You have to face up to the facts. You can’t count on the government or on your employer to ensure your financial well-being in retirement.
Although some lucky people still work for employers with generous retirement plans, the trend is to take those away in favor of plans that place more financial responsibility on employees. So don’t count on a handout, even if it’s currently promised. We’ve all seen recently how easy it is for companies to break those contracts with their employees.
Many employers of yesteryear felt it their moral duty to provide financial support to retired employees and their families. Most promised their workers a company-funded benefit at retirement which was related to salary and years of employment. To fund the benefits, firms invested money each year and drew upon this pension fund to pay retiree benefits.
A significant advantage of traditional pensions (to employees) is that employers bear all the investment risk. Even if the stock market does poorly, a worker still receives the promised benefit, assuming that the company doesn’t go bankrupt. Although these "defined benefit plans" are costly, employers offer them because they feel that the advantages – employee loyalty and morale – outweigh the costs.
But things today are different. Workers don’t stay with the same company for an entire career. They retire earlier and live longer. And we all know what’s happened to the cost of health insurance. In a globally competitive business environment, the huge cost of providing income and health care to retired workers puts more generous firms at a significant financial disadvantage.
Although some have resisted, many large companies have dropped their old pension plans in favor of less generous or different types of plans. Some have been phasing in these changes by freezing the plan for older workers and offering something different (and less costly) to new hires. Retiree health coverage is declining.
The general trend is to shift risk to employees by promising contributions to individual accounts instead of guaranteed benefits. Many require or allow you to contribute out of your own income (on a pre-tax basis), sometimes matching your contribution. Increasingly, individuals are required to choose between investment alternatives for their accounts.
Unlike traditional pensions, future retirement income for individual accounts isn’t guaranteed. It depends on how much you’ve accumulated in your account by the time you retire. Investment choices can make a big difference. Riskier investments, on average, earn greater returns. But if the stock market crashes right before you retire, you may be out of luck.
A report released this month by the Employee Benefit Research Institute (www.ebri.org) showed the average savings in individual account plans is only about $20,000. Even those who are close to retirement (ages 55-64) had accumulated less than $50,000 on average, far less than needed for 20 or more years in retirement.
If these trends continue, the retirement of the future will look much different than the retirement of today. We’re likely to see a reduction in early retirement and more elderly working to supplement their income. Although Social Security is currently a safety net for those with insufficient savings, the future of that program is uncertain.
What can you do? First, you should take retirement plans into consideration in choosing where to work. When offered the opportunity, you should contribute as much as you can afford. (Most people contribute far less than the maximum allowed under IRS guidelines.) If you don’t have an employer plan, you should contribute the maximum allowed every year to an individual retirement account (IRA). Last, you need to educate yourself about your alternatives so that you can make wise investment decisions.
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Vickie Bajtelsmit, Professor of Finance, Colorado State University College of Business, firstname.lastname@example.org,