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BENEFITS BEAT
Now, Can I Ever Afford to Retire?
"The market meltdown moved my cheese!"
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For private-sector workers — and especially retirees dependent on their 401(k) plans as their primary retirement benefit — the investment losses suffered in this past year are devastating. In the public sector, 90 percent of workers belong to a traditional pension plan as their primary retirement benefit. This has insulated them from most of the financial damage wreaked by the Big Bad Bear Market of 2008.
But even with a guaranteed pension serving as the floor of their retirement plan, most public workers are still affected by the meltdown of stock market value and the recession now under way. Pensions and Social Security should never provide the only sources of retirement income for public workers, so we need to look at the other nest eggs that public retirees depend upon. In addition, many public employees belong to pension systems that previously relied on excess investment returns to finance "ad hoc" cost-of-living allowances. Those may now go the way of the dodo bird.
Supplemental savings in 457 and 403(b) plans. Most public employees are encouraged to save for retirement through a supplemental savings plan — and the vast majority do. For municipal workers, this is typically an IRS Section 457 deferred compensation plan. For teachers and hospital workers, it's usually a 403(b) plan. The employees' money is invested on a tax-advantaged basis at their direction. Over the past 20 years, the companies that administer these plans have worked hard to educate employee participants about basic retirement investment strategies. Most workers have either purchased a "life-style" or "target-date" mutual fund that gives them broad financial market diversification across asset classes, based on their risk tolerance and/or their age. Others have constructed their own portfolios according to guidance provided them by the plan administrators, the plan literature and online investment guidance systems.
Thirty years ago, public employees were notorious for investing too conservatively — at least in the minds of most financial professionals. By nature averse to risk, they chose interest-bearing accounts, often sold to them by insurance companies without much competition, and avoided stocks. In recent years, however, most plan administrators showed them the potential to earn higher returns by investing a significant portion of their savings in the stock market through mutual funds available in these plans. By 2000, the average public employee was invested almost as heavily in the stock market as a typical public pension plan, with almost 60 percent of assets collectively invested in stocks. As retirement approaches, most were encouraged to dial that ratio down, and in fact most older public workers tend to invest more conservatively as they approach retirement age.
Personal savings outside of employment. The third leg of the so-called "three-legged stool" of retirement savings is personal savings. For most public employees with modest incomes and limited inherited wealth, the personal savings component of their overall portfolio is typically less than their workplace retirement savings plan, but most do have some outside personal assets as well. If held in a bank, the money is usually invested very conservatively. If held in a brokerage account, it is usually in stocks or stock mutual funds, and if invested directly in mutual funds, the mix depends largely on individual proclivities.
How the market has impacted retirees' non-pension retirement funds. Individual public employees suffered billions of dollars of investment losses in the past year, and the value of their retirement savings at work and at home has declined. The key to the level of impact is mostly a function of age and investment discipline. Older workers and especially retirees have the most accumulated and therefore had the most to lose. The extent of their losses depends on the aggressiveness of their personal asset allocations — their portfolio mix.
Did you act your age? For those who followed the time-tested concept of investing at least their age in bonds and fixed income investments as a percentage of the portfolio, the impact of the market will likely be manageable. Here are some examples:
A 50-year-old worker with 15 years until reaching Medicare retirement age would have lost 35 percent of the 50 percent stock component of her portfolio, under a 50-50 asset mix. Allowing for income and capital gains on the bond or fixed-income component, the overall portfolio will likely have lost about 15 percent of its total value this past year. With 15 years until reaching a retirement age of 65, there is still sufficient time to catch up, and although it will take considerable time for the market to recoup its 2008 losses, the odds are pretty good that this investor will still achieve her plan. At most, she would need to work one or two years longer, at which point she will also be eligible for full Social Security benefits without a reduction.
A worker who played it more aggressively and invested a higher percentage in stocks, however, may need to work even longer than that in order to rebuild his portfolio. And for those who had expected to take early retirement, there is a good chance that it will be necessary to defer those plans for a year or two. Early retirement is an especially dangerous idea when markets are volatile, as there are too many years ahead to fund without having a floor of income and protection against inflation.
For retirees, the key question is "What percentage of the nest egg was invested in stocks?" For retirees on a pension, the pension acts like a bond portfolio and provides stable, fixed income. These individuals typically rely on their supplemental savings for "extras" and to pay for travel and discretionary expenses. They may need to cut back their spending for several years until the recession ends and the stock market eventually recovers some of its losses, but it is less likely that they will need to return to work.
Life for retirees will be more challenging for those whose entire retirement income is based on a defined-contribution plan such as a 401(a) money purchase plan used by city managers and other mobile employees. As with the example above, those who retired at 65 and invested a bond ratio equal to their age will probably weather the storm as their stock positions would have been only 35 percent or less of their total portfolio, and their Bear Market losses would be about 8 to 9 percent of the total portfolio after considering their bond income. They may need to cut back on expenses or find some supplemental income until such time as the markets recover in the next business cycle expansion (perhaps two or three years), but they should survive.
However, the retirees who left work before age 65 with only a defined-contribution plan and invested more heavily in stocks may need to make dramatic lifestyle adjustments — unless they have saved aggressively and lived on less than 5 or 6 percent of their assets including investment income each year. These individuals may need to return to work or make severe cutbacks in their spending, including even a change in residence or other strategies to reduce monthly spending. Their problem is that they are now forced to withdraw cash from their retirement accounts and "sell low" without any chance to recover in the future. Such individuals are strongly encouraged to seek the assistance of a qualified, reliable professional financial planner as soon as possible.
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Girard Miller, a senior strategist for retirement plans and investments and at the PFM Group, has 30 years of experience in the public, private and nonprofit sectors. He can be reached at millerg@pfm.com.
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