Pensions are a relatively new phenomenon. The first pensions date back to the 17th century, but the first modern pension scheme didn’t come into effect until 1889, when Prussia (now part of Germany) established an old age pension program. The program was financed by a tax on wages. Benefits started at age 70.
Old age pensions quickly spread to other industrialized nations. In 1934, President Franklin D. Roosevelt announced a plan to help fund the retirement needs of older Americans. The result was the Social Security Act. Eight decades later, social security is the single largest expense in the federal budget.
Social Security’s Fundamental Problem
Social security is a pay-as-you-go system. Contributions aren't banked for payment to the person who made them. Rather, like a Ponzi scheme, earlier "investors" have first access to the funds taken in. The so-called Social Security Trust Fund doesn't exist, at least not in the form most people believe it does. It represents only an entitlement to future benefits, financed by future payments from workers.
Social security schemes are sustainable only as long as the ratio of people paying into the system and those receiving payouts stays about the same. Today, the ratio of contributors to beneficiaries is at an historic low. In the next 25-50 years, it will go lower still. In 1960, the worker-to-beneficiary ratio was 5.1:1. In 2005, it was 3.3:1. In 2020, it will be about 2.6:1. In 2060, it is projected to be 2:1, but it is likely to be even lower.
Each year, the board of trustees for Social Security Administration publishes an annual report on the sustainability of social security benefits. In 2012, the board projected that full benefits could be paid through 2038. Four years later, though, the board projected social security would be insolvent by 2035. Meanwhile, the Congressional Budget Office projects an insolvency date of 2029.
Unfortunately, even that projection is over-optimistic. By 2029, millions fewer workers will pay into the system than even the most pessimistic scenarios estimate.
Blame technology. In the next few years restaurants will be staffed entirely by robots or automated servers. Hotels will be equipped with automated check-in systems and robotic butlers. And imagine a future where driverless vehicles are the norm. That development alone will render more than four million jobs in the US obsolete. Indeed, researchers at Oxford University estimate that nearly half of US jobs could be eliminated by technology in the next two decades.
With tens of millions fewer workers paying into the system, I doubt that social Security will be able to pay out more than 50% of promised benefits to anyone retiring in my lifetime.
The Crisis in Defined Benefit Plans
The news is just as bad, if not worse, for “defined benefit plans” that pay guaranteed benefits for life after retirement. Unlike social security, the money you pay into a defined pension plan is supposed to be saved, invested, and then paid out to you.
Unfortunately, it doesn’t always work that way. Take United Airlines, for instance. In 2002, the company filed for bankruptcy. Three years later, a bankruptcy court gave the company permission to terminate its pension plans. The plans were taken over by Pension Benefit Guaranty Corporation (PBCG), a federal agency.
A few years later, I had a consultation with a retired pilot who had worked for United for more than 30 years. He had been guaranteed a pension of $120,000 annually when he retired. But the maximum pension benefit PBGC can pay is only about $60,000 annually. His pension benefits fell by 50%.
Defined benefit plans for state, county, and municipal government workers are in even worse shape than private pensions due to an explosion in “unfunded liabilities.” These are pension payments that a government is obligated to make, but does not have money set aside to pay. Between 2005 and 2015, the unfunded liabilities reported by state pension systems nearly tripled, from $339 billion to nearly $1 trillion.
The actual shortfall is much higher. The unfunded liabilities of government-sponsored defined benefit plans are calculated based on the assumption that their investment portfolios will generate an average annual return of 7.6%. Unfortunately, they’re not earning anything close to that, due to slow economic growth and ultra-low interest rates. By comparison, private defined benefit plans must set aside assets to accommodate a rate of return based on supposedly risk-free long-term US Treasury obligations – currently around 3%. If government pension plans were obligated to fund future obligations based on the risk-free 3%, they would be $3 trillion short of full funding. That’s three times the official shortfall.
The only way to make up the shortfall is to raise taxes. But who will pay those taxes, when tens of millions of Americans are unemployed, thanks to robotics and other advanced technologies? Like social security and private pension recipients, government pension recipients will receive much lower payments than they anticipate.
Your IRA or 401(k) is Probably Underperforming
The final leg of the American pension system is self-funded pensions, namely, IRAs and 401(k) plans.
Unfortunately, Americans as a whole aren’t especially savvy investors. IRAs and solo 401(k)s, as a group, have significantly underperformed. For instance, the average 401(k) balance increased 2% from 2013 to 2014. But the S&P 500 increased 13% that year. The average 401(k) earned less than one-sixth of the broader market.
Still, since 401(k)s and IRAs are fully funded by investors, their returns aren’t dependent on taxpayer bailouts. But they require significant investor savvy to generate the highest returns.
Count on Living to 100
There’s a final nail in the coffin for traditional retirement planning. Biotechnology promises to significantly boost lifespans in the years ahead.
Research in anti-aging biotechnology is accelerating. One compound – rapamycin – extends health spans in animals by about 15%. That would be about a 10-year increase in human lifespans. And rapamycin is just one chemical – there are many more compounds being researched that could significantly extend human lives.
The Social Security Administration, the Pension Benefit Guaranty Corporation, and pension administrators have all failed to take the high probability of longer lifespans into account when calculating the long-term viability of their funding models. But they should, because rapamycin and other medical breakthroughs promise significantly longer lifespans in the next few years.
The bottom line is that the sources of funding for your retirement are much more precarious than you’ve been led to believe. And you could easily live a decade or more longer than your parents did.
In my own retirement planning, I’m counting on living to 100. And I don’t want to run out of money at age 95.
If social security and traditional pensions are floundering, where will you come up with the money to pay for 30 or more years of retirement? I’m preparing a report on this topic that will be offered as a supplement to The Lifeboat Strategy. Watch your inbox for details.
