America's Retirement Timebomb!

Over the next five years the largest cohort of the baby boomer generation will reach retirement age and while it is broadly assumed that they will have comfortable retirements, a recent analysis of their assets shows that more than half of this final group of boomers are not financially prepared to retire whatsoever.
In today's video we look at how American retirees found themselves in this position, and how much you need to save to have a comfortable retirement.

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Additional Reading:
While America Aged by Roger Lowenstein: https://amzn.to/4fLLZ45
Peak Boomers Paper: https://www.protectedincome.org/wp-content/uploads/2024/04/Peak-Boomers-Econ-Impact-Study-ALI-RII-Shapiro-Stuttgen-EMBARGOED-Apr-18-2024-041924.pdf
Fed Survey: https://www.federalreserve.gov/econres/scf/dataviz/scf/chart/#series:Retirement_Accounts;demographic:agecl;population:4;units:have;range:1989,2022
Private pensions in the United States: Gambling with retirement security: https://www.cambridge.org/core/journals/journal-of-social-policy/article/private-pensions-in-the-united-states-gambling-with-retirement-security/F6599767174900C76CF00146B9F295C4

Transcript

Over the next five years the largest cohort of the baby boomer generation will reach retirement age and while it is broadly assumed that they will have comfortable retirements, a recent analysis of their assets shows that more than half of this final group of boomers are not financially prepared to retire whatsoever.

Younger viewers might be shocked to hear this, after all, much has been made of the data showing that while retirees make up only 17% of the population, they hold more than half of America's wealth.  This is of course to be expected – as a group who have worked their whole lives should have accumulated more wealth than those just starting out in the workforce.

The Baby Boom generation is usually defined (in the United States) as the group born between 1946 and 1964 during a post-world-war-two period of growing American affluence.  The group now approaching retirement age are described in a new study as peak boomers – which are the group born between 1959 and 1964. This younger group of boomers are less financially secure than their siblings who are often just a few years older and many don't have sufficient savings to cover the costs of a comfortable retirement. A 2022 Federal Reserve study found that 43% of 55 to 64-year-olds had no retirement savings at all and 30% of Americans over the age of 65 were economically insecure – which was defined as bringing in less than $27 thousand dollars per year per person. The fact that this younger cohort of boomers are less financially prepared than the group already of retirement age means that this problem is only going to grow.

The new study from the Retirement Income Institute shows that based on an analysis of their assets, two-thirds of peak boomers will be financially challenged in retirement.

This group are a group who mostly entered the workforce right at the time when defined benefit – or traditional- retirement plans disappeared.

A defined benefit plan is a retirement plan that guarantees a fixed monthly payment to retirees which is usually protected by federal insurance. When an employee dies, their beneficiaries often receive additional payments, depending on the plan. This type of retirement plan has mostly been replaced by defined contribution plans, where a defined amount is contributed each month, but the eventual payout is unknown and depends on a combination of how much was set aside and investment returns.

According to the study, just under a quarter of peak boomers have defined benefit plans and the group with these plans mostly had union jobs for private employers or worked for state and local governments.

The most common retirement plans amongst peak boomers are defined contribution plans like 401(k)s. 48 percent of peak boomer men have defined contribution plans with median holdings of just under a hundred thousand dollars and 41 percent of peak boomer women have these plans with median holdings of just under sixty thousand dollars. The greatest disparity within this group explained by educational attainment: 55 percent of Peak Boomer college graduates have defined contribution accounts with assets worth $117 thousand dollars compared to 40 percent of the high school graduates having these accounts with assets of only $31 thousand dollars. Only 13 percent of those without high school diplomas have defined contribution accounts at all, and these accounts have a median balance of around ten thousand dollars.

Boomers of course own assets other than just retirement accounts, many own homes, cars, collectables, cash savings and things like that.  According to the study, more than half of peak boomers have total assets of $250,000 or less and can be expected to rely primarily on Social Security as their main source of income in retirement.

One of the co-authors of the study – Robert Shapiro writes that “America has never seen so many people reaching retirement age over a short period, and well over half of them will find it challenging to meet their needs through their retirements, let alone maintain their current standard of living. They lack the protected income that many older Boomers have from solid pensions or higher savings.”

So how did American retirees find themselves in this position, and how much do you need to save to have a comfortable retirement?

