The U.S. Retirement Crisis And The Impact On State Finances

We’ve been stating for a while that the unfolding U.S. retirement crisis would not only create a social and economic issue for individuals but that it would likely impact U.S. states, as well. We’ve just stumbled across an article in Employee Benefit Adviser written by Paula Aven Gladych, titled “Pennsylvania Focuses on Retirees Who Can not Afford to Retire”.

The article highlights the economic impact on Pennsylvania’s budget from increased expenditures to support the elderly population. According to Joe Torsella, PA State Treasurer, “when people don’t save enough for retirement, the states have to pick up the slack in long-term care and Medicaid and Medicare costs and state budgets get messed up trying to allocate enough funds to handle these extra charges”.

Pennsylvania decided to commission a study to look at its demographics and its ever-growing population of retirement age people. “As we suspected, there are significant impacts to state finances going forward from the state of our retirement preparedness,” Torsella says.

According to the article, “in 2015, Pennsylvania spent $4.25 billion in assistance costs for elderly residents. Fifty-four percent of this cost was attributed to the 21% of the elderly population who have $20,000 or less in annual household income, according to the report.”

If the elderly had been better prepared for retirement, meaning that they could replace roughly 70% of pre-retirement income, the state would have likely saved about $700 million in state assistance costs. The net impact of state assistance costs due to insufficient retirement readiness is likely to exceed $1 billion in the next 12 years.

We know that many small employers do not offer their employees a retirement program. We also know that employees are not likely to save outside of an employer-sponsored plan.  Thus, it is imperative for states to begin to offer state-sponsored retirement programs that can offer payroll deduction to these small employers and their employees.

As the social safety net gets more expensive, tax hikes are likely to follow. There is a great chance that well-heeled residents will seek to live in less expensive states. We have already witnessed a significant exodus from Illinois to nearby states.  If not careful, we could easily see this happen to other “Blue” states that have been impacted by recent Federal tax changes impacting one’s ability to deduct “SALT” taxes.

Finally, without a decent retirement benefit to rely upon residents won’t have the financial wherewithal to remain active participants in their economy. This will also negatively impact tax collections, businesses, and ultimately that state’s labor force.  It is truly a vicious cycle.


Two Important 401(k) Policy Efforts

According to an article on the 401K Specialist website, there are two important policy initiatives that could provide participants with low savings balances a retirement savings boost. The proposed initiatives deal with Auto Portability and missing participants, which we highlighted in a March 9, 2018, blog post. The policy efforts seem to have bi-partisan support (that’s almost shocking).

With regard to Auto Portability, the legislation is calling for the “routine, standardized, and automated movement of an inactive participant’s retirement account from a former employer’s retirement plan to their active account in a new employer’s plan.” This is critically important because of research that shows more than 50% of balances below $5,000 are more likely to be cashed out than moved to a new employer.

The total of “missing” accounts/participants is staggering.  We reported in a previous post that roughly 25 million abandoned accounts exist with approximately $8.5 trillion in assets. Finding the owners of these accounts will certainly go a long way to reducing the negative effects of low household savings. The Act proposes the creation of a national registry for participant contact information. The Social Security Administration and the Department of the Treasury are identified in the bill as responsible for the administration of the registry.

These initiatives should absolutely be supported.  Given that defined contribution plans are fast becoming the only retirement game, we must do whatever we can to make it easier for our workers/participants to accumulate retirement assets. As we know, too many of our workers (1 in 5 over 65 are still in the workforce) are facing the likelihood that retirement is not an option. Let’s try to reduce that percentage of workers forced to remain in the labor force and these legislative efforts will certainly assist in that effort.


It Just Gets Uglier

Towers Watson has produced a study highlighting the fact that only 5% of new hires in the private sector have access to a defined benefit plan (DB).  The move away from DB plans to defined contribution plans has been amazingly swift. As we’ve discussed on numerous occasions, placing the burden on individuals with the marginal capability to handle this responsibility will likely create a social and economic crisis for older Americans.

According to Towers, “workers who experience a loss of guaranteed retirement income may not exit the workforce in a timely fashion—an outcome that traditional pensions were at least partly designed to avoid. Such counter-cyclical workforce trends could necessitate increased severance pay, raise benefit costs, and reduce mobility within an organization.”

