to have a clear idea of what you’re getting into before you decide to tell your employer that you’re leaving.

The typical retiree’s sources of income include Social Security.  They may have a pension, although fewer companies are offering them.  If there is a gap between those sources of income and their spending plans, the difference is made up by using their retirement savings.

Running out of money is the single biggest concern of retirees.  The big question is how long we will live and the amount we can draw from our savings before they are depleted.

For simplicity, let’s assume: You’re ready to retire today and plan to have your retirement savings last 25 years. You’ve moved your savings into investments that you believe are appropriate for your retirement portfolio. The investments will provide a constant 6% annual return. You’ll withdraw the same amount at the end of each year.

If you saved this amount Here’s how much you could withdraw annually for 25 years
$100,000  $7,823
$200,000 $14,645
$300,000 $23,468
$400,000 $31,291
$500,000 $39,113
$600,000 $46,936
$700,000 $54,759
$800,000 $62,581
$900,000 $70,404
$1,000,000 $78,227

Keep in mind that these examples don’t include factors such as inflation and volatility that can have a big impact on your purchasing power and account value.

For example, if inflation were 4% a year, a withdrawal of $31,291 25 years from now would only be worth $11,738 in today’s dollars.

Investment losses would decrease your account’s growth potential in subsequent years. To account for these factors, you might need to save even more.

Many experts estimate that you’ll need 80% or more of your final annual salary each year in retirement. Social Security may only provide around 40% of what you need. And don’t forget that retirees typically have different types of expenses compared to people still in the workforce, such as increased health care and travel costs.

This is why planning is so important.  A financial plan will provide you with answers to many of these questions.  Retirees also need to reduce the chances that their portfolio will experience major losses due to market volatility or taking too much risk.  This is where a Registered Investment Advisor who is also a Certified Financial Planner (CFP®) can help.  At Korving & Company we prepare retirement plans and, once you approve of your plan, we will manage your retirement assets to give you peace of mind.

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