Pension Thinking
Pension plans, designed to provide lifetime income upon retirement, are being abandoned or are facing economic challenges.
→ The collapse in 2000 brought to light corporate pensions’ underfunded status. As a result, companies moved aggressively to have employees self-fund their retirement through 401ks and other defined contribution plans.
Public pensions continue (mostly state and municipal), however, these plans face an estimated $6T of benefits earned but not yet paid for, according to one recent article. The public pension shortfall is a result of overzealous asset return estimates (7.5% is reported to be the norm), which has led to serial underfunding. The public pension numbers above do not include Social Security’s well publicized long-run problems. Currently, the Old-Age and Survivors Insurance and Federal Disability Insurance (OASDI) trust fund reserves will be depleted in 2034, according to Board Trustees‘ most recent report (Social Security’s issues are more related to demographics). Three strikes against the sustainability of pension plans: corporate, municipal and national.
“Financing retirement spending is no easy task. But despite the challenges, we encourage 401k and IRA owners to think of retirement planning as creating their own household pension.”
The lesson to be learned from these institutional pensions? Financing retirement spending is no easy task. But despite the challenges, we encourage 401k and IRA owners to think of retirement planning as creating their own household pension. Doing so requires looking beyond asset values to the amount of income needed upon retirement. Understanding pension math is important and involves a basic NPV calculation where future spending is discounted at the portfolio’s expected return. The result is a “funding ratio” of sorts. If current assets exceed discounted future spending, a surplus exists. With realistic inputs (0% Real?) applied to this framework and a commitment to ongoing monitoring, outcomes can be improved while avoiding the pitfalls experienced by institutional pension managers. ⇣
⇢ How does this proposed framework compare to what is being offered in the marketplace today? Quite simply, there is a stark difference. While the pension approach focuses on future cash flows by incorporating assets and future spending liabilities, 401k providers and IRA custodians largely report performance based on asset-only values and their (short-term) performance. The former is designed to promote retirement sustainability while the latter is arguably designed to encourage short-term trading activity.
When current industry practices are not getting the job done to prepare working professionals for retirement, isn’t it time to consider a different approach? Stop focusing solely on returns and expand your approach to match current and future assets with retirement spending.
Finally, while we’ve focused exclusively here on the role 401ks and IRAs play in your retirement plan, it’s important to note that Social Security, home equity and even legacy pension benefits may play a role in your retirement income plan. Any comprehensive retirement balance sheet will incorporate and track the value of these valuable resources. ⬥
Investment advisory services provided by Forward Wealth Management, LLC. Past performance may not be indicative of future results. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.