In addition, as of 2015, only 20% of Fortune 500 companies still offered a DB plan (traditional or hybrid) to salaried new hires, down from 59% among the same employers back in 1998. Furthermore, there has been an uptick in plan freezes and closings since the 2008 financial crisis. By 2015, 39% of sponsors had frozen a DB plan, and 24% had stopped offering their primary DB plan to new hires.

City of New Haven Contemplating a POB

The City of New Haven, CT, is contemplating a pension obligation bond (POB) to sure up the City Employee Retirement Fund. The proposed ordinance allows the city to issue up to $250 million in pension obligation bonds next fiscal year to help pay down some of the unfunded liabilities.

CERF, along with the Police and Fire plan, is one of two defined pension plans that the city pays for each year to cover retirement benefits for city employees. The P&F covers pensions for public safety personnel like police and firefighters; CERF covers pensions for all other unionized city employees.

According to Acting Budget Director Michael Gormany and City Controller Daryl Jones, CERF and P&F are each currently funded at around 40 percent. But, we aren’t sure if this is based on GASB accounting or a true mark-to-market basis.  If the former, the funded status could be a lot uglier.

CERF and P&F were each funded at 60.6 percent in June 2008. That number has decreased precipitously over the past decade as the city has struggled to deposit, invest and earn enough money to keep up with the ever-increasing pool of retirees and beneficiaries.

The city is expected to contribute $21.9 million in CERF and $34.6 million in P&F, which are the same as last year, but since 2012 the combined contributions have grown by more than $16 million.

The proceeds from the potential POB would flow to CERF and not P&F.  It is anticipated that the funds would bring the funded status to 85%.  However, as we’ve witnessed on many occasions, the proceeds would be injected into the same asset allocation, and the goal would remain to achieve the return on asset assumption (ROA).

Given where equity valuations are, we believe that injecting this money into a traditional asset allocation is foolish. A better strategy for CERF would be to determine the amount of money necessary to retire all of the retired lives and to then immunize those lives. This strategy would improve the liquidity necessary to meet benefit payments and it would convert the fixed income exposure, with its interest rate sensitivity, to a cash matching strategy that eliminates this source of volatility.

Furthermore, by retiring all of the currently retired lives, the investing horizon is extended allowing for the liquidity premium to be captured from investments in equities, real estate, and other non-traditional investments (alternatives).

There are too many examples of public pension funds issuing POBs at the peak of the equity market in an attempt to capture the potential arbitrage between the ROA and the debt service. Unfortunately, most of those efforts have proved futile. Let’s stop managing pension plans against an ROA objective and start managing these assets to provide the promised benefit at the lowest cost.

The issuance of a POB is not the problem.  But, using the proceeds to fund a traditional asset allocation is! When will these plan sponsors and their consultants learn?



U.S. Retail Sales Fall Again

According to a WSJ article today, U.S. retail sales fell for the third straight month.  This seemed to generate a lot of head scratching from the article’s author, who stated, “the drop was unexpected in part because many Americans’ tax withholdings dropped in early February due to a $1.5 trillion tax break signed into law late last year.” However, a look at the beneficiaries of this tax largess highlights the fact that most of the benefit went to the top 1% (they do pay most of the taxes). Those in the bottom 60% of income receive a very modest reduction, with the bottom 20% getting an average $60/year in tax savings.

Just how much of a benefit will retailers actually see when most of the tax break goes to the very highest income earners who likely already have most of what they need? Furthermore, the U.S. savings rate is at a decades low 2.4% in 2017.  Also, total consumer debt is at an all-time high, with auto and student loan debt eclipsing $1 trillion each, revolving credit debt at more than $800 billion, and mortgage debt on one to four family homes at greater than $10.6 trillion.

As we’ve reported in many KCS blog posts, U.S. wage growth has been fairly stagnant for the past two decades. Given that U.S. GDP is driven by personal consumption (still roughly 70%), the combination of modest wage growth and higher levels of debt should constrain the average American consumer. Had the proceeds of the significant corporate tax rate cut been used to reinvest in plant, equipment, inventory, jobs, and wages, we’d likely see a significant economic pop, but early indications suggest that corporate America would rather buy-back shares than invest in their businesses or workers!

