Collapse of three-legged stool threatens retirement security

If you like a good horror story at Halloween, here’s one that should shake you to your core: For many Americans, the prospect of a secure retirement is evaporating like a vampire exposed to sunlight.

Saving enough during one's working years to retire securely has never been easy, but the burden of preparing for retirement has increased in recent years, Tyler Bond and Dan Doonan explain in their recent research paper, The Growing Burden of Retirement, published by the National Institute on Retirement Security.

Financial advisers are very familiar with the back story. Social Security now replaces less income than it did in the past. Fewer Americans are offered defined-benefit pensions through their employers. And defined-contribution plans, such as 401(k)s, shift investment risks and distribution responsibilities from employers to workers — risks that individual are often poorly equipped to manage on their own.

Throw in historically low interest rates that make makes it difficult for retirees to generate predictable income from traditional fixed-rate investments, and you have the perfect storm of risk on both the accumulation and distribution sides of retirement.

Much of the focus in retirement planning is on the savings needed to generate enough income in retirement. Under the traditional retirement model of a three-legged stool, guaranteed income from Social Security is one leg of the stool; guaranteed monthly income from a defined-benefit pension is another; and savings, either through an employer-provided defined-contribution plan or private savings, form the third.

“While retirement planning would certainly be easier with two guaranteed income streams from Social Security and defined-benefit pensions, the three-legged stool now is elusive for most Americans,” Bond and Doonan wrote in their latest research paper. “Only 6.8% of current retirees receives retirement income from all three of these sources.”

While individual workers face more risks, they also face rising expenses in retirement, the NIRS report said. The costs of housing, health care and long-term care have all increased and present greater obstacles now than in the past decades. As the population in the United States continues to age — all baby boomers will have reached retirement age by 2030 — these costs are projected to rise even more.

Seniors generally have higher health care costs than younger people and these costs are often the largest single expense faced by older Americans. And while not every older American will need long-term care, for those who do need it, it can be prohibitively expensive. Finally, housing costs remain a concern for many seniors as older homeowners are increasingly entering retirement with a mortgage.

Taken together, the costs relating to health care, long-term care and housing, as well as the challenge of accumulating adequate retirement savings and investing it well to last a lifetime, make retirement a difficult puzzle to solve. Those challenges also highlight the value of financial planning.

The American College of Financial Services echoed the concern that “America’s three-pillar retirement system is facing a potential crisis” in its recent report on the likelihood of 401(k) and Social Security reform in the next few years.

“The government retirement income program, Social Security — perhaps the most important pillar for many current and soon-to-be-retirees — may soon fall short in funding to pay full benefits to new claimants,” the American College paper stated. “At the same time, the second and third pillars of the system — workplace retirement fund and personal or private retirement plans — have proven inadequate to the task of preparing Americans for retirement.”

Despite the efforts of the government, the private sector and the financial industry, millions of Americans are approaching retirement with insufficient savings — or no savings at all, the paper said.

While the total amount of assets saving in retirement plans is substantial — 401(k) assets totaled $6.3 trillion as of June, according to the Investment Company Institute — the amounts saved by individuals vary dramatically. Many high-income earners, who typically work with financial advisers, have saved hundreds of thousands or even millions of dollars. However, the median amount of retirement account savings held by families ages 56 to 61 was just $21,000, according to the Economic Policy Institute.

There are several reasons for these retirement savings gaps, including some workers' having no access to workplace-based saving plans, failure to enroll in a plan, inadequate contributions and early withdrawals and leakage.

“Given growing concerns around retirement stability and legislators’ interest in reform, there is a high likelihood of changes over the next few years,” the American College report said, noting that the most important potential changes relate to taxation, as outlined in Democratic presidential candidate Joe Biden’s platform. In addition, current savers could also see rules around early withdrawal and required minimum distributions with implications for their long-term financial plans.

The American College’s word of advice to advisers: Keep abreast of inevitable legislative developments and adjust plans accordingly.