In the United States, until very late in the nineteenth century pensions were pretty much unheard of, there were some benefits for Union army veterans who had been injured, but retirement as a distinct phase of life devoted to leisure didn’t exist, nor did unemployment. People worked their whole lives and as they aged, they continued to work, but worked a bit less, and if needed turned to their family and friends for food and shelter. Back then people didn’t live as long as they do today - in 1900 only 4% of the population was over the age of sixty-five. 

With medical advances and the introduction of modern plumbing people started to live a lot longer, and due to industrialization and the appearance of the factory, people didn’t work on farms anymore where they could slow down as they aged. Factory foremen weren’t interested in having less productive workers slowing down production lines.  

American Express who started out as a freight forwarding company in 1850, introduced the first private pension plan in 1875, providing benefits for employees 60 years of age or older who had 30 years of service with the company.  The railroads – which were the high technology companies of the day followed suit.  This allowed them to attract the best workers, incentivized the workers to stay on the job – as they only got a pension after thirty years of service, and allowed companies to retire the older workers and replace them with young more productive workers.

The railroads were soon followed by banks, insurers and utilities – the kind of companies interested in attracting and keeping a stable and skilled workforce.  Changes to the tax code meant that money put into pension plans was tax deductible, so by the late 1920’s a significant minority of employers offered pension plans of some sort.

Some of the biggest factories in the United States were the car companies in Detroit who paid their workers well but were adamantly opposed to trade unions.  In 1927 when the Model T Ford was discontinued, 100 thousand workers (around the world) were put out of work for months while the factories were retooled for the Model A.  A few years later, The Great Depression saw wage cuts and layoffs on a much larger scale.  Life was not easy for an autoworker.

Labor unions grew in power during the Great Depression as workers turned to them to find work and protection.  An out of work physician in California – Dr. Francis Townsend began agitating for a national retirement scheme where the government would distribute $200 per month to each American over the age of sixty and pay for it with a sales tax.  He argued that the increase in consumption would boost the economy. Millions of Americans joined Townsend clubs – and to a certain extent Social Security was enacted in 1935 as a response to this agitation.

The businesses who had been early adopters of pension plans – like the railways - hadn’t done much analysis on the long run cost of these programs, they simply paid benefits from general funds.  As business conditions worsened during the depression, the railroads in particular came under stress.  The Pennsylvania Railroad, whose pension expense had been 235 thousand dollars in 1900 had reached $8 million dollars by 1931. The railways were less profitable and dealing with competition from long distance trucking. They discovered during this slowdown that pension expenses, unlike wages could not be reduced with the business cycle. It got so bad as the railroads fell into bankruptcy that railroad pensions had to be bailed out by congress with the Railroad Retirement Act.

By the end of the second world war – around the time the first of the boomers were being born, Americas demographics had changed.  Now, 7% of Americans were over the age of 65 – twice the percentage from 1900 and experts projected that this percentage would double again by 1980.

Two government policies enacted during the war had incentivized the growth of pension schemes.  The first was a tax on excess profits which made the the tax shelter offered by retirement plans more attractive to employers.  The second was a government freeze on cash wages – which incentivized businesses to offer noncash benefits like pensions to workers to attract talent.

By the end of the war, one sixth of the US workforce now had pensions – but they were mostly offered to professionals, not blue-collar workers.

The National Labor relations act of 1935 had given workers the right to form unions and the right to collective bargaining. Its effect was muted during the great depression and during the war, but the unions erupted once the war ended as workers had been squeezed by wartime inflation combined with pay freezes.  There was a series of crippling strikes against steel mills, coal mines, shipping companies, refineries and auto manufacturers which almost ground the US economy to a halt.  President Truman took control of the coal mines and railroads to keep the economy alive. He threatened to use the army as strikebreakers and asked Congress for the power to draft strikers into the military to then make them work. The strike lasted for 21 months, and the unions finally accepted Trumans terms and returned to work.

As inflation ebbed and the cold war escalated, public opinion was less sympathetic to organized labor.  Unions reduced their demand for pay raises and instead asked for pensions and other benefits that employers were more willing to agree to.

