Thursday, October 24, 2013

Retirement Begins at 22

Fifty years ago retirement was not a serious problem for most Americans. There was a covenant between American industry and the American worker, “Give me the best 30 years of your life and I will help Social Security take of you in your old age.” There was a third leg to this stool, but it wasn’t critically important. A pension plus Social Security would cover your need for income in retirement. The third leg, your savings, particularly the equity in your home would provide the diligent, responsible American retiree with a few quality of life luxuries, like that Mediterranean cruise your wife always wanted. Americans sold their big homes in expensive cities in the North where there were good paying jobs. They moved south, somewhere warmer and cheaper, bought a small house, and lived happily ever after.

In the 1970s the covenant began to unravel. Big unionized industries like the automobile business passed peak employment. In some of these industries like integrated steel, producers like Bethlehem went out of business or like U.S. Steel mutated into an unrecognizable multi-national conglomerate that no longer needed very many American workers. Even low wage industries like textiles and the garment trade left this country for cheaper labor and fewer regulations.

In shouldn’t have surprised anyone that once Bethlehem when bankrupt, it would only be a matter of time before its pension fund was exhausted and that is exactly what happened.

Then, in 1978 an obscure change was made to the IRS code that would revolutionize everything. Originally intended as a loophole that would give wealthy executives a tax break on deferred income, the 401 (k) plan became a simple tax-advantage way to save for retirement. Unlike the traditional defined benefit plan that guaranteed a pension to a retired employee, the 401 (k) shifted all of the risk and most of the expense of saving for retirement from the company to the employee. Needless to say, American corporations loved that idea.

Today, only 35 years later, the once sacred defined benefit pension is almost gone. It only remains in a few unionized industries and the public sector. Many of these public sector pension systems like CalPERS, The California Public Employees' Retirement System, are headed towards bankruptcy. It is unlikely they will survive in their current form for another 20 years. The cost of guarantees to public sector employees is growing faster than the economy of California. California already has the fourth highest tax burden in the country. It is rated as the 41st on the list of overall state business climates. If taxes can’t be raised, if the tax base isn’t likely to grow, but the demands on municipalities continue to increase, expect to see more municipal bankruptcies in places like Vallejo where the taxpayers can no longer pay their retired civil servants.

The graph at the beginning of this post demonstrates that the future of Social Security does not look very secure. While there is no immediate danger of bankrupting that incredibly important social service safety net, when the baby boomers, like me, pass from this vale of tears the cupboard is likely to be pretty empty.

If you live long enough, the day will come when you will no longer be able to perform your job. It is likely that sometime before that day arrives your job will cease to be the source of satisfaction that once made it a central component of your self esteem and happiness. When that day comes you will want to be able to retire. Unfortunately, funding your retirement is now your responsibility. If you start early this will not be difficult. If you are distracted for too many years by other considerations, like getting married, buying a home, and raising a family it will be much harder.

A simple calculation based on the widely recommended rule of thumb for retirement savings (15% of pretax income deposited in tax favored accounts) for a combined family income of $60,000 over the course of a 40 year career nets $1,297,123 at a reasonable 5.5% rate of return on your investments after taxes and inflation. This amount nets a safe 4% annual draw of $51,884 in retirement. Add $20,000 a year from Social Security (but don’t count on it) and you’ll be OK. The bad news is this will be hard for a young family. The good news is that once the kids are gone, you will be reaching your peak earning years just when you will be finished paying for college tuition and that 30 year mortgage. In the last 10 years you should be able to save a lot more than 15% of your pretax income and still take a nice vacation every year.

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