Will you Die Poor?

With the gradual decline in defined benefit retirement plans the issue of saving for one's old age becomes important. I'm not going to rehash all the common financial advice that one sees coming from those who stand to make money of the situation.

Rather I'm just going to point out how difficult the problem is, and how much the average person is at risk of having an impoverished old age.

For the past decade, or so, the long term interest rates have been in the 4% region. Let's assume that this continues to be the pattern. Now the median family income is about $60,000 per year. Let's also assume that one can get by on less during retirement, say $40,000. Well, at 4% return this implies having a nest egg of $1,000,000. With this amount one could put the money into to treasury bonds and live off the interest. This, however, leaves out the effect of inflation. While inflation has been at about 2% during most of Greenspan's tenure at the Federal Reserve, it has now crept up to about 4%. What this means is that in about 18 years your $40,000 annual withdrawal will only have about $20,000 in buying power.

There are a couple of options. One could buy an annuity with the $1,000,000 nest egg. A straight annuity generally yields about 6% so you would get $60,000 per year from your nest egg instead of $40,000. The difference is that in the first case your principal would be intact and could be left to your heirs, while in the second they would get nothing. These are rough figures. There are options which guarantee a certain minimum number of years of payout to guard against the risk of dieing to soon, or getting a graded payout which tries to compensate for inflation. These are just additional forms of insurance bundled into the annuity and, thus, lower the payments.

Now most retirement planners include Social Security as well. So let's throw that into the mix. We assume two wage earners of median income having a full working life. In this case the annual benefits would currently be in the $15,000 to $20,000 range. So if we add this to the annuity payout of about $30,000 we will still require about a $500,000 nest egg. How does one accumulate this amount?

Putting $10,000 per year into treasury bonds at 4% for 30 years will yield a little over $500,000. The mutual fund industry wants you to put the money into stocks. Let's assume the long term average yield is about 7%. In that case you only need to put about $5,000 per year aside. The problem with this approach is that all the risk is concentrated at the end. During the period from 1971-73, for example, the value of stock funds declined by half. If you had chosen to retire in 1973 and move your money into an annuity it would have been as if you had thrown away 15 years worth of retirement savings. Stock funds are really too risky for one's nest egg. The mutual fund industry has started to offer "life-cycle" products which shift the proportion of money invested from stocks and into bonds as one gets older. This just means that the growth rate will be less and the eventual nest egg will also be less. As an estimate let's split the difference and say you will need to contribute $7,500 per year as a balance between growth and safety.

Given your current life style and expenses, can you do it? Can you take about 10% of your gross earnings and set it aside each year? It would seem that most median income families can't. What are the alternatives? The most obvious is that many people are going to be living in or near poverty. Their social security will be the bulk of their income. For those who were earning $60,000 having to live on $20,000 at retirement will require massive adjustments. For example, if you own your home and have paid off the mortgage, will you be able to afford the real estate taxes, heating and utilities and other household expenses?

Even now some people are starting to take out reverse mortgages to cover living expenses. Depending on the terms this may have the effect of leaving their heirs with no value from the family home. Others are selling and moving into cheaper accommodations. If this becomes widespread dedicated senior housing may spring up which is priced at a level so that the real savings will be minimal. Moving to cheaper locales may seem like an option, but how many people from New York will want to move to Nebraska just because the housing is cheaper? Lack of friends and family, and the change in lifestyle seem to make this an option for only a small minority.

The most likely scenario, in my opinion, is the re-emergence of the multi-generational household. With housing prices increasing and the squeeze on the availability of desirable land there will be irresistible economic pressure for adult families to move back in with their parents, or, in some cases, for the parents to use the sale of their home to help their children buy a big enough house to accommodate both generations. This trend will represent just another facet of the decline in the standard of living for the middle and working class that is occurring in the US.

As an aside, the same thing can be seen in higher education expense. In prior generations the parents paid for the children's education. With the decline in real wealth they can no longer afford to do this. They have no education nest egg set aside. As a consequence the children are being forced to pay for their own education via student loans. The wealth has already been shifted out of the present generation in the form of future debt. Thus the standard of living of the young has already been further lowered.

Present world trends of transnational competition, population growth and the increasing scarcity of raw materials all point to a steady decline in the standard of living of the majority of the US population. Promises of growth by politicians from improved education, or productivity gains, or tax reform are not realistic. The US will just continue to get poorer relative to the rest of the world. Five percent of the world's population cannot continue to command the type of resource use that it had in the 20th Century.

The best I can offer for advice is, save what you can, eliminate unnecessary spending, and stay away from risky investments promoted by the investment industry.

Moral: Save now or starve later.


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Copyright © 2006 Robert D Feinman
Feel free to use the ideas, but the words are mine.