In the good old days nobody had to worry that her pension would disappear at some point in her retirement. Today the newspapers are full of stories about under-funded pensions, pension-funds looted by greedy executives and bankrupt companies and governments that are unable to meet obligations to retirees.
Unfortunately there is a lot of truth to the pension scare stories. The Pension Benefit Guarantee Corporation (the federal agency that insures private pension plans) ran a $26 billion deficit in 2011 this was up from $23 billion in 2010. The agency is strapped for funds because of all the money lost in the 2007-2008 Economic Meltdown. The PBGC was coping with such problems as the bankruptcy of American Airlines.
Private Pension Funds
Private pension funds are usually managed directly by a company. The drawback here is that corporate management can raid the fund and use the money for other purposes. Wall Street Journal reporter and author Ellen Schultz has alleged that changes to the law have made it easier for management to get away with such plundering.
In her book Retirement Heist Schultz exposed how a number of companies including IBM, Verizon, GM and GE managed to divert private pension funds for other purposes. She demonstrated that a number of companies were able to effectively reduce pension payments to retired workers.
The good news for those with private pensions is that the PBGC will pay a portion of the pension if the fund runs out of money. Unfortunately the PBGC will only pay part of the money. To make matters worse there is little action the agency can take if a private pension is reduced.
Government Pension Funds
Pension funds for government workers could be in much worse shape than those in the private sector. Pension funds for state and local government workers in the United States were under funded by $2.5 trillion in 2011 according to Orin Kramer the former head of the New Jersey state pension fund. Kramer’s estimate was based on an examination of the top 25 public pension funds in the US.
This means that state and local government funds could reach a point where they would not be able to cover pension checks. Since these funds are not insured by the PBGC the pensioners would have to ask the states or local governments for the funds. The state of Illinois reportedly had plans to sell $3.5 billion worth bonds to pay for its pension obligations in 2011.
It is hard to believe that politicians would raise taxes or cut government services to cover such obligations. Even if they took such actions the officials would probably be voted out and replaced by somebody who would reverse course. Therefore significant cuts to government pensions on all levels in the US are likely in the near future.
How to Protect Yourself
If you are planning to rely on a pension when you retire you have two courses of action. You can hope that politicians and corporate executives will live up to their promises. Or you can take action to insure your own financial future. There are ways to compensate for lost pension income.
Betty and Wilma are both state government employees with good pensions. Betty trusted the politicians’ promises about the state retirement fund so she spent her extra money on a larger house, clothes and a cabin at the lake. Wilma didn’t believe what the politicians said so she used part of her salary to purchase a deferred annuity. When she retired Betty and her husband bought a new motor home. When Wilma retired she used her savings to buy an immediate annuity.
A few years later Betty saw a news story about the crisis at the state pension fund and noticed her pension payment getting smaller. Then a year or so later the pension check stopped coming and Betty and her husband had nothing but Social Security to live on. Betty and her husband ended up having to sell everything and move in with their son and daughter in law.
Wilma meanwhile was receiving her Social Security and monthly checks from two different insurance companies. She had plenty of money and was able to enjoy her retirement with her husband in her home. Wilma even had enough money to travel and buy a new car.
The moral of this little story is obvious: you must take action to protect yourself and ensure your own retirement income. Guaranteed pension incomes have gone the way of the Dodo Bird and the Eight Track Tape they are extinct.
The best answer to the question how much money do you need to retire is as much money as possible. The more money you have when you retire the better. The reason for this is obvious you want to live something like your present lifestyle after you stop working. Unfortunately you will no longer have a salary or business income coming in so you will need to compensate for it.
Something else to consider is life expectancy people are living longer. Many people who retire at 65 today will live to 85 or 95 or even longer. That means twenty to thirty or even forty years of retirement. A large percentage of these people will need some sort of nursing care or assisted living arrangements at some point. These are expensive and despite what some people think Medicare will not pay for such care.
That means you need to save and invest as much money for retirement as you can. It also means that most retirement savings plans will not be enough. A large percentage of older people will end up in the terrible situation of being broke and retired at some point.
