Living longer is a blessing. But how to fund extra years has emerged as a global conundrum, one that will not be solved with the pension systems now in place. Life spans have stretched by more than a decade since 1970, making lifetime income too costly for governments or corporations to guarantee. If trends continue, the number of poor or nearly poor seniors will double to 4.3 million by 2022, according to one study. Here is a peek inside the financial labs where experts are trying to find solutions.
This bedrock benefit lifts 15 million seniors in the U.S. out of poverty each year and is the sole source of income for nearly 1 in 4 recipients. It's not going away. But by 2033, payroll taxes will be enough to pay only 77% of promised benefits. "There is more energy than you might think" for benefit cuts and tax increases that favor those of lesser means, says Jared Bernstein, former economic adviser to Vice President Joe Biden. One possibility is raising or removing the cap on annual earnings subject to Social Security tax ($118,500). There would be pushback against means testing. Presidential candidate Bernie Sanders is among those on board.
Guaranteed retirement accounts
Imagine a new account, above and beyond Social Security, 401(k)s and private pensions. It would be professionally managed, giving savers access to the lowest fees and broadest diversification. Contributions would be required of all workers and taken from your paycheck. The money would be invested conservatively, untouchable through loans or early distributions, and upon retirement paid out as an annuity. "The 401(k) is a failure," says Teresa Ghilarducci, professor of economics at the New School for Social Research. "We need a universal, mandated retirement-savings system." She believes that these accounts could be a reality within a few years and that as workers came to value low fees and guaranteed income, these new accounts would either supplant 401(k) plans or force them to compete with lower costs and more guarantees.
The 401(k) may have life in it yet. The search is on for ways to seamlessly convert some or all of your 401(k) assets into guaranteed lifetime income without taking a lump sum and paying hefty fees to buy an immediate annuity. Treasury and the IRS recently cleared the way for target-date funds inside a 401(k) to make deferred annuities a default option. "But we are not yet where we need to be," says Chip Castille, chief retirement strategist at BlackRock, which is pioneering 401(k) annuities. Look for remaining legal and other obstacles to phase out in the next few years.
Most investing is about maximizing returns. But an actively managed portfolio that over your entire working life seeks only to generate a reasonable target level of lifetime income upon retirement would hold more stable securities and shield you from what academics call sequence risk--the chance that you'll suffer a big market hit at the worst time. Australian researcher Michael Drew has demonstrated that two identical savers with the same average annual returns can have vastly different wealth after 40 years--a spread of millions of dollars--just because one took their losses late in life when they had more to lose and little time to recover. Target-income funds "only take the amount of risk needed to reach the target, after which portfolio risk is lowered," says Drew. Such a fund would naturally be light on stocks when the market is most volatile throughout your career--and have done its job, and be parked in safe securities, as you approach retirement and are most vulnerable.
As we live longer, we should work longer. But you can start taking retirement-fund distributions before age 60 and collecting Social Security at 62. Normal retirement age, now 65 to 67, has risen much more slowly than life expectancies. Look for lawmakers to raise certain age thresholds, especially on the back end, like when you must start taking minimum distributions (70½) and stop accruing benefits by delaying Social Security (70). As barriers to working longer fall, formal programs that enable seniors to phase into retirement through part-time or less stressful jobs will take root. "There must be widespread resolve among employers and policymakers," says Catherine Collinson, executive director at Aegon Center for Longevity and Retirement. Three-quarters of seniors want to keep working for reasons having nothing to do with financial concerns, and yet only a quarter say their employer has a program to help them retrain or downshift, the center found.