Ellis: Fixing The Retirement Crisis
The good news is that Americans are living longer and spending more years in retirement than ever before. However, funding retirement is a fast-approaching crisis. On this week’s WEALTHTRACK we have an exclusive interview with Financial Thought Leader and legendary investment consultant, Charles Ellis, who tackles America’s greatest domestic financial challenge in a new book, “Falling Short: The Coming Retirement Crisis and What To Do About It”.
Charles Ellis Co-Author “Falling Short: The Coming Retirement Crisis and What To Do About It”
CONSUELO MACK: This week on WEALTHTRACK, The crisis is coming! The crisis is coming! Financial Thought Leader Charles Ellis is sounding the alarm about the fast developing retirement crisis with a new book, Falling Short: The Coming Retirement Crisis and What to Do About It. The big problem and how to solve it are next on Consuelo Mack WEALTHTRACK.
Hello and welcome to this special retirement edition of WEALTHTRACK, I’m Consuelo Mack. Retirement is a universal goal, one frequently neglected in our youth, addressed in middle age and, if we are fortunate enough to get there in good physical and financial shape, enjoyed in later years. Funding retirement however is a national challenge and a fast approaching crisis. Americans are living longer and spending more years in retirement than ever before.
According to a recent report on mortality from the centers for disease control, a woman who turned 65 in 2012 can expect to live another 20 and a half years on average to 85 and a half. A 65-year-old male in 2012 will live another 17.9 years on average to 82.9. The golden years have never lasted this long, nor been so difficult to finance.
Aside from longevity, many other factors that used to contribute to a secure retirement have changed. Up to thirty years ago about half of the private sector work force had defined benefit pensions for life, managed and guaranteed by companies, as well as health benefits.
Now the vast majority of private sector workers are managing their own retirement funding through defined contribution plans, such as 401ks. And they are doing so much less effectively, saving far less than they need. In addition they are paying an ever-increasing portion of their health benefits.
In 2013 the median household approaching retirement with a 401k or IRA had $111,000 in its retirement account. If a retired couple withdraws the widely recommended 4% of that amount a year they receive only $400 a month of inflation-adjusted income. Usually their only source of income aside from Social Security.
Unfortunately, Social Security is contributing less to retirees’ income than it has in the past for several reasons, including the phasing in of already legislated budget cuts, increases in Medicare premiums, which are deducted from Social Security benefits and taxation of those benefits. In 1985 Social Security replaced about 40% of the typical workers pre-retirement income. If that worker had a non-working wife the replacement rate jumped to 60%.
It is now estimated that Social Security will replace only 31% of the average worker’s pre-retirement income by 2030. Despite all of these challenges, this week’s Financial Thought Leader guest believes retirement is a solvable crisis on both the individual and societal level.
He is Charles Ellis, a legendary financial consultant, Founder of Greenwich Associates, an international business and investment strategy consulting firm, Business School Professor at both Harvard and Yale, and author of 16 books including the investment classic, Winning the Loser’s Game. He is also the co- author of the recently published Falling Short: The Coming Retirement Crisis and What to Do About It. I began the interview by asking Ellis about the immediacy of the retirement crisis – were we about to see lines of impoverished seniors at soup kitchens?
CHARLES ELLIS: First of all, right now, there’s no crisis visible. There are no lines. There are no screaming headlines. There are a lot of people who just, we’re going to find a way through this, don’t worry about it, and there’s no urgency to do anything about it.
CONSUELO MACK: Out there.
CHARLES ELLIS: That’s out there in the world. If you ask people in the financial world, they say I don’t see any particular big problem. If you talk to people and they try to say, well, it’s an interesting question, but we don’t yet see any evidence of major problem, if you talk to people who are the managers for 401(k) plans, by and large, they would say things seem to be doing pretty well. And then you say well, you’re talking a slice of time, as of right now. And I remember when I was 12, 13, 14, my brother and I, we’d compare how dark our tans were, and we were proud if we had a darker tan. Now we both go to see a dermatologist twice a year because we get skin cancers. Where did the skin cancers come from? The 12, 13, 14-year-old boys, going out and trying to get a dark tan. The problem was baked in the system way back then. This is the old chicken and the python kind of reality. The problem is there, and any demographer would be able to tell you, yes, it’s coming through, and it will be, unless there’s a change made, it will be a serious problem that will affect millions of workers in ways that we wouldn’t like to see, and the rest of us as a nation would say, that’s not the way we want to see America.