Your IRA Will Not Be Enough
Here is a dirty secret that a lot of retirement planners will not tell you. Most Individual Retirement Accounts (IRAs) and 401K plans will not contain enough money to finance a comfortable retirement lifestyle. The average IRA or 401K only lets a person invest around $2,000 to $3,000 a year.
You can save up more through stocks, CDs, savings accounts and other investments but these are considered taxable income. Having a lot of money in them can raise your income tax rate. Fortunately there are vehicles you can use to save unlimited amounts of tax-deferred retirement savings. They are called deferred annuities and you can purchase one at any time.
Annuities are tax-deferred and you can use a deferred annuity just like an IRA or 401K. You can invest a percentage of your salary in one. Funds from IRAs and 401Ks can also be rolled over to annuities without incurring any additional taxes. Something to be aware of is that you will have to pay a 10% tax penalty on funds you take out of annuities before age 59½.
Ensure Streams of Income
Simply having a large amount of money saved or invested for retirement is not enough. You will have to have funds that are easy to access and a regular stream of income. This income should be coming in even if you become unable to manage your financial affairs.
An annuity is a contract between you and an insurance company. Under the terms of the contract the insurer has to make a regular payment to you or a beneficiary you chose for a fixed period of time. There are variations of this contract that ensure a life time income. So you can receive a payment until you die. If George retired at age 70 and bought one of these plans he could receive a payment until he dies even if lives until 110 years old.
It is possible to set up an annuity that will automatically put money into your bank account every month. That means George could have the funds available to cover day to day expenses such as rent, utilities, insurance and if necessary nursing care.
Never assume that the funds you have set aside will be enough for retirement. Always save as much as you can and then save some more. That way you will not end up broke and retired.
Inflation is something that most investors will not think about before it is too late. Unfortunately inflation can destroy the value of almost any investment and turn potential returns into losses. Inflation-adjusted investments are designed to preserve value.
How Inflation Destroys Investments
Inflation’s affect on investments can be devastating. Take the case of a bond that pays 3% interest, if the rate of inflation is 4% the bondholder actually loses 1% of the bond’s value. If the inflationary period continues for ten years the holder would lose 10% of the bond’s value.
Even though the rate of inflation in the US is quite low right now it can go up. In 1972 the US inflationary rate was 3.25% but by 1980 it had risen to 13.5%. That meant the inflation rate was ten times the standard interest rate on vehicles such as bank accounts. This was not even the highest inflation in US history, in 1946 inflation hit 19%.
Everybody needs to have at least a few inflation-adjusted investments to protect his or her investments. There is no guarantee that high inflation will not return at some point and destroy your investments. Such vehicles are a good insurance policy against this scourge.
Adjustable Rates and Principals vs. Inflation
The most common inflation-fighting mechanism is an adjustable interest rate. The interest rate changes to match the rate of inflation that stops an investor from losing value when the value of money falls.
A popular investment that employs an adjustable rate is TIPS or Treasury Inflation Protected Securities issued by the US government. TIPS pay interest on an inflation-adjusted principal so they never lose value. In this arrangement the value of the bond is based on the current rate of inflation not the purchase amount. A big advantage to these securities is that you can purchase them directly from the Treasury.
There are also inflation-adjusted municipal bonds. These use a similar mechanism to adjust the value or the interest rate to compensate for the erosion of value. The Treasury also issues a class of inflation adjusted bonds called I bonds.
Other Inflation Fighters
Another popular means of compensating for inflation is an indexed investment. In this arrangement a portion of the investment is placed in an index of stocks. Since the stock market usually increases in value at a rate that is much higher than the rate of inflation it will make up for most losses.
Indexed annuities and indexed insurance policies are designed to prevent the loss of insured investment income in inflationary periods. Fixed annuities in particular can be very vulnerable to rising rates. The typical indexed annuity combines an index and a fixed-annuity to guarantee income.
Some indexed annuities even offer a guaranteed rate of return. Under this mechanism the return remains at the highest level even if the market falls. This locks in higher returns to compensate for inflation.
How to Use Inflation Adjusted Investments
The average person should have at least 10% of his or her retirement investments in some sort of inflation-adjusted vehicle. This should compensate for normal inflation. In an inflationary period it is often a good idea to transfer a large percentage of your money into adjusted vehicles.