Investor Charley Ellis is deeply concerned about pensions being underfunded as we approach peak boomer retirement years. He discussed it with Ted Seides on the Capital Allocators podcast which I summarize in full here.
The roots of our pension crisis can be traced back to 19th-century European rail workers! Here’s a summary of the problem, how we got here, and what to do about it.
The Pension Crisis
Scope of the Problem
Public pension plans are impossibly underfunded
If you look at what are the biggest problems we as a nation have in the investments world, it’s pensions or retirement security. You can see it easily in the state and city funds that are seriously underfunded. They need 7.5% rate of return which they’re not going to get because they’ve got 25% in 2.5-3% bonds. They’re just not going to get it.
Households are underfunded
If you look at individuals, half the population does not have a retirement plan. For those that do 401k is increasingly dominant, taking over from defined benefit system. The average person approaching age 63.5 which is the retirement age in this country is thinking:
“I’ve got 165,000 smackers in my account. Why my wife and I are going to Florida to play some golf, some tennis, have some fun. We’re gonna have great years. We’ve earned it. It’s been a long long working run, but we’ve earned it it’s going to work out just fine.”
Except…
Anybody with any knowledge about investing knows right away — $165,000 if you take money out, from 63 years old to 85 or 90 is not enough. You’re not going to have anywhere near enough per year, cobbled together with social security to make anything like a decent connection.
Something over 65% of your life time health expenses are spent in your life six months. Well, that’s where half the bank for personal bankruptcies come from all kinds of trauma that goes with that as well assisted living expensive and dementia. So we’re going to have a real problem with old age, retirement security.
Political nightmare
So what are people gonna say?
“God damn it. I worked hard all my life I played by the game rules as everybody laid them out. And I was supposed to be able to retire at a decent age and enjoy retirement. That’s part of the deal.”
But the answer they will get back?
“Sorry, but nobody else understands that to be the part of the deal. And you’re on your own.”
So you will have a giant generation that is angry, focused, and motivated to do something about this false promise.
If you think we’ve had divisive politics in the past, imagine what it would be if you had millions of people and their relatives all saying “It isn’t fair. It isn’t right. These guys got screwed.” I think we’re going to have a terrible societal problem, political problem.
How Did We Get Here?
The retirement problem is rooted in an era of different needs and circumstances.
History of the retirement age
- Age 65 came from Social security which dates back to 1935,
which came from:
- Railroad Retirement act in 1923,
and even before that:
- Churchill and Chamberlain jointly put forward in the United Kingdom retirement at 70, but people thought that was unfair because the Germans used 65.
And here’s where we get to the root…
- German’s retirement age dates back to early 1880s
Baron Von Bismark tried to unify the German municipalities via technology namely the telegraph and the railroads. The telegraph combined with the post office allowed instantaneous communication anywhere in Germany.
We’re going to bring coal and iron ore from the rural and other areas to where the steel mills are and we’re going to build steel mills and have tremendous industry. And then railroads are going to be able to bring people from the cities out to the countryside for weekends, vacations can be normal, and we will bring from the countryside, fresh fruit, fresh vegetables, all kinds of wonderful things that for people to eat, it’s going to make everything terrific. That’s great.
But where are you going to get the workers to work on the railroad?
Offer lifetime employment.
You get them to come out of the forest because they can get lifetime employment. That’s terrific. What do you call that? That’s guaranteed. This is a commitment. It’s the honor of Germany. Okay. Let’s go.
So what happened?
Well after a couple of years there were accidents on the railroads. Trains ran into each other, people were killed. Public outrage and scrutiny.
What’s going on?
Well, let’s send a study group and find out what the heck is going with these accidents. Well, we found out what the answer is in the work. Laying tiles, lifting heavy ties, brailles, shoveling coal, all kinds of heavy work. They’re saying to the older guys in their late 50s and 60s, your too old for this kind of work. You take the easy job. You’ll be in charge of the switches.
Then what happened?
So the switches are being manned by guys in their early 60s. A beautiful summer’s day and no trains coming in for the next couple of hours, why not take a little nap? And they’re just taking a nap, forget to wake up, and the accident happened.
The solution?
Guarantees for life. Pay them not to work. To be cost effective find the min-max where it costs not too much to solve most of the problem. And the answer was 65. Most people don’t live to 65 in those days in Germany, but those who do are really doddering, so they will only last for another couple years after 65 anyway.
An obsolete model
We have inherited and retained a retirement model that is a poor fit for our post-industrial circumstances.
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- People live longer now. The ratio of non-working to working years has increased.
- People are able to work longer as manual labor’s share of the economy has declined.
Dealing with the Crisis
Extend your savings
- Take social security later…instead of 62 if you wait until 70.5 you make 76% more inflation-protected for the rest of your life. If you wait, you have fewer years in retirement, so they’re willing to give you a larger amount.
- Continue funding your 401k in your 60s. These are the easiest years to save money. So you can ramp up your savings, dump it into the 401k as fast as you could. (also there are catch-up allowances)
Do all of these things and your chances of being in serious financial trouble in retirement go from awful to not too bad. So if we act soon, we could make a big, big difference in what could otherwise be one of the worst problems our society has ever faced.
Why has this been so challenging to solve?
The big problem is nobody’s paying attention to it. It’s too late. Congress is dealing with politically urgent issues. We need to agree to raise the retirement age to 70 but it’s easy to say that when you are not a ditch digger or coal miner.