Pension Tension
Is your retirement plan heavily dependent on corporate pension plans, 401-k, or Social Security? If so, then I hate to tell you this, but there is a good chance you will be involuntarily initiated into the Grab Your Ankles and Make a Wish Foundation, courtesy of mismanaged corporations who pay deposed executives small fortunes the same day they send notices to worker bees announcing benefit cuts due to “budget shortfalls.” On the Social Security front, our politicians continue to promise that they will rescue Social Security, but the reality is that the solution has a big price and nobody, at present, has the testicular fortitude to propose viable solutions. It is like breaking your shin bone in two places. The longer you wait to see a doctor, the worse the situation gets. Can it be “fixed” – yes, but the solution becomes more painful and it may not heal as well as you would like, even with the best doctor in town.
The pension fund “issue” is politically popular because of the increasing number of baby boomers who are going to be retiring in the next two decades. However, for the soon to be retired crowd, the only solution available is a governmental band-aid. The more interesting crowd is the one that still has enough time to build a retirement that does not depend on either the government or corporate pension plans. Before sharing a few ideas on how you can do that, let’s start with a review of the current retirement landscape:
Retirement Myth #1: “corporate pensions are safe” – really?
Let me quote from the Pension Benefit Guaranty Corporation's Fiscal Year 2004 Financial Results Press Release:
“The Pension Benefit Guaranty Corporation's insurance program for pension plans sponsored by a single employer incurred a net loss of $12.1 billion in fiscal year 2004, according to the agency's financial statements released today. The program's fiscal year-end deficit increased to $23.3 billion from $11.2 billion a year earlier. For the first time, the total number of people owed benefits by the PBGC passed 1 million.”
Continuing on:
“In addition to losses booked, the PBGC calculates "reasonably possible" exposure, an estimate of the amount of unfunded vested benefits in pension plans sponsored by companies at greater risk of default. The 2004 financial statements estimated PBGC's reasonably possible exposure at $96 billion, up from $82 billion a year earlier.”
In summary, retirement funds are not safe. There are plenty examples of famous companies such as Arthur Anderson that have gone down in flames. For every famous one there are many more that have suffered the same fate. Even “strong” companies like General Motors have substantial under-funded pension liabilities.
Note that it is not just a matter of whether your retirement is there for you when you retire; you need take into consideration that companies often change policies depending on how they are doing. It is no less damaging to be informed late in your career of severe benefit cutbacks.
Retirement Myth #2: “none of this matters since the Pension Benefit Guaranty Corp. which is sponsored by the US government guarantees our benefits” – really?
Some interesting facts – the first of which comes from the November 15th, 2004 results release by the Pension Benefit Guaranty Corporation:
"The PBGC is committed to protecting pension benefits, and with $39 billion in assets we can continue to meet our obligations for a number of years," said Executive Director Bradley D. Belt. "But with more than $62 billion in liabilities, it is imperative that Congress act expeditiously so that the problem doesn't spiral out of control.”
Continuing on:
“The maximum pension benefit guaranteed by PBGC is set by law and adjusted yearly. For plans ended in 2004, workers who retire at age 65 can receive up to $44,386 a year. The guarantee is lower for those who retire early or when there is a benefit for a survivor. The guarantee is increased for those who retire after age 65.”
Assuming the US government can print all the money it needs to honor its debts (ignoring inflation for now, which is often caused by actions like these), this means that the most they will be required to pay you is $44,386 a year. There are a lot of people making more than that right now who would hardly feel protected if they were expecting to get $88,000 per year, saw their company hit hard times, and then late in the game find out that the fine print is not so fine after all.
Retirement Myth #3: the stock market will keep going up forever -- really?
