Steve Klingaman

Steve Klingaman
Minneapolis, Minnesota,
January 01
Steve Klingaman is a nonprofit development consultant and nonfiction writer specializing in personal finance and public policy. His music reviews can be found at

Editor’s Pick
JANUARY 22, 2009 12:14PM

Would-Be Retirees Confront the Doom Loop

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    Pretty much everyone gets hurt in our economic meltdown, save for the first-time homebuyer with a secure job and great credit.  One group about which we’ve heard very little is those who were about to retire when the crisis hit.  They are the vanguard of the Boomers, born in the aftermath World War II.  They are now approaching age 65.

            On the whole, this group, who exemplified the new American tradition of serial careers, have no, or puny, pensions.  They were the guinea pigs for the great 401k experiment. For those who did save diligently, we have a financial tragedy in the making.  For those who didn't, they always had a financial tragedy in the making.

            Timing, they say, is everything.  In saving for retirement, if you save early and often, the thinking goes that time is pretty much on your side.  But there is another side to the equation and that is the timing of your retirement.  Recent research indicates that a severe downturn in the market at the beginning of retirement can portend catastrophic results for your long-term portfolio, especially if you play your cards wrong.  And what would the wrong move be?  The worst thing you can do is to increase your percentage withdrawal to make up for the lost earning power of your diminished portfolio.

Ugly Math

            Best practices in retirement planning dictate that you withdraw 4 -5 percent annually.  This rate of withdrawal theoretically allows your portfolio to continue to grow sufficiently to generate future earnings at a sustainable rate.  So let’s say you were one of the truly diligent savers who saved a million dollars in your 401k.  If you reached this milestone you were in top 10 percent of all retirement savers.  You were the bulwark of your generation—never to become a ward of the state in your golden years.

            At a withdrawal rate of 4 percent, you would collect $40,000 a year to live on.  Theoretically, this rate of withdrawal allows your portfolio to grow over time, reducing the chances that you will outlive your money.  This amount, when combined with social security and the equity in your home, would allow for a modest retirement in the post-pension age.

            But that million dollars was the amount you had saved as of December 31, 2007.  In 2008, your portfolio took the big plunge.  That little envelope from your investment company reveals that the Standard & Poor’s 500 stock index lost 38.5% on the year.  You might as well have invested in cold fusion for all the good your prudence did you on this blue chip exchange.

            Your diversified portfolio theoretically mitigated that loss.  Let’s say you did the standard 60-40 stock-bond split.  This is the hypothetical starting point for an endowment portfolio designed to support a permanent endowment.  Taking stock of a sample bond portfolio, the Vanguard Total Bond Index Fund earned a 5 percent return last year.  That’s positive territory though many bond funds did not fare as well.  So your total portfolio loss might be in the range of 22 percent, meaning that your portfolio on December 31, 2008 was worth a paltry $792,000.  So what happens if you try to recapture the $40,000 you want to live on next year?  You have to increase your withdrawal rate to 5.1% to make up the difference.

            In an up market you might get away with such a withdrawal rate—but not in these perilous times.  Your remaining balance:  $752,000—is likely to earn another minus 10 to 12 percent this year.  That leaves you with just $662,000 from which to withdraw your living expenses the following year.  Final result:  Doom Loop. That nest egg that was supposed to last a lifetime is headed for extinction within fifteen years.

Part-Time Retirement?

            So what does the would-be retiree do?  There are just two choices here—really only one choice, and that is, hunker down and work another year or two.  The maximum allowable amount of those earnings should go right into your 401k to repair some of the damage.  At least you’ll be buying stocks on sale—though bonds are no bargain.

