"Retirement - Is There One in Your Future?"

Sydney M. Williams

Thought of the Day

“Retirement – Is There One in Your Future?”

April 28, 2010

After a day in which the Dow Jones declined 2.0% – the first decline in excess of 1.5% since February 4th and the longest period between such declines in three years – largely because of Greek debt concerns, it is worth considering the desperate situation of our own unfunded pension liabilities.

Writing in yesterday’s Wall Street Journal, Washington correspondent, Gerald Seib, wrote that just as the American government is addicted to debt, so are the American people. In a survey released yesterday, Putnam Investments of Boston found that 40% fewer Americans expect to fully fund their IRAs this year than last year and that “62% (believe) their savings are unlikely to provide them with a sizeable retirement nest egg.” With total retirement assets in the U.S. at about $18 trillion, that works out to around $175,000 per worker – nowhere near what will be required.

Two years ago, Roger Lowenstein wrote While America Ages. In the book he suggested that total cumulative retirement deficits are approaching one trillion dollars. Given a recent study by the Stanford Institute for Economic Policy Research, that number must understate the real situation. The Stanford study reviewed the unfunded liability for California’s three largest pension funds – CalPERS, CalSTRS and the University of California’s Retirement System – and determined that those three funds alone were underfunded by more than $500 billion. (The group at Stanford used a discount rate of 4.14% – a rate tied to the Ten-Year – versus discount rates of between 7.5% and 8% used by the three pension giants. Using the higher discount rate, the unfunded liability shrinks to $55 billion, but that discount rate seems extremely aggressive in today’s world.)

An estimated 78 million baby boomers will begin turning 65 in 2011, creating a further pressure on an already over-burdened Social Security System. Two years ago the federal government estimated that by 2017 Social Security would be paying out in benefits more than it was taking in. Four years ago the estimate had been 2019. It is now expected that more money will be paid out this year than the System will collect.

In the mid and late 1940s, the concept of a pension was an agreeable enticement and an attractive amenity for the young who had returned from the War. Society was less mobile than today. Families tended to be larger. And actuaries knew that life expectancy was in the late 60s and early 70s. For the most part pension assets were invested in Treasuries and High Grade Corporates. Typically, the discount rate used was the Ten Year Treasury. Given life expectancy, population growth and the safety of the investments, it was analogous to floating down a gentle stream on a comfortable raft. As the years went on, the current grew swifter. Baby boomers had fewer children and life expectancy increased. Pension managers began to seek higher returns and discount rates became more aggressive – thereby reducing corporate contributions.

By the late 1970s, corporate pension managers and consultants began to realize that future liabilities threatened the viability of their businesses; so they began converting defined benefit programs to defined contribution plans – 410Ks and the like. The onus for saving fell to the individual. But in a world in which consumption (conspicuous or otherwise) trumped savings, millions of aging baby boomers chose to live in the present and let the future take care of itself. Now, they are beginning to realize that the dream of a retirement for millions is turning into a nightmare. Reality is staring them in the face. Those still in defined benefit plans – today almost the exclusive purview of the public sector – risk bankrupting their cities and states. The only answer will be reduced benefits and more years at the wheel, as the price for promises that were easy to make but have proven impossible to keep.

Keeping with the river analogy, we are now in the midst of the rapids and the roar of the falls can be heard above the din of the deniers.

Can something be done? Of course; it will have to be so. Retirement age will be increased. Benefits will be reduced. The President has on staff a number of behavioral economists and he will need them to alter the tax code to discourage consumption and to increase savings. President Obama has done the right thing in establishing a bi-partisan National Commission on Fiscal Responsibility and Reform, headed by Alan Simpson and Erskine Bowles. Their first report is scheduled to be delivered in December, after the mid-term elections, and that is a positive thing, for their recommendations may well be harsh (and should be). In fact, if the Commission takes its mission seriously – and I am sure they will – many of their suggestions will appear draconian. But that is what it will take, if we are to avoid the fate of the Greeks.

The question, from where I sit: will Congress, which has shown a unique proclivity to excuse itself from any responsibility for the credit collapse, also do the right thing and have the courage to implement needed reforms, or will they follow the path of least resistance, a way that leads toward inflation and depreciation of the Dollar?