A Paradigm Shift of Income Planning

The retirement crisis is likely to continue given the direction our pension plans are heading.  It is no secret that the traditional pension plan is pretty much unheard of in the private sector.   Today, your only real hopes of receiving a pension are through a government job.  Even at that, state and federal governmental authorities are struggling to make the payments on a monthly basis.  This is all the more reason why employees need to take their retirement needs into their own hands. 

With the lower yields, pension plan administrators have to take on much more risk in order to keep up with the billions of dollars in monthly payment obligations.  Many payment obligations today were designed decades earlier when the economy could favor annual yields of 7 -8%.  The global recession yields today are closer to 2%.  So in order to make up difference, administrators are turning to higher risk investments, many in the form of junk bonds.  Unfortunately, higher yield potential comes with a greater chance of default.

U.S. pension plan managers are investing large amounts of capital into smaller speculative-grade borrowers, trying to yield the magic 8% yield needed for their payment obligations.  Much of this debt is from smaller start-up companies looking for capital to try and capture a small portion of a saturated market.   Borrowers with less than $500 million in annual revenue are paying much higher returns since big banks have decreased small business lending by 12% since 2008.  Big banks have decreased their lending to these smaller companies due to the default ratios they were experiencing.  None the less, fund managers are actively pursuing these debts due to the Federal government’s promise to hold interest rates low through 2014. Unfortunately, these are the risks fund managers are being forced to take on in order to make these overwhelming payment obligations.  This is a destructive trend, and regrettably a necessary evil.        

According to a study by the Pew Center on the States in Washington, states were $1.38 trillion short of their retirement obligations in 2010; which was up 9% from the year prior.  These numbers include $757 billion in underfunded pension obligations and $627 billion short in retirement health.  These numbers will continue to snowball with low interest rates making it impossible for this trend to continue without exploring alternate forms of revenue. 

A few weeks ago voters in San Diego and San Jose, California approved measures to restructure benefits for municipal workers in cities that could not afford them.  Several states including Wisconsin, Indiana, and Ohio have already started to limit collective bargaining for public employees, and have started cutting benefits accordingly.  These limitations include reduced payouts for pensions and drastically less protection of healthcare benefits.  Many other states, including Texas, are trying to renegotiate less favorable benefits for teachers and state administrators in order to help cut costs.  Eventually, government pensions are likely to go away in exchange for a deferred compensation plan, following the suit of the private job sector. 

It is no secret where this is heading.  We are seeing a paradigm shift from the responsibility of the employer to the employee.   Employees today are being forced to be more self reliant with respect to health care and retirement obligations.  Relying on employer or governmental obligations is proving to be a trend of the past.  Because of this, many employees are redirecting their deferred compensation plans to vehicles that will yield an income stream within retirement.   Vehicles not dependent upon a fund manager yielding needed returns, but instead with income guarantees backed by cash reserve pools.   These income streams are guaranteed for life and use income account values (non-cash values) to determine the amount of income one is eligible for at a given age (usually from ages 50 to 90). 

Failing to adapt to these market trends is going to result in Americans struggling throughout their retirement years because of lack of income.  Social Security and pensions simply will not exist for many in the coming years.  I believe that every US citizen under the age of 50 should not count on much, if any, social security benefits being available to them starting at the age of 62.  Furthermore, when you take into account that over 90% of workers today are not being offered pensions, the idea of a lifetime income becomes very attractive.  Once again, adaptation is the key.   Those who fail to secure their income needs for retirement can count on being a future burden to this country.         

Death of the Traditional Pension Plan

The traditional pension plan is a concept from the past that is likely to never come back to the American culture.  The concept of the pension plan is ingrained into the fabric of our country’s roots, and Generation X is going to be the first generation in US history that will not experience the benefits of this retirement plan.   Through adamant deregulation of the investment banking industry from the early 1980s throughout the 1990s, deteriorating market conditions have caused corporations to steadily abandon the traditional pension plan.     