            A part-time retirement might be a solution, if you can live on a diminished draw on your retirement savings—say something in the 2 percent range.  Either that or move to Ecuador.  Retirement experts, including John Bogle, founder of Vanguard Investments, say your stock-bond diversification should mirror your age.  He recently said he did just fine last year thanks to a portfolio that held only about 20 percent of his retirement savings invested in equities.  That would mean our would -be Boomer retiree would have had 64 percent of his or her portfolio invested in bonds.  This is rare, although present circumstances illustrate the wisdom of that course.   And I would contend that if you did follow the bond-percentage-to-your-age rule, chances are you would never have amassed that million dollars to begin with.  If you did, you would have to have saved at a rate achieved by only the top 1 percent of all retirement savers.

            The scenario above is a best-case scenario.  Most people who are ten years away from retirement have less than $500,000 sacked away—in most cases, far less.  And diversification ratios for these savers shows a far greater exposure to stocks.  Combine that with the well-documented inability of the little guy to invest well and you have a looming retirement catastrophe on the horizon.  What this means to most Boomers—and it is amazing that more attention has not been focused here—is an almost-certain decline in the standard of living they will experience in retirement.

            What, if anything, can be done about it?  For those close to retirement, time is not on their side.  They don’t have the time, or in many cases the job, to make up for lost ground.  The whole picture adds up to a broken de facto national retirement savings policy.  In reality, there is no policy.  The most the Bush administration could muster was the pathetically off-base social security privatization initiative. 

Modest Proposals

            Federal tax policy could be used to strengthen the nation’s retirement platform right now. The government could begin by requiring more employers to offer 401k plans, even for "starter" jobs.  In addition, the government should mandate employer matches to 401k plans.  The amount employers contribute should be increased by a point or two, which should be rewarded by tax incentives.  Second, the default option for worker participation in retirement plans should be automatic participation, with modest tax penalties to the individual for nonparticipation.  This is the only way to provide a future hedge against the unprecedented demands on Social Security as a tidal wave of Boomers retires.

            For those close to retirement, or already in retirement, some portion of the federal bailout budget should be set aside for a tax holiday, a temporary tax relief program for low-income retirees living off of their 401ks with no pension assistance.  Their 401k withdrawals should be taxed not as ordinary income as is presently the case, but at the lower capital gains rate.  This program should remain in effect for up to three years—until the market returns to some semblance of normalcy.  Why?  The government should reward those who have attempted to do for themselves to avoid increased dependence on all manner of government programs.

            Corporations have long been lobbying for a lower corporate tax rate.  The Obama administration should lower the rate for companies that contribute richly to worker retirement plans.  Three tiers of relief should be offered according to the following conditions:

  • Biggest breaks for companies that offer full pensions
  • Second-tier breaks for companies that offer mini-pensions in addition to 401k plans
  • Smaller breaks for companies that offer an automatic opt-in 401k plan with a 7% employer match

            For individuals age 55 and up, make-up caps on 401k plan contributions should be abolished.  Individuals age 55 and up should be offered a tax credit for make up contributions above 15% of salary.

            The 2001 and 2003 tax cuts helped only the über-rich—and these benefited the top micro-tier of privileged families to the tune of hundreds of millions of dollars a year.  Reverse these cuts and you have a small kitty with which to move these reforms forward.

            The new way forward for a national retirement policy should be a tripod of Social Security, personal savings and corporate contributions.  This is the only way to avoid the looming Social Security crisis.  If we are going to assume more debt now, it should provide benefits to individuals far more than banks and it should help to reduce systemic entitlement costs down the road—for we will have to cut these in order to pay for all of the economic stimulus on the table today.  And those on the cusp of retirement should receive additional help now to ease the losses due to market abuse on the part of those who should have been subject to regulatory oversight all along.  If you want responsible behavior and market-based solutions, reward "retirement market" reforms now.

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People save money?

Damn, I forgot to do that ...

Oh, well, I'm only 52.
Thanks. I hear Belize is nice this time of year. Not to make light of all of this.
Much of what you say makes sense. I'm closer to 60 than 50 years old and I confess a deepening sense of panic. I had hoped to retire earlier (62) due to health concerns...well...our 401 K investments took a 40% loss this year (slightly higher than your quote) and it's devastating to hear your prediction of another loss year at least. I am running out of time.

