Reliance on defined contribution plans, primarily the 401(k), and the confluence of a flawed system, an erratic stock market over the past 13 years, and a looming bond bubble stands to create the Retirement Cliff: a drastic shortfall in funds for most retirees.

The Cliff means that millions won’t have enough money to enjoy a comfortable retirement or even retire at all. It could cause enormous personal and societal distress.

In 1974, with the signing of ERISA, the shift of saving for retirement was drastically put onto the shoulders of individuals. It was up to the individual to fund the plan invest the assets, and bear the longevity risk.

Originally, the 401(k) program was meant to supplement defined benefit plans and Social Security, and boost retirement income by about 25 percent to 30 percent. Today, Americans are using the 401(k) plan to fund nearly 100% of their retirement income need, other than what they’ll collect from Social Security As this shift occurred, the risk of saving for retirement was tossed like a hot potato from the employer, to the employer and employee, to now solely on the employee or participant.

Erratic Stock Market

In the summer of 1998, when 401(k) participants were asked what they expected for an annual return they often said 20 percent to 50 percent per year! They lost all sense of risk. Unfortunately, many investors who had too much of their 401(k) plan in technology saw half or more of their retirement savings evaporate during the dot.com crash. Then, when2008 hit, 401(k) investors were not ready for the worst financial crisis since the Great Depression. For the second time in a decade, investors saw their assets erode and their account balances plummet.

Today, the market has finally surpassed the heights it attained in March of 2000; however, we have not felt the power of market compounding over this period. For example, most financial calculators that crunched future retirement values assume a rate of return between 7% to 9% per year. The rate of return for the S&P 500 Index from 3/1/2000 to 12/31/2012 was an annual average rate of return of 1.66%, while the inflation rate rose at a 2.45% rate. That assumes a buy-and-hold strategy. Too many participants bought high and sold low and now often have negative long-term returns.

Bond Bubble May Pop

Today’s super-low bond rates can’t last forever. Bond values decline when rates go up. Some experts say that when the 10-year Treasury returns to its long-term average, existing Treasuries could see a double-digit loss of value. The problem is the timing of the normal rotation from stocks to bonds for baby boomers as they near retirement, while bond values may begin a prolonged decline at a time when baby boomers can least afford it.

Retirement Cliff

The present status of the retirement system does not bode well for the retirement system, or for baby boomers who have or will be reaching retirement age from 2012 to 2030. Today, demonstrating that you’re meeting ERISA requirement to act in the best interest of plan participants is crucial. As participants will ask themselves, “Did I get proper education on my 401(k) plan?” “Did I have a wide array of investments to choose and were they monitored over the years?” and perhaps, “Who is responsible for me not having enough money to retire?”  Today, plan sponsors must employ a sound investment policy statement and process as well as a sound education policy and process.

Avoiding the Retirement Cliff

The principles of dollar-cost averaging and compounding interest have been proven over time. Most 401(k) participants tend to think week-to-week or month-to-month. Long-term thinking often goes against human nature and encouraging it requires out-of-the-box strategic thinking, while also requiring all of us to believe in what we are saying.

Ideas which have struggled in the past like automatic enrollment at meaningful percentages paired with automatic deferral increases are plan design features whose time has come. . In addition to increased participant involvement, employers must consider a greater match or profit-sharing non-elective contributions.

Asset allocation is easy to understand, but emotionally, it is nearly impossible for most employees to implement. If we are to improve the prospects for the baby boomers and beyond, we need to educate clearly, effectively, and in a manner that can be easily implemented.

Numerous studies released by firms like Mass Mutual and Putnam illustrate the cost to employers for their aging workforce who are delaying retirement due to inadequate financial resources. The pressure is on the retirement industry and society to alter the present course of retirement savings, or face the reality of an insufficient and flawed system. It’s not inevitable that millions of Americans will fall off the Retirement Cliff, but we must act now to ensure a brighter outcome than is presently projected.

David P. Boucher CFP, AIF, is a principal of Longfellow Advisors in Boston.  He provides strategic and tactical consulting services for retirement clients that encompass the fiduciary aspects of plan management. He has been published in and quoted by many publications and can be reached at dpboucher@lf-adv.com.

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