Why Gen X And Late Boomers Aren't On Track For Retirement

According to a recent study, Gen Z and late baby boomers are on track to replace only about half their current income when they reach retirement, meaning they will need to seriously downgrade their lifestyles. There are two main factors causing this: the breakdown in the employer-provided retirement benefits and a wider web of increased debt and lack of financial literacy.

Laura Shin
5/28/2013 @ 10:33AM
Forbes

According to a recent study, Gen X and late baby boomers are on track to replace only about half of their current income when they reach retirement — which means they’ll need to seriously downgrade their lifestyles. Most financial planners recommend replacing, at the very least, 70% of one’s income.

In contrast, Depression babies, War babies and early boomers were on track to replace, respectively, 86%, 99% and 82% of their pre-retirement income.

Why are more recent generations finding it harder to save enough for retirement?

I talked with two economics professors who cite two types of factors — the breakdown in the employer-provided retirement benefits and a wider web of increased debt and lack of financial literacy. Unfortunately, neither explanation offers a quick-fix solution, though they do hint at ways you cam help improve your retirement picture.

The Shift Away From Pensions To 401(k)s

Teresa Ghilarducci, a labor economist at the New School and a nationally recognized expert in retirement security, says there’s only one explanation for why Gen X and late baby boomers will be less ready for retirement than their parents were.

“The reason for the lack of preparedness is because of the collapse of one layer of the retirement cake, which is the employer-provided layer,” she said by phone.

In the last three decades, the number of unions fell, older workers faced higher unemployment and competition began to heat up with countries like China, making it harder for older workers to negotiate for stronger retirement benefits.

Additionally, as 401(k)s were being introduced in the 1980s, people thought they preferred to have control over their retirement accounts and their investments, said Ghilarducci. But it turns out that if they actually have a choice between a pension and a 401(k), they prefer the pension.

A pension is a type of “defined-benefit” account, giving an employee a lifetime payout based on a formula taking into account factors such as how long he or she has been with a company and not necessarily based on how well the investments do. A “defined-contribution” plan, such as a 401(k), on the other hand, offers no guarantee on how much money will eventually be paid out.

“When people have a choice — and they have a choice in the public sector — they actually choose, when they’re asked, for a defined-benefit plan. So, it’s clearly employers who prefer the 401(k), and that’s because they’re cheaper,” Ghilarducci said. (Companies that offer pensions have to dip into their own earnings if the pension’s investments fall short, since the employee will still receive the promised payout.)

Why Defined-Benefit Plans Are Better For Workers

According to Ghilarducci, there are four reasons that, for workers, defined-benefit plans such as pensions are superior to 401(k)s and similar accounts:

1. A defined-benefit plan requires the employee to enroll, unlike defined-contributions, which are often voluntary.

2. With such a plan, neither the employee nor his or her relatives can get access to their retirement savings. (This is a big drain on assets in defined-contribution plans such as 401(k) accounts.)

3. Defined-benefit plans offer a higher rate of return. “Professionals invest the defined-benefit plan,” Ghilarducci said, “not the individuals choosing various mutual funds. And defined-benefit plans always outperform defined-contribution plans.” In fact, last week, a study by Towers Watson showed that, in 2011, investment returns in pension plans outperformed those of defined-contribution plans by the largest margin since the 1990s. Out of 2,000 plan sponsors analyzed, defined-benefit plans had median investment returns of 2.74%, while defined-contribution plans had median returns of −0.22%.

4. Finally, a defined-benefit plan pays out an annuity for the rest of the employee’s life, so the employee doesn’t bear the risk of outliving his or her money — a frightening possibility for holders of 401(k)s and similar accounts.

Ghilarducci discounts some other factors that are frequently cited: “There’s a lot of noise that you’ll hear — that it’s lack of financial literacy, that it’s student debt,” she said. “None of those matter. Having an $8,000 or a $20,000 to $30,000 debt does not affect accumulating the more than $600,000 that most people need for retirement. Those are fly-speck reasons. There are lots more reasons to think that people are more financial literate now than they were 30 years ago. So no other reason holds a candle to the collapse of the employer-employee retirement system.”

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