In the past all people had to do was go to school to get a nice, safe, secure job, buy a house, and work at that nice, safe, secure job until they retired. And from the time they retired until they died the company they retired from would take care of them. This is what was known as a “defined benefit” plan, or DB plan.
A defined benefit, or DB, pension plan was a retirement plan that defined the benefit or the dollar amount a retired person would receive. For example, if an employee worked for 40 years for a company and retired at 65, a DB plan might pay that employee, let’s say, $2000 a month for as long as he or she lived.
And if the retiree worked for a generous company that person may have received a COLA, cost of living adjustment. As inflation went up, so did that retiree’s DB payments. Some also had medical plans for as long as they lived. So as long as the retiree lived, he or she could go the doctor and the company would flip the bill.
In other words the DB pension plan became very, very inexpensive for companies as more people retired and lived longer through improved health care. This is the reason legislation known as ERISA was passed in 1974. The ERISA law changed the world forever in a massive way, but not many people realize it.
ERISA stands for Employee Retirement Income Security Act. It was the act that made 401Ks possible, and effectively changed most retirees pension plans from a defined benefit plan to a “defined contribution,” or DC plan.
A defined contribution, or DC, pension plan is a retirement plan in which the retiree “contributes” the money for their retirement. In other words, a worker’s retirement is only as good as the contribution…if there is a contribution. This was the government and big businesses’ way of passing on the problem of retirement from the employer to the employee.
Although the intention of ERISA was to pass the responsibility of retirement for retirees from the employer to the retiree, another intention was to spread the wealth around via investing and the stock market.
With a DB plan the retiree could only receive what the company decided to give them but with a DC plan, if the investments in the retiree’s plan did well the retiree could possibly have a lot more to retire on than they invested.
However, a DB plan has protection against a stock market crash and a DC plan doesn’t, so if retirees lose their money in the stock market they’re just out of luck. Likewise, there were many inherent flaws with the passing of the ERISA law that were not addressed that will lead to THE biggest stock market crash in history.
1. The law has a mandatory withdrawal mechanism. ERISA requires that people begin withdrawing out of their IRAs and 401Ks at 70 1/2 years old. This flaw will cause major problems around the year 2016.
In the year 2016, it is estimated that there will be over 2.2 million people turning 70 in America. In 2017, the number of people turning 70 will jump to over 2.9 million. The jump is caused because the first of the baby boomers begin turning 70. That is a jump of 700K more people turning 70 than in the year before and the number increases from there on.
In one year there is a jump of nearly 30 percent. That may give you an idea of the effect the baby-boom generation will have on DC pension plans and the stock market. It’s tough for a market to keep going up if people are required by law to sell what they own.
It’s like trying to fill a bathtub while more and more holes are punched in the tube. Pretty soon people don’t want to fill the tub.
Why is there a mandatory withdrawal, the answer is simple. The answer is taxes. It appears that when this law was passed, the Internal Revenue Service (IRS) wanted to know when they were going to get paid. Depending on what type of DC plan the retiree has, it will either be taxed when it’s put in the retirement account or taken out of the account.
2. The law failed to require the education system to provide proper financial education. Many people are financial illiterate; they don’t know how to read a financial statement, and in some cases don’t even know what a financial statement is.
3. No one is questioning the assumptions. The assumption that the stock market will always go up, that the advice of their financial planner is correct when it comes to investing for their retirement, that they will have enough for retirement, etc. And if the retiree gets handed bad advice from a financial advisor and lose money, they have very little recourse.
4. There are too many mutual fund companies. Today, there are more mutual fund companies than publicly listed companies…which makes it hard to figure out which funds are good and which funds are bad. That also means the chances are good that the average investor may choose the wrong funds…a group of funds that doesn’t provide the gains required for a financially secure retirement.
5. The cost of retirement keeps going up. Having more and more mutual funds chasing only a few real stocks from real companies causes the price of these companies’ stock to be overinflated, which means the cost of retirement keeps going up.
6. A DC plan doesn’t protect you after retirement. The stock market may crash after the person retires, wiping out the retiree’s nest egg and financial security. Out of a job and out of time, it would be tough to rebuild that nest egg if the funds were lost.
Don’t believe it, just look at former Enron employees. And even diversification for many of those former Enron employees didn’t work. The problem with diversification is that it is still a risky and poor choice; and diversification in the stock market is really not diversifying because the retiree is still putting their eggs all in one basket—paper assets.
To be truly diversified a retiree needs to be invested in more than just paper assets such as stocks, they need to be invested in real estate, businesses, physical commodities, etc. That is true diversification. So even if the biggest stock market crash in history does occur the retiree could live off other investments.
7. Many employees aren’t contributing to their retirement plans. There have been figures that range from 10 percent upwards to 50 percent of all baby boomers not have anything set aside for retirement. That means an extra financial burden for the generation that follows the baby boomers…specifically, their children.
One of the reasons workers aren’t contributing to their DC pension plans is because their taxes are high, the cost of living is high, the cost of raising and educating children keeps going up, and many workers simply don’t have realize that time, investing for the long term, is essential for the plan to work.
If workers don’t begin setting money aside early, the next flaw in the system takes priority.
8. A DC plan may not work for older workers. If a person is 45 years of age or older when they begin setting money aside for retirement, a DC pension plan may not work. There is simply not enough time for the plan to work. That means if a person begins setting money aside at 45 or older and has little to invest, or they lose their retirement and must start over again, the DC plan may not work.
9. Too many noninvestors are handing out investment advice. Many investment advisors educating the public are not really investors…they are salespeople. On top of that, many financial advisors don’t really know if their advice will stand the test of time through the ups and downs of financial markets.
Many investment advisors don’t really know if the person they’re advising will be able to survive on the advice and products they are selling. Most investment advisors are required to sell only their company’s financial products, which limits their objectivity.
Furthermore, most advisors only know one category of investments, investments such as paper assets, or real estate, or businesses. Very few have a well-rounded education and are qualified to talk on the synergy of these different asset classes.
10. Can you afford to stay alive after you retire? As more and more baby boomers begin to retire we will see the real test of the assumptions of a DC plan. While this act focuses on retirement, will a DC plan provide for something more important than retirement…and that is health care. Will a retiree be able to afford health care for as long as they live?
A person can scale down and live frugally after retirement, but the price of health care is only going up. In the near future, whether a person lives or dies will be a matter of whether they can afford medical care or not. And there may be millions of people who will not have enough money inside their DC pension plans to afford that medical care.
What about Medicare and other forms of socialized medicine? Well, if the statistics are correct, American socialized medicine may already be bankrupt. If socialize medicine is to be a national right, then taxes will go through the roof, and if taxes go up, businesses will leave the country…aggravating an already overtaxed population.
In just a few years, not only will the market be hit by millions of baby boomers beginning their systematic withdrawals, the market will also be hit by millions of baby boomers needing money for medical expenses.
Let’s say a 75 year old retiree with a DC plan with $500K in assets in his portfolio has limited medical insurance and suddenly needs $150K for life-saving cancer surgery. Do you think this retiree will choose to save money and not have the surgery or will he sell $150K worth of mutual funds to cover those expenses?
My guess is that there will soon be millions of retirees selling large portions of their portfolios, and not following the plan of systematic withdrawal, in order to cover medical expenses. If that happens, what happens to the stock market? Will it continue to go up?