CONSUELO MACK: Let’s define what’s changed. Why don’t Americans, or why don’t so many Americans, have enough savings to see them through their retirement years? What has fundamentally changed? Because if you look back 20 or 30 years ago, my parents’ generation and my grandparents’ generation, it seems that we weren’t in this kind of terrible situation.
CHARLES ELLIS: Well, for those who worked in the corporate sector, private sector, back in your parents’ time, all they had to do to have a secure retirement was tell the company what address to send the checks. Period. Now we’ve said no, no, no, let’s empower each individual to manage for himself or herself. And we got started on that during a bull market, when it looked like, hey, it’s not all that hard, it’s kind of interesting, I like doing it, and people got a positive attitude towards the idea of self-directed, you know more about yourself than anybody else, this is your money, you should have it in your control.
CONSUELO MACK: Freedom of choice.
CHARLES ELLIS: Then we get through some choppy, choppy periods. And all of a sudden you start to say, well, how are we doing now, and here’s the kind of reality that just bowls you over, average person at 65, planning to retire, has got in his view or her view more money than I ever dreamed I would have. Consuelo, do you have any idea how much money I’ve got in my retirement plan? I’ve got $100,000. Nobody in my family has ever had $100,000.
CONSUELO MACK: Has ever had that amount.
CHARLES ELLIS: So they feel pretty good about it. There’s only one problem. We have learned how to take care of ourselves better and better and better, so we live longer and longer and longer. I don’t know if you’ve noticed, but the Society of Actuaries just added another two years on to life expectancy. We are, on average, at 65, going to last into our mid-80s. What’s wrong with 20 years of retirement? We all get tennis rackets and golf clubs and go play with all these bright young nice people, and have a nice time. We’re going to travel and see the world. We’re going to have all kinds of fun. Well, that may be true in the newspapers and the ads and the magazines, but actually, let’s come back to reality. It’s not going to be quite that dreamy. If you’ve got 22, three, or four years on average, and of course that means, with the bell curve, some people are going to live into their 90s. You’ve got $100,000, plus your Social Security. It isn’t going to be enough.
CONSUELO MACK: That’s the biggest change.
CHARLES ELLIS: You are going to run out of money. And when you really understand that you have run out of money, you’ll be separated from the company by quite a few years, you won’t be able to go back to work because your skills won’t have been kept up to speed, you won’t even know where to go to work. And if you’re in your 70s or early 80s and you go to get a job, people are going to say, I’m sorry, we just don’t have any openings for you. So you’ll be really on your own.
CONSUELO MACK: We are basically left back to our own devices, and we tend not to the great savers, and we tend not to be great investors.
CHARLES ELLIS: We’re not very good savers, and we’re candidly, seriously faulted as investors.
CONSUELO MACK: And many people are looking at Social Security as their annuity. Basically, it’s going to be their income stream. What’s wrong with the reliance on that income stream? What’s changed there or is changing there as well?
CHARLES ELLIS: Well, Social Security does protect you from starvation. And from awful things, but it is not going to provide you with an opportunity to have anything like the level of living that people have gotten used to. I don’t know about you, but I don’t want to step down substantially, like a third or more lower income during my retirement years.
CONSUELO MACK: And two income families are the norm now, as well …
CHARLES ELLIS: Because they have to.
CONSUELO MACK: So you have two incomes to replace. And Social Security is not going to do that either.
CHARLES ELLIS: It isn’t set up for that. It’s going to protect you from the worst of the awfuls, but it’s not going to make you happy camper, it’s not going to give you enough to be able to continue in whatever lifestyle you’ve gotten used to. So the retirement plans, the 401(k)s or whatever retirement plans, are really an important part of the welfare of millions of people as they come to their retirement years.
CONSUELO MACK: Another change is that medical costs are going up, as a portion of your disposable income. They’re increasing, and there’s no end in sight. That’s another cost and expense that retirees didn’t expect.
