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A Paradigm Shift of Income Planning

Written By: Cal Burgess, Retirement Servicing Group PLLC

The retirement crisis is likely to continue given the direction our pension plans are heading. It is no secret that the traditional pension plan is pretty much unheard of in the private sector. Today, your only real hopes of receiving a pension are through a government job. Even at that, state and federal governmental authorities are struggling to make the payments on a monthly basis. This is all the more reason why employees need to take their retirement needs into their own hands.

With the lower yields, pension plan administrators have to take on much more risk in order to keep up with the billions of dollars in monthly payment obligations. Many payment obligations today were designed decades earlier when the economy could favor annual yields of 7 -8%. The global recession yields today are closer to 2%. So in order to make up difference, administrators are turning to higher risk investments, many in the form of junk bonds. Unfortunately, higher yield potential comes with a greater chance of default.

U.S. pension plan managers are investing large amounts of capital into smaller speculative-grade borrowers, trying to yield the magic 8% yield needed for their payment obligations. Much of this debt is from smaller start-up companies looking for capital to try and capture a small portion of a saturated market. Borrowers with less than $500 million in annual revenue are paying much higher returns since big banks have decreased small business lending by 12% since 2008. Big banks have decreased their lending to these smaller companies due to the default ratios they were experiencing. None the less, fund managers are actively pursuing these debts due to the Federal government’s promise to hold interest rates low through 2014. Unfortunately, these are the risks fund managers are being forced to take on in order to make these overwhelming payment obligations. This is a destructive trend, and regrettably a necessary evil.

According to a study by the Pew Center on the States in Washington, states were $1.38 trillion short of their retirement obligations in 2010; which was up 9% from the year prior. These numbers include $757 billion in underfunded pension obligations and $627 billion short in retirement health. These numbers will continue to snowball with low interest rates making it impossible for this trend to continue without exploring alternate forms of revenue.

A few weeks ago voters in San Diego and San Jose, California approved measures to restructure benefits for municipal workers in cities that could not afford them. Several states including Wisconsin, Indiana, and Ohio have already started to limit collective bargaining for public employees, and have started cutting benefits accordingly. These limitations include reduced payouts for pensions and drastically less protection of healthcare benefits. Many other states, including Texas, are trying to renegotiate less favorable benefits for teachers and state administrators in order to help cut costs. Eventually, government pensions are likely to go away in exchange for a deferred compensation plan, following the suit of the private job sector.

It is no secret where this is heading. We are seeing a paradigm shift from the responsibility of the employer to the employee. Employees today are being forced to be more self reliant with respect to health care and retirement obligations. Relying on employer or governmental obligations is proving to be a trend of the past. Because of this, many employees are redirecting their deferred compensation plans to vehicles that will yield an income stream within retirement. Vehicles not dependent upon a fund manager yielding needed returns, but instead with income guarantees backed by cash reserve pools. These income streams are guaranteed for life and use income account values (non-cash values) to determine the amount of income one is eligible for at a given age (usually from ages 50 to 90).

Failing to adapt to these market trends is going to result in Americans struggling throughout their retirement years because of lack of income. Social Security and pensions simply will not exist for many in the coming years. I believe that every US citizen under the age of 50 should not count on much, if any, social security benefits being available to them starting at the age of 62. Furthermore, when you take into account that over 90% of workers today are not being offered pensions, the idea of a lifetime income becomes very attractive. Once again, adaptation is the key. Those who fail to secure their income needs for retirement can count on being a future burden to this country.

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