Consumers are facing worrisome challenges in both working and retirement years. Pre-retirement, they plan to lean on social security for most of their income and they save what they can toward a retirement nest egg. Done right, retirement savings contributions can escape income tax, but political meddling with federal tax rates can wipe out most or all of the discretionary income typically contributed to plans like an IRA or 401(k). Saving has become difficult because there has been a lack of growth in household income since 2000 for those at or nearing retirement. Worse yet, unemployment can devastate hopes and retirement nest eggs and for 6.2% of those aged 55+, employment is elusive.
Pre- and post-retirement, nest eggs need careful management, but lately there are no “great” strategies. Compound interest used to be a portfolio’s good friend, but not recently. Ten-year T-bill yields at the 5% level in 2007 have slipped to a 1.6% level. Junk bonds can offer 5% yields but with substantial risk. Blue chip equities can deliver 2% dividends with the normal market risks, and a few can offer 7%-15% with substantially more risk (some MLPs, energy, and mortgage REITS). However, capital gains taxes are expected to increase and dividend taxes may triple for seniors, as the Bush-era tax cuts are set to expire. The effect of these pending tax increases will sharply reduce the market value on money market funds, adversely affecting most retirement accounts.
Steadily increasing equity in homes has reversed course, depleting a big piece of retirement assets. The upside-down real estate market is the major reason why Canadian households are now wealthier than their American counterparts.
Regardless of the risk level you tolerate, inflation eats 1.4% of retiree’s returns. Don’t dare make a bad stock (or bad muni) pick. Be wary of the eventual rapid increase in interest rates – it’ll destroy some bond funds. Despite low yields and big uncertainties, seniors need to nail down expectations for the markets and make investments accordingly.
In the post-retirement period, seniors will also face rapid increases in health costs and taxes, and whether you need it or not, mandatory distributions of 4% or so from IRAs when we near age 70. The minimum distribution increases with age, so it’s difficult to consistently “out-yield” the minimum distribution. You can’t outrun the IRS. Medicare coverage supplement premiums are already inflating to accommodate Obamacare. Even with government health coverage, deductibles, “not-covered” services, and co-pays can be a huge chunk of retirees’ net income.
In a quarter of households, consumers work during retirement to supplement social security and investment earnings or nest-egg draw-down (55% have some asset-based income). Unless Congress acts, working seniors will be paying more and getting less. For those in the lowest income categories, Food Stamps and Medicaid are common substitutes for income. 41% of retirees receive pensions, but their numbers are declining and some of those benefits are evaporating as firms bankrupt and leave pension funding gaps.
Simply put, there is no shortage of challenges for retirees.
Senior consumers may still sometimes walk hand-in-hand on the beach toward a sunset, but less often and some not at all. The bruising realities of grasping for money and spending it frugally occupy much of their retirement. Congress could do more to encourage successful retirement planning and savings. Keeping dividend and capital gains taxes from increasing in January would be one big way to reduce retirement uncertainty, and other measures should be considered. After all, it is better to help seniors successfully plan for retirement now, rather than relying on subsistence support to help them later.
Alan Daley is a retired businessman living in Florida who follows public policy from the consumer’s perspective.