Pension Time Bomb
It’s estimated that there are over 50 million pensioners in the United States alone.
Like the United States, the United Kingdom, Japan, Italy, Germany, and many other countries around the world are all in big trouble when it comes to the solvency of their pension funds. I believe we are in the early stages of the greatest retirement crisis in the history of our nation and, indeed, the entire world.
Even if you don’t have a pension or a 401(k) plan, you are about to have your financial life severely disrupted by forces outside of your control. And second, regardless of whether you’re a Baby Boomer who is about to retire or a Gen X just starting in life, this systemic crisis will affect you.
What Is A Pension Plan?
To better define a pension plan, you first need to know the differences between the two types of retirement plans.
First, there is a Defined Benefits (DB) plan. DB’s include pensions as the primary component. DB’s were considered to be one leg of the Three-Legged Stool of Retirement Planning philosophy. The post-World War II generation used the Three-Legged Stool metaphor to represent the defined benefit plan, along with traditional savings and Social Security. When combined, all three “legs” would provide a comfortable retirement for almost everyone.
However, a few things challenged the strength of that plan.
First, President Nixon took the U.S. (and therefore the world) off the gold standard in 1971. Nixon did this because the US was increasing its trade deficits with other countries. In other words, we were importing more than we were exporting.
When a currency like a dollar, yen, or peso is not tied to real money like gold or silver, and governments can print more and more money out of thin air. This leads to the devaluing of the purchasing power of that currency.
The second event that weakened the Three-Legged Stool philosophy was the slow migration from DB plans into the second type of retirement plan: the Defined Contribution (DC) plan like 401(k) plans in the United States, the Super in Australia, and the RRSP in Canada.
In 1974, the Employment Retirement Income Security Act (ERISA) was passed in the United States that set minimum requirements for private companies to provide retirement and health plans for their employees. This lead companies to change from a pension plan (which guaranteed money to its employees) into Defined Contribution plans instead.
Kim and I had Ted Siedle, the co-author of my book Who Stole My Pension” on our podcast, The Rich Dad Radio Show.
Ted explains how ERISA didn’t cover public pensions.
“… believe it or not, state and local pensions aren’t governed by any comprehensive federal law or any comprehensive law at all. Corporate pensions are governed by something called ERISA. The employee retirement income security act, which has a lot of requirements for corporate pensions. Public pensions are not subject to ERISA.
And what you find across the country is the boards of these public pensions are made up of politicians, school teachers, firefighters, cops, sanitation workers. So there’s no one on these boards that has experience managing pensions and there’s no law that requires. So if you, if you’re thinking that the person running the board overseeing your pension knows what they’re doing, that’s just plainly not true and all you have to do is look up the biographies of these people and you’ll see that they are typically either elected officials or state employees.”
For example, Ted continues to explain the looting of Rhode Island pensioners:
“Rhode Island was a crazy situation. About seven years ago, a little-known so-called money manager, a woman named Gina Raimondo ran for state treasurer. And with the support of a lot of major Wall Street firms, she got herself elected to run the $8 billion state pension.
This woman who had had virtually no experience in investing got control of this $8 billion pension fund that controls the state economy. So the first thing she did was she told people that they needed to cut the benefits, paid to the workers by 3%. That’s an austerity plan to improve the financial health of the pension. But what she didn’t say was that she was going to pay Wall Street 4% on the riskiest gamble the state had ever taken in hedge funds and high-risk private equity funds that ultimately cost the pension half a billion dollars. And so for small states like Rhode Island losing half a billion dollars of the $8 billion pension is devastating. How do you make up half a billion dollars?”
Rhode Island is not alone. Half of all state and local pensions have cut pensions since 2008 and more will be facing cuts in the future. The widespread looting Ted has been investigating is global in its reach. Everywhere from Croatia to the UK and Australia to Japan are feeling its effects.
The 401(k) vs Pension Plans
Returning to the 401(k) and other Defined Contribution plans, Ted continues to explain that these new company-sponsored retirement plans were slowly gaining popularity with companies as a cost-saving measure to replace the pension.
As Ted sees it, the truth is that the 401(k) will never provide the level of retirement security that a pension provided. The average 401(k) account for a 65-year-old is only $50,000. For most people, that will barely cover expenses for a full year.
Take the police force of Atlanta, for example. Ted was recently hired to sit down with their city council to migrate their failing pension plan into a 401(k)-type plan. As he sat in a room with a few hundred armed policemen, he had to inform them that the proposed 401(k), regardless of its performance, was never going to outperform their current pension. According to Ted, the public servants were having their gold ripped away and replaced with a lump of coal.
The Death of the Pension Plan
While working with Ted on Who Stole My Pension?, Ted said, “Every pension death I’ve witnessed involved multiple experts responsible for monitoring the deceased’s ‘vital signs’ i.e. soundness of the plan, including the calculation of future liabilities and assumed rates of return, allocation of assets, and fees paid to investment managers. The judgments of these so-called experts are rightfully called into question by the unexpected death. To the extent they may have contributed to the demise of the plan, they should be held accountable.”
Pensions don’t just implode overnight. There are always warning signs or ‘red flags’ that have been disregarded for decades. Why? Pension deaths are almost always foreseeable. Likewise, pension deaths are almost always preventable. If not foreseen and prevented, then someone was not doing their job.
How To Save Your Retirement
If you’re a boomer, this news should be a wake-up call for you. Many people don’t realize how expensive retirement is. Today, many who’ve reached retirement age are bagging groceries to make ends meet, and that is still not enough.
The good news about a wake-up call is that it also presents an opportunity. Before you get too far down the path of financial ruin, take the time to honestly assess your financial position.
First off, list out every expense that you have. This includes things like your groceries, estimated health costs, travel, and entertainment. And then assume they’ll only go up by 3 to 5% per year, especially health costs, which by some estimates are expected to be 40% higher by 2035.
Oftentimes, we’re unaware of how much we truly spend. So it’s helpful to go over your bank records for the last couple of years to get a full picture of how much you truly spend and on what you spend your money.
Next, list out your income in another column. Then, take your hand and cover your income. What would you do if you didn’t have it and had to pay those expenses?
I like to do this exercise because it brings home the reality of how precarious our financial states can often be. The reality is that you don’t have an income when you retire to rely on, so your investments better do the trick.
Taking a look at your portfolio of investments, do you think you have enough cash flow to cover your expenses each month? If you’re like most people, the answer is no. Rather than have cash flow, most people have a strategy to pull money out of a saving account like a 401(k) each month. That is not income, it’s savings, and it will eventually run out.
So, the question you need to answer is this: how much cash flow would you need each month to retire comfortably and not worry?
Once you know how much money you need in cash flow to cover your expenses, it’s time to start investing in assets that produce cash flow like real estate or business.
You can start small and continue to reinvest your returns into more and more cash-flowing investments. If you have a large amount of money stashed away in retirement accounts, I would explore what it would take to move some of it into these types of investments, ones that will provide true cash flow and thus true peace of mind come retirement time.
Editor, Rich Dad Poor Dad Daily