Post war welfare states were emerging in Europe where Britain nationalized coal, rail, gas and electricity and built public housing such that 40% of the population lived in government housing up until the 1980’s

In France, Charles De Gaulle nationalized the energy, transportation, aviation and financial industries, absorbing Air France, the country’s eleven largest insurance companies and most of the banks. Frances largest automaker Renault was confiscated and its founder and owner, Louis Renault, died in prison while awaiting trial for producing trucks for the enemy during the occupation. By 1946, the French government directly controlled 98 percent of coal production, 95 percent of electricity, 58 percent of the banking sector, 38 percent of automobile production, and 15 percent of total GDP.  This is not what the Americans wanted…

In 1950, the United Autoworkers Union after a crippling strike at Chrysler struck a deal with the big three automakers – known as “The Treaty of Detroit” which gave autoworkers pensions equivalent to around $1500 per month in today’s money.  A few business journalists at the time recognized the danger of these deals, noting the incalculable nature of pension obligations and asking if the businesses would even be around in the distant future when these obligations came due. The plans endowed pensions to all employees – for whom no money had been set aside, some of whom were already nearing retirement. At Ford – which was still a privately held company, the estimated liability on day one was a staggering $200 million dollars.

After their success with the automakers, other unions were successful and American workers now had defined benefit pension plans.  In 1955, the United Autoworkers Union pushed even harder.  The car companies negotiating hand was weakened by the fact that they were rolling in money.  General Motors had just been the first American company to ever earn a billion dollars in a year.  The union wanted protection from layoffs and pushed for guaranteed wages whether an employee was working or not. Pensions were boosted 50%, disabled workers got double pensions, workers got seven holidays and three weeks of paid vacation per year. They also demanded an even costlier benefit, health care for retirees.

By 1960, 40 percent of American workers had won or been granted pensions and fewer men than ever before were working after the age of sixty five.  In 1920, 60% of seniors were still working, by 1960, only 30 percent were. The unions next began demanding early retirement with full pensions.  This was the era of the rise of the American middle class, where a factory job could provide a good living for an American family.  

There was, however, a black spot on the horizon. In 1954 Packard had failed, wiping out a chunk of pensions owed to their employees. Studebaker who had been struggling for years agreed to its fourth pension hike in eight years in 1961.  The union was able to celebrate another big win, and Studebaker could hang on to its scarce cash – after all pensions wouldn’t need to be paid out for years- unlike wage hikes which were immediate.  Two years after this agreement, Studebaker failed and thousands of employees lost the bulk of their pensions. 

By the mid 1960’s automobile profits began to slow, and in 1967, the first Datsun was sold in the United States.  Americans loved the new Japanese imports which were much cheaper as labor costs were a lot lower in Japan.

The unions were at the height of their powers however and kept pushing.  It was after all their job to get as much for their members as they could.  In 1973 the UAW negotiated full pensions for early retirees – which was known as the 30 and out.  Any worker could retire as soon as they had served thirty years on the job.  Many started working at age 17, which meant that they could retire at age 47 with a full pension – which included a top up to compensate them for the fact that Social Security wouldn’t kick in until they turned 65. This was disastrous for the auto industry, as apart from the early retirements, Americans were living much longer than ever before and the actuarial cost of these pensions was exploding.

This wasn’t just happening in automobiles; it was happening in steel and rubber too where pension costs had risen at three times the rate of wages. American manufacturers were unable to compete with foreign competition when the cost of pensions and healthcare alone were higher than the margins on a Japanese car. Even a Japanese car that was being built in the United States cost thousands less to build per unit as the Japanese factories were not unionized.

By the late 1990’s General Motors had 180 thousand employees and 400 thousand retirees it was paying pensions to.  In 2001 Bethlehem Steel had eight times more retirees than workers and its pension fund was 3.7 billion dollars in the hole.  No investor would have put money into the company if it involved taking on that obligation, so the firm went bankrupt, and the pension obligation went to the Pension Benefit Guaranty Corporation, a federal agency set up in 1974 to insure pension benefits up to a reasonable limit.

A wave of bankruptcies – like the airlines in the early 2000’s meant that this federal agency – which was backing pension plans - itself had a serious deficit, and the US auto industry with its massive obligations was on the rocks.

By 2005 Starbucks was spending more on healthcare than on coffee beans – which partially explains their terrible coffee.  In 2006, the average compensation of an autoworker – including benefits was $81 per hour.

It wasn’t just big industry that faced these problems.  Government employers had started offering pensions before private industry did – at first for hazardous lines of work – police, firefighters, jobs like that, and initially the benefits were only for people injured in the line of work. Roger Lowenstein’s book – While America aged – while almost twenty years old is probably the best history of American Pensions and how everything went wrong.  I’m leaning quite heavily on it in researching this video.  He describes how the transport workers union in New York negotiated massive salaries and benefits out of politicians – almost unopposed – as the elected officials negotiating with union leaders were well aware that the unions could sway elections.  This led to deals where subway workers with a high school education earned more than the average New Yorker and could retire after twenty five years, making more in retirement than they earned when on the Job – and often spending more of their life retired than working.