CHARLES ELLIS: Well, when we say health care, we euphemize it too fast. Yes, it’s health care. In your 60s and 70s, it’s pretty minor. But in your 80s and 90s, you’re talking about assisted living for at least half the population. That’s expensive stuff. It’s not $15 or $20, it’s $50,000, $60,000, $70,000 every year, and where in the heck can people get that kind of money? Well, they need it. Fine, but where are they going to get it? And the answer is, they’re going to have to provide more and more of it for themselves.
CONSUELO MACK: One of the chapters is “What can we do as individuals? If, obviously, again, it’s our responsibility as individuals to support ourselves in retirement. Work longer is one of the first recommendations that you make in Falling Short. How much of a difference does working longer make in our ability to pay for our retirement?
CHARLES ELLIS: Listen closely, my children, and you shall hear. Let me give you a quick summary of a couple different things. Number one, in Social Security, you can claim benefits at 62. You can defer until 70. The difference in how much you would get every year, every month, every day, between claiming at 62 and claiming at 70, is 76 percent more if you can hang in there a little bit longer.
CONSUELO MACK: No contest.
CHARLES ELLIS: And that lasts forever, in terms of your lifetime. You have no outliving your money kind of risk at all, and it’s adjusted for inflation, so it keeps rising if it needs be. That’s some terrific deal.
CONSUELO MACK: Fabulous.
CHARLES ELLIS: And most people who had anything like a factual understanding of you can go down this way and claim at 62, you can go down this way and claim at 65, or you can go down this way and claim at 70, would look at you and say Consuelo, it’s pretty damn clear, if I can do it, I should go for 70. Now, there are people who’ve got physical limits, can’t do it. I understand that. But for those who are able to do it, they ought to have the factual information so that they could realize this is not a tricky question, this is not hard to figure out. I got it. The big money is down this way, the small money is down this way. Which choice would I take?
CONSUELO MACK: Unless you’re a fatalist and think you can die at 64, in which case you’ve got nothing…
CHARLES ELLIS: Right, which I don’t recommend anyway. And the second thing is, if you say look, I’m going to add those eight years, I’m not going to claim at 62. And now we have retirement at about 63-1/2, but for convenience, let me use 62, just because that 62 to 70 gives you the 76 percent lift from Social Security. What do you get from your 401(k)? Well, you’ve got eight years when you’re not taking money out, eight years when your expenses actually are a little bit lower, in your 60s and early 70s, then the health costs start to come in. But you don’t take money out, you can put money in, and you could make a larger contribution, because now you can really afford it, and you’re going to get on investment return on the money that’s in the plan. Add those together, and be conservative on the numbers, and you come out with something at least 150 percent more in your fund, therefore, in your payout every year. Add the two together, and you go from I can’t live with this to I’m okay. I’ve never seen a problem that was this big a problem where the solution was so straightforward. First we get all the companies who’ve got 401(k) plans to follow best practices. And that’s pretty strong stuff. If you go to work for the company, you can say I don’t want to participate in a plan, and if you say I don’t want to participate in your 401(k) plan, fine, you opt out. But if you don’t say I really don’t want to do it, I’m opting out, you’re included.
CONSUELO MACK: Automatic.
CHARLES ELLIS: Automatic.
CONSUELO MACK: The saving is happening, and this is when you say you’ve got to save more is the next step as well. That helps you, the automatic savings is the best way to do it.
CHARLES ELLIS: It makes so much sense. You automatically start at the amount the company matches, so if the company matches X percent, you already doubled your money by saying okay, I’ll do that. Then you increase, and the sensible way to increase is a quarter to a third of every raise you get, will be put aside for you, for your future years, Christmas Club kind of a concept. We all would like to be better savers than we are. A little help goes a long way. If the company deducts it and you never see it, it’s easier to make the adjustment, and you keep ramping up, and pretty soon you’ll be at 14 percent per year savings until you need it later in your life. It’s not taken away from you, it’s just putting it aside for when you will need it, and you will. That would be a tremendous positive. Then you go to one of the target date funds, so that it’s automatic investment, not that it’s going to be brilliant investing. It’s pretty sensible investing, it’s like the blue plate special at a nice restaurant, it’s probably pretty good. And you can opt out of any one of these things if you want to express your rights, but if you don’t have a strong conviction, it’s kind of nice to know that people have thought about it and got a program for you. And then you can also do the required minimum distribution, which the government requires you to distribute a certain amount out of your 401(k) plan.