It might – since the United States leads the world in technological innovation and still has a substantial human capital surplus. On the other hand, rising stock prices are also a function of demand, and demographics aside, one of the biggest sources of demand for stock has been dismantled the last twenty years with the migration from defined benefit to defined contribution plans. The evidence has shown that most people in defined contribution plans under-contribute and under-invest. Time will also tell whether the average person, who has little to no formal investment education or experience, will make better investment decisions than professional administrators. Along these lines, professional administrators are allowed to invest in almost any type of investment product but most employees in 401-k programs have far fewer choices (being able to choose from a huge number of similar mutual funds does not constitute a good menu).
Retirement Myth #4: all this retirement talk only pertains to older people – really?
Now is the time to take action – not when it is too late. One of your most powerful tools is the power of compounding, which works best over long periods of time. I also think one of the best tools you can use is real estate, which historically rewards the patient investor more consistently than the short-term speculator. I also like real estate because you can skillfully use it to take advantage of known demographic trends.
How do you do this?
I’m a real estate investor – by choice. When you study demographics, both here in the United States and elsewhere in the world, it becomes clear that we have one of the greatest opportunities sitting right in our backyard. Our country is growing and several States will be the recipient of a disproportionate share of the increase in population and new jobs. In a recent study that ranked US cities in order of new job growth, Florida registered seven of the top twenty cities (and five of the top ten). The population growth in Texasis growing with similar momentum.
My company, Tierra Capital, L.P. runs an institutional opportunistic real estate fund in Texas and Florida. In addition, we run a property management company called Tierra Property Management that manages both commercial property for the Fund, third party property and investor condominiums for smaller individual investors. When friends ask how and where to start, I often introduce them to a local builder with whom we have worked and whom we respect. With low rates, people like the idea of buying a new duplex for $150,000 in a growing suburb of Austin, Texas. Although every situation is different, we encourage people to think about using no more than 65% leverage and locking in the currently low long term rates – either 15 or 30 year durations (we recommend the 15 year loan and encourage people to see the benefit of the quicker paydown). With healthy rents, the cash flow covers all the debt service, real estate taxes, maintenance, insurance and our fees and while it also leaves some left over, the real value for the investor is that they are buying a new asset, in a growing area with positive catalysts and the tenants are paying for half the price of the purchase over time (assuming 50% debt for example). The end result is that over time these investors will end up owning multiple properties, all paid off, and receiving steady streams of cashflow. If you built it and you maintained them, you can be assured that in the future you are going to have a steady stream of recurring cash flow. In addition, as the area improves and grows, there is also a good chance that rents will increase along with property values. Many people also take comfort in the fact that they understand real estate, they can see it, they can touch it and they like the area.
There is little certainty when investing in stocks and there is no chance that your interest income will increase over time with bonds.
It is true that investing in real estate entails all sorts of risks – which are important to understand and manage and can be a topic for future discussion. It is equally true that it has proven over time to be one of the best ways to build passive income and build wealth.
No matter your age, I’d encourage you to sit down and commit your retirement plan to writing and figure out whether you are overly dependent on pension plans of one sort or another. My Father, who taught at a Southern California University for over 35 years before retiring (and is fortunately grandfathered under a defined benefit plan), told me just a few days ago that he heard that the California teachers pension fund wants to change their obligation from defined benefit to defined contribution. He retired just in time but many hard working teachers are likely to find their retirement assumptions change dramatically midway through their career.
Act on your retirement plan today and you’ll enjoy an even better tomorrow.
Make It Happen!
Stefan
Post Script:
Proposals have been made to increase the penalties that corporations face if they are not honest and forthright with their employees about disclosing pension shortfalls. Under the proposed policy, penalties for failure to issue an under-funding notice are tied primarily to the number of plan participants rather than the number of days of delinquency. The guideline penalty ranges from $5 to $100 per participant, depending on whether the failure is a first-time violation and whether the plan corrects the failure prior to audit. [Did you read this? Your entire retirement could be ruined due to poor corporate management and you may not even know it; and all the company has to pay if they get fined for not properly disclosing this to you is $100 per person!]
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