The first pension plans in the US were given to veterans of the Revolutionary War, and more extensively in the Civil War.  The promise for a guaranteed paycheck in exchange for your services to your country was an attractive motivator for soldiers, and still is today (and rightfully so).   The concept of this idea caught wind and extended to state and local governments through the late 19^th century.  This unique retirement plan attracted several employees to governmental jobs and helped grow our government accordingly.

The first organized civilian pension plan was offered in 1920 through the Civil Service Retirement System (CSRS).  This organization provided retirement, disability, and survivor benefits for nongovernmental employees.  It was the first of its kind on US soil.  Once the CSRS was formed, the American dream of retirement became a reality for civilians.  The CSRS remained in power until 1987 when it was renamed Federal Employees Retirement System (FERS).

After the Great Depression, Wall Street integrated its entire financial planning ideology around the concept of the pension plan.  Since income planning was not an issue, thanks to the popular pension plan and social security, the accumulation of funds to supplement retirement took center stage.  This financial planning practice turned into a multibillion dollar industry for several decades.  This was able to happen because the Glass Steagall Act limited Wall Street on the amount of risk they could take on by separating financial services, which in turn allowed for consistent growth that fueled the economy and embedded the pension as the retirement dream in the US.

 The traditional pension plan started to fade quickly in the latter part of the 1980s.  Wall Street’s attempt to deregulate the financial sector, and overturn the Glass Steagall Act, was unfortunately starting to prove successful.  After the Monetary Control Act of 1980, banks were allowed to dictate what interest rates they were able to pay on CDs and fixed accounts as well as what interest rate they wanted to charge on mortgage loans.  With this act, some banks started to pay CD rates as high as 20% and charged interest rates on home loans as high as 20% as well (rates that never reached this level before).  Prior to this act, home loan interest rates were federally regulated to prevent such actions.  This ultimately led to the recession of the 1980’s and for the first time in our US history the number of companies offering traditional pension plans started to decline. 

Deregulation continued to take its toll throughout the 1990s and allowed the investment banks to control all the financial sectors without any limitations.  Once again, prior to 1980 the Glass Steagall Act prohibited these actions from taking place and in turn allowed the market to sustain positive growth for several decades.  Eventually, the actions of our top investment banks brought upon the Collateralized Debt Obligations (CDOs), which ultimately led to the Financial Collapse of 2008.  The rest is recent history. 

The steady decline of the pension plan in the 1980s was replaced with an escalating number of deferred compensation plans.  The burden of retirement was placed on the employee, as most employers could not afford to pay the pensions. Over the last 12 years most deferred compensation plans have yielded a negative return, drastically delaying retirement for many.  Volatility continues to be the norm and the only real remedy is the hopes of the Federal government cutting a check at the tax payer’s expense. 

Without refocusing long term planning efforts to income planning, this trend is likely to continue.  Most experts today agree that Americans under the age of 50 will only see a fraction of what social security pays today.  Furthermore, with the vast majority of Americans without a pension for retirement, most will be walking into retirement with near zero income.  Those who fail to act on contractual income guarantees will fall victim to this retirement trap, and their only hope is to rely on a deferred compensation plan that has at best broken even over the last decade.  Bottom line, the traditional financial planning method is not working, and will continue to deteriorate the American dream of retirement.

Today the only promise of income planning for life is offered through the Insurance industry.  Instead of focusing on hedging against risk for the investor, they focus on guaranteed payouts through a non cash value account known as an income account value.  In exchange for a lump sum amount, an investor can guarantee an income stream for life while having access to the cash value as well (a feature the traditional pension plan failed to offer).  This payment is guaranteed regardless of future market conditions through protected cash reserve pools.  The longer one waits for an income stream, typically the more income they will receive. 

During the financial collapse of 2008 the Insurance industry had record sales utilizing lifetime income.  The need for income planning could not be more important.  Investors are starting to realize that a paycheck for life is outweighing the need to try and beat the market within a global recession.  Make no mistake about it, those who fail to utilize proper income planning are likely to never retire; or at best severely delay their retirement.