Lowenstein looks at the pension crisis in SanDiego where by 2005, the municipal pension fund was 1.7 billion dollars in the hole - a debt equivalent to $6000 dollars for every family in the city.  The press had begun referring to the San Diego as Enron by the sea. This massive debt came from labor unions wringing higher benefits from weak politicians for decades, forcing the eventual expense onto later generations.  Eventually the SEC had to investigate the city’s municipal bond disclosures regarding its pension and retiree health care obligations, sanctioning both the city for securities fraud and its auditors.

Many workers today bemoan the disappearance of defined benefit plans, which have mostly been replaced with defined contribution plans, but when you look at the history of these pensions, you can see that they can to a large extent be blamed for the decline of large-scale manufacturing in the United States.  When we blame foreign competition and outsourcing for the decline of manufacturing, we need to add to that list labor unions who negotiated the deals for workers that crippled the businesses that employed them.  In the mid 1950’s General Motors was the most profitable business in the world, churning out innovative products that people lined up to buy.  When they became unprofitable mostly due to terrible labor deals – Japanese manufacturers were not only able to undercut them in price, but because they had significant profits they were able to reinvest in improving their cars, while US manufacturers stagnated.

As the pension problems of the US auto industry became glaringly obvious, other big American firms like Hewlett Packard, Verizon and IBM saw the writing on the wall and froze their defined benefit pension funds, such that employees would no longer accrue benefits. The only pensions being offered now were defined contribution plans.  The new companies that began to rise in the 1990’s like Walmart, Amazon and Microsoft didn’t provide pensions to their employees and were able to hire and fire as needed and pay a market wage.

While many of the boomer generation did well out of the high pay and good pensions that existed when they entered the workforce, many of the younger boomers will not have done nearly as well as their older siblings, as these deals were already on their way out by the time they started working.  Unfortunately, they will have seen the people a few years older than them retire comfortably and figured that things would just work out for them too. But those older boomers had very different finances.

When we look back at the disappearance of middle-class manufacturing jobs – we have to remember that this really only existed for a short period of time – and the high pay and benefits eventually bankrupted the companies that agreed to pay them.  It is not obvious that those days are ever coming back – despite what politicians might tell you.

Many workers who have not planned well for retirement may plan on simply working deeper into old age, but health issues can often prevent that from being a viable plan.  If you remember from the start of the video, the least educated workers are usually the ones without good retirement plans, many of whom will have earned a living doing physical work which can be harder to do as you age, and your health deteriorates.

Roger Lowenstein sums up his book by pointing out that financial debacles usually involve some sort of borrowing and borrowing is essentially an arrangement between the present and the future. The pension schemes that blew up, or the retirement plans that failed were predictable in the way that the outcome of overspending on a credit card is predictable.

A report from the US Senate Health, Education, Labor, and Pensions Committee from earlier this year found that about half of American households "will not be able to maintain their" preretirement living standard and that 56% of low-income households — and 45% of those who are middle income — are "at risk" of not maintaining those preretirement standards at age 65.

Federal programs like Social Security, Medicare, and Medicaid are of great importance to retirees, but they are often insufficient, meaning that the burden of caring for older people falls on younger family members who are still supporting their own children. 

As the boomer generation leaves the workforce in the next five years it can be expected to have an impact on the economy, retirees typically spend less money and spend it on different things than the employed do.  As an example, they spend a lot less on transportation and more on healthcare.  To offset the lower spending, economists highlight that productivity can be expected to grow as young people replace the elderly in the workforce.

So how much should you be setting aside – or have set aside - for retirement today?  Well according to T Rowe Price, by age 35 you should have set aside a year to a year and a half’s income as retirement savings.  By age fifty you should have 3 and a half to six years of salary as savings. By retirement you should have seven and a half years to thirteen and a half years worth of salary set aside.  Their assumptions are that this money is in a tax deferred retirement account is invested to earn 7% per year – which means is mostly allocated to stocks rather than bonds – or real estate.

Thanks for tuning in to this week’s podcast.  If you found it interesting, I’d really appreciate it if you could write a short review on your podcasting app or send a link to a friend to help the podcast grow.  Have a great week and talk to you again soon.  Bye.