Unfortunately, It Will Get Real Easy For A Majority Of Americans!

An article by Alicia H. Munnell, Center for Retirement Research at Boston College, was published on the MarketWatch website on February 27th.  As I’ve said before, I think that she and her team do an incredible job of presenting retirement-related research, and it is certainly one of my go to sites for information on our retirement industry.

The headline of her article was “It’s Harder Than You Think To Spend Down Your 401(k) In Retirement”, and she’s attributing this difficulty to the fact that there aren’t any easy drawdown mechanisms in 401(k) plans.  According to Ms. Munnell, innovation is being stagnated because plan sponsors fear litigation, while at the same time Congress is unlikely to mandate annuity-type product for defined contribution plans.

As a result, little is being done to help guide the employee upon their retirement.  Unfortunately, those individuals are being given an cash distribution upon retirement, which requires them to manage the future drawdowns – good luck!

I don’t disagree with anything that Ms. Munnell has stated so far.  However, I do disagree with her when she states that she is “more concerned about people hoarding their retirement savings than blowing them on a trip around the world.”

I don’t believe that a majority of Americans will blow their savings on a trip or a second home or the fancy pickup truck. What I do believe is that a significant majority of American workers will NOT save enough to have a “pile of cash” to hoard. By all indications, Americans across the age spectrum are saving far too little at this time to accumulate a meaningful retirement account.  KCS produced information in an earlier blog post today that highlights the significant percentage of American workers that have less than $10,000 in retirement savings.

Ms. Munnell points out that “recent studies show that people draw down their balances in retirement much more slowly than expected. But most of today’s retirees with a retirement plan have an old-fashioned defined benefit plan, so these studies have little to say about the likely behavior of those retiring entirely dependent on 401(k) plans.” That’s the rub! We are entering a new paradigm in which most Americans (>80%) in the private sector are not participating in a traditional DB plan.

The expectation that these workers would all of a sudden fund, manage, and then disperse a retirement benefit with little education is simply poor policy, and the social and economic impact will likely be quite grave. I’m much more concerned about the ability of Americans to save in the first place, which is proving to be a nearly impossible task for many workers, than I am about their “inability” to drawdown a retirement benefit fast enough. It really won’t be difficult to spend an account balance that is as meager as those that have been accumulated to date.

It Is Much Worse Than The Headline!

GoBankingRates is out with their annual survey on retirement readiness. They reported that ONLY 42% expect to “retire” broke, which is down from 55% last year.  However, retiring broke means that you’ve saved less than $10,000.  Really? That is the metric that we should use to measure the preparedness of our workforce?

Did you know that adults 65 and older spend about $46,000 / year? Did you also know that the average Senior Citizen spends approximately $275,000 in out-of-pocket health care expenditures? Saving $10,000 for retirement will buy you less than 3 months of average annual expenses while covering less than 4% of your likely out-of-pocket medical expenditures.

Yes, those closest to retirement (aged 55-years-old and up) are doing better than the younger generations, but not by much. Roughly 23% have saved more than $300,000, but another 33% have saved $10,000 or less. My gosh!

At KCS, we continue to believe that the lack of wage growth is impacting a worker’s ability to save more than an employee’s need for immediate gratification, as many in the media would like us to believe.  GoBankingRates asked the roughly 3,000 participants to indicate why they aren’t saving enough for retirement.  Their answers shouldn’t surprise anyone.

Seventy-nine percent of the survey responders indicated that they either don’t make enough, are currently struggling to cover basic living expenses, are paying down debt, or had to use “retirement” funds for an emergency. Only 10% blame their employer for not offering a plan, while the remaining 11% said that they don’t need to save for retirement – must be nice, unless they are planning for an early demise!

The loss of employer-sponsored defined benefit pension plans is placing a tremendous burden on the average American family, and it will only get worse as the remaining DB plans get shuttered. If a 9-year long equity bull market (happy anniversary) can’t positively impact the retirement savings of our workforce, what happens when we invariably have another bear market.