CONSUELO MACK: Starting at 70.
CHARLES ELLIS: Yeah. You can say okay, I’m going to use that mathematics to decide how much to take each year. It’s a very sensible, fairly conservative, it’ll last for a long time, it’ll work out well for you. You have everything on automatic pilot, just like in the old days…
CONSUELO MACK: With a defined benefit plan…
CHARLES ELLIS: …except now you don’t have to tell anybody what your mailing address is, because you’ve got it.
CONSUELO MACK: What’s the most conservative, sensible way to handle a rollover?
CHARLES ELLIS: Well, one way is don’t do it.
CONSUELO MACK: Don’t do it.
CHARLES ELLIS: The second way is to do it with a very well regarded, famous name organization.
CONSUELO MACK: I know you were on the board of Vanguard at one point, so in previous conversations we’ve had, that certainly is one of the top names on your list. What are the other firms?
CHARLES ELLIS: T. Rowe Price is a wonderful organization. Fidelity does very good work. The Capital Group or the American Funds do very good work. Putnam under the new administration it started in the last several years is doing very nice work. There’s some really good organizations who take all this responsibility really seriously.
CONSUELO MACK: Really seriously.
CHARLES ELLIS: Why not deal with them?
CONSUELO MACK: One of the most interesting recommendations that you made in the chapter on what can we do as individuals, is to use your home equity. Explain how the home or homes can be a source of income for us in retirement.
CHARLES ELLIS: Pretty straightforward. Most, very large number of people, have their own home, and they’ve paid off the mortgage. So it’s their own home, free and clear. Most people who have a home think of it as something they want to leave to their children, which is an attractive idea, and appeals to me. But they should at least be aware of the fact that there is a way which you can work out with a financial institution, that you essentially sell the home to them, and they will pay you out a certain amount, like a reverse mortgage, and they payout a certain amount of money to you every year. And rather than being impoverished and embarrassing your children, when they receive the estate and the home is being left to them, talk about it with them. And probably, it would make sense for most families to think through, would this be a good idea? And for a fair number of families, it would be a good idea, to draw off as spendable money, what could be taken in a reverse mortgage with your own home. Then you get to live in the home that you’re used to, in the neighborhood that you’re used to, with the shops and stores that you like, and you probably care about that.
CONSUELO MACK: And again, go to a reputable bank, in order to get a reverse mortgage.
CHARLES ELLIS: Yes, be careful.
CONSUELO MACK: Right, be careful. What can we do, as a nation, Charlie, to solve the retirement crisis?
CHARLES ELLIS: The most important thing we can do is start talking about it like you’re doing this evening. The privilege of being with you, talking about a problem that’s not visible yet except to demographers and people paying attention, who all say it can’t be avoided unless we do something about it. That’s really important, and the reason for writing this book is sort of Paul Revere’s ride. Every Middlesex village and town, the British are coming, the British are coming. We’ve got a problem, let’s start dealing with it. It would be terrific if Congress would get interested in this. And the only way Congress is going to get interested is the private sector says, “Say, Congress, we really want you to get interested.”
CONSUELO MACK: Right. But are there actual steps that can be taken? And one of them is to …
CHARLES ELLIS: Sure, and number one is, tell people what’s really going on. Go to Social Security today, and you say, well, I think I’ll work until 70, you’ll get sort of a quizzical look from the person that you’re talking with, wondering why would you do that? You can retire at 65. That’s labeled full retirement. Why don’t we re-label things, and make 70 be full retirement? That’d be one small step, but the right direction. Second thing is, we as a nation, this is a little bit of an economics thing, but we as a nation do the equivalent of spending over $160 billion every year to motivate companies and unions and public entities, states, cities, municipalities, to have retirement plans. We give them a tax break. That’s the equivalent of an expenditure, when you say I won’t collect the taxes, I’ll give you a tax break, that is $162 billion every year. You remember Ronald Reagan saying actually, “This is my microphone, and I paid for it”, which was one of his stunning little moments in the campaign. Well, it’s our table, and we paid for it, so we’ve got a legitimate interest. What should we do to exercise that interest? My opinion, we should make it a requirement. If you want to have a 401(k) plan that’s tax-deductible, you have to follow best practices.