Again much of what you say makes sense and I like some of your tax proposals. However, it is all built upon the assumption that people HAVE and RETAIN their jobs that allow them to make 401K contributions.
Dear Feathered Thing,

It's enough to want to make you migrate south! My portfolio took a hit larger than that described in the article because mine relies on a higher percentage of equities, international stocks, real estate, emerging markets and financials; all of which got slaughtered. Still, a paper loss such as you describe is brutal.

With an official unemployment rate of 7 percent and an unofficial rate of maybe 13 percent, 87% of the workforce is still at it--at it is critically important to save during hard times because that is when stocks are, as they say, on sale. All I can say is don't bail while the market is in the tank!
Let's see...I thought I retired 2 years ago. Oooops! Nah, not really. Part-time here, part-time there. I got a new lead. The US Census Bureau is now taking applications for the 2010 Census. I hope I make that long. In my book all math is bad when the numbers stop working for you. Cheers!
I never listened to the experts. I was urged to take my money out of the state retirement system and put in a 401(k) because an expert said it would make more money in the long run. My co-workers who did that are still working while I retired early on the state system early buyout in 2003.

Beside the state system, I put money into a supplemental retirement account and invested conservatively into a guaranteed principle--no stocks because I thought it was the same as gambling. The experts advised against my conservative approach. The account made only 7% gains during the boom years of the 90s. Today, it makes 3% but I haven't lost anything. I don't make any withdrawals from that account and only plan to do so late in life.

Those who have lost 30-40% of their retirement accounts probably had gained a great deal during the 90s. Too bad they didn't take the money out before the fall if they were planning to retire soon. Now, they are stuck but that is the price they paid for gambling in the stock market.

My approach is not for everybody--you have to be extremely patient, save a lot, and decrease expenses. You can't live in a big house and need to think twice about having more than a couple of children. But, the simple life pays off in the long run. Maybe that's a lesson we all can take from this.

Thank you for your comment. You raise an important point. People must make decisions with which they are comfortable. Some, like yourself, are decidedly risk averse and would never be comfortable with "letting the money ride." And a pension fund, where your employer assumes the investment risk, is the gold standard. I have seen employers let private money managers in to the workplace to pitch highly inappropriate investment options to an unsuspecting audience. The reason is simple. If you opt out, your lower the employer's risk.

As I see it, there is a fundamental difference between gambling and investing. To buy and hold--in a properly diversified portfolio built with index funds especially--for the long term is not gambling as I see it. The risk you assume by opting out of the market is a guaranteed risk. Inflation will decrease the buying power of your retirement money over time. The modern stock market, since 1929, has delivered a long-term average return of about 7.5%. A balanced portfolio comprised of a gradually increasing percentage of bonds can be expected to return about 5.5% over time. This provides a powerful hedge against inflation.

But the most important aspect of any long-term plan is that of sustainability. If you keep your expenses down, way down, you can fund a retirement without recourse to the market. This minimalist approach works best for some.

With funds at risk in the stock market in the present horrible moment, most people can expect that the market will return all of what has been lost, and then some, over time. The problem is that in this case, it is going to take a good bit of time. Some people just do not have that luxury of waiting unless they extend their working years.
Fidelity Investments reported on January 28th that 401k plans lost an average of 27 percent in 2008. The average balance per account decreased from $69,200 to $50,200 on the year due to market declines. On an up note, the study noted that Americans stuck with their savings plans during the year--a good thing in falling markets. Of course if you are a boomer and your 401k is your main retirement savings vehicle, you better have a lot more than $50,000 stashed away by now.
Update: The New York Times ran an editorial on this topic on January 26, which triggered some fascinating letters in the February 2 Letters to the Editors section.