CONSUELO MACK: I see. So it’s automatic.
CHARLES ELLIS: Automatic start, automatic escalation, automatic investment, all that sort of stuff, that protects us from ourselves. We’re not experts at this.
CONSUELO MACK: We could do that as a Federal law as well, require that everybody be enrolled in some sort of retirement.
CHARLES ELLIS: Well, Congress came very close, came very close, and recommended the best practices be followed by every plan sponsor. They decided not to say it’s a requirement, so it’s not that big a step, it’s just an incremental another step. I recognize that politics is a complicated world, but there’s no reason not to.
CONSUELO MACK: Are there things that other governments have done, things like this, that they’ve made mandatory that you have an individual savings account?
CHARLES ELLIS: Yeah. If you wanted to get the best system anywhere in the world, you go to Australia, and say tell me, what are you guys doing? Well, everybody’s in, and everybody has … Required, their employer and the employee, are required to save 14 percent. They gradually increased it until it got up to 14 percent. And they’ve got some very simple, straightforward investment vehicles, and that’s it. You’ve got to invest in those vehicles. It’s not all that hard. If the Aussies can do it, maybe we can do it.
CONSUELO MACK: Why can’t Americans do it? Bottom line, we can’t wait for the government to solve our own retirement crisis, our own individual retirement crisis, so it’s work longer, save more.
CHARLES ELLIS: Know enough to decide for yourself whether you should stop at 62, 65, or 70. Get the facts on the tables you can choose for yourself. That’s a no-brainer. Just be informed, and then make a sensible decision. The same thing.
CONSUELO MACK: Automatic savings.
CHARLES ELLIS: Every company that’s got a plan ought to be following best practices. There will be cost, there will be inconvenience, but the payoff is so large for so many people, that it just makes such great sense to do it. And we’re a nation that is proud of doing the right thing, and we should be. And this is another opportunity where the costs are pretty small, the benefits are very, very large, and it is the kind of America we want to live in.
CONSUELO MACK: Charley, last question. We always ask everyone at the end of a wealth track interview if there’s one thing that we should all invest in or do for a long-term diversified portfolio, in this case for a more secure retirement. What would you have us do or what would you have us own?
CHARLES ELLIS: I’ll give you a very straight answer, and I’d be prepared to give you a very long and complicated, with logic train behind it, because the power of the logic is unbelievable. Everybody who is not a genius in investing should be using index funds that are low-cost, and they should be doing it with all their savings that are investment for the long run. I do. I hope you do. And I think everyone of your listeners should focus on today, we’ve got such a good stock market that’s so effective at doing the right thing and figuring out the price of the right shares, we should all be using index funds.
CONSUELO MACK: In our stock portfolio portion?
CHARLES ELLIS: Yes.
CONSUELO MACK: Charley Ellis, thank you so much for joining us on WEALTHTRACK.
CHARLES ELLIS: Thanks.
CONSUELO MACK: At the close of every WEALTHTRACK we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is read Falling Short: The Coming Retirement Crisis and What to Do About It. I can’t say it any better than investment legend and vanguard founder Jack Bogle does on the cover: “I loved this book! It is short, punchy, and highly readable. It provides a full analysis of the grim status of our nation’s retirement savings plans and offers solutions that are realistic and long overdue. I recommend it to all those concerned about America’s retirement problems, including their own.” From a personal finance perspective, it was particularly helpful in showing the huge financial advantages of working longer, taking Social Security as late as possible and using a home as a source of retirement income. Plus Ellis’s recommendation to use the IRS’s required minimum distribution rules as a personal retirement drawdown strategy is explained in the book and is definitely worth considering. To see this program again please go to our website on wealthtrack.com. Where you can see other Financial Thought Leader and Great Investor guests. For those of you who have connected with us on Twitter and Facebook thank you for doing so. We appreciate your comments and suggestions. Have a great weekend and make the week ahead a profitable and a productive one.