Why You Can’t Save for Retirement Like You Used to (and What to Do Instead)
Individuals and families today face unique and demanding challenges when it comes to saving for their future. Unlike the past few generations that came before them, they may not be able to rely on promises of fixed income from government programs like Social Security or defined benefit (pension) plans from their employers.
Instead, the burden of financing their future falls almost entirely on their own shoulders. And as you’ll see below, this burden is a heavy one.
In my opinion, a rapidly changing economy means that it’s time to rethink the way we save for retirement and replace the income we earned during our working years. But before we get to that, let’s take a look at the specific obstacles today’s investors are facing.
The Perfect Storm
With more than three decades of experience in the financial services industry, I see five particular challenges facing the retirees of the future. Combined, these challenges are going to make it very difficult—if not impossible—for individuals to fund a comfortable retirement that will last their lifetimes. These challenges include:
Social Security’s dim future
The demise of defined benefit plans
The burden and uncertainty of the 401(k)
Market volatility
Longer life expectancies
By unpacking each of these obstacles, we are in a better position to strategize how future generations can build wealth creatively to surmount these particular challenges.
1. Social Security’s Dim Future
As I’ve noted before, the Social Security program is experiencing significant financial problems. In 2022, the Social Security and Medicare Boards of Trustees found that the OASI Trust Fund will only be able to pay scheduled benefits until 2034, at which point the fund’s reserves will become depleted. Continuing tax income will be sufficient to pay just 77% of scheduled benefits at that time.
Why is this happening?
First and foremost, the actuaries who determined how to fund and maintain the Social Security Trust Funds in the 1930s naturally based their calculations on assumptions about life expectancy and the number of participants that made sense for the times.
For instance, the ratio of covered workers to beneficiaries has shrunk drastically. In the 1940s, there were 159 workers for every 4 participants in the Social Security program. In 2013, the ratio of covered workers to beneficiaries was 2.8. The margin continues to narrow as the Baby Boomer generation, one of the largest generations in history, moves into retirement age.
And due to advances in healthcare, those retirements are going to last a lot longer than the retirements in the 40s, as life expectancies have increased significantly for both men and women.
Simply put, there is a much larger pool of beneficiaries drawing on Social Security funds for a longer period of time than there used to be, with a much smaller pool of workers paying into the fund.
Unless policy changes are enacted, it’s likely that younger generations—the generations who are expected to live longer—will not be able to rely on Social Security benefits to cover a meaningful portion of their monthly expenses.
2. The Demise of Defined Benefit Plans
Defined benefit plans, or pension plans, used to be commonplace. Much like Social Security, they offered an employee who met certain conditions a fixed, pre-set amount of income they could depend on to last through their retirement.
But today, pension plans are rare. In fact, the U.S. Bureau of Labor Statistics found in 2021 that only 15% of private-sector workers had access to a defined benefit plan. (Civilian and state and local government workers fared rather better.)
Most defined benefit plans have been replaced by the much more cost-effective defined contribution plans, with the most common being a 401(k). In the early 1980s, large corporations petitioned the IRS to provide them with a tax-efficient way to help their highest-earning employees save for retirement above and beyond the company’s defined benefit plan.
So the IRS came up with 401(k)-type plans, and made them available to all employees—not just high earners. As middle- and lower-class employees lost bargaining power due to factors like overseas outsourcing and the decline of unions, employers started replacing expensive defined benefit plans with the cheaper 401(k)-type plans as their primary retirement plan.
3. The Burden and Uncertainty of the 401(k)
The decades since have revealed that the 401(k) plan has not been the most effective retirement savings tools for the average worker. While savings rates are increasing every year, the Bureau of Labor Statistics found that in 2021, only 51% of private industry workers chose to participate in their employer-sponsored retirement plans, even though 68% of workers had access to one.
Additionally, 401(k)-type plans require the individual to make their own investment decisions from the menu of options provided by the employer, many of which consist of high-cost mutual funds. Fee transparency for mutual funds is not well-regulated. Oftentimes, investors don’t realize how much they’re actually paying in fees when they choose certain investments, which can significantly impact the growth and returns they’ll see from their contributions.
However, the problem goes further. The stocks, bonds, and mutual funds available to 401(k) investors don’t provide the returns individuals really need to live on in retirement. Here’s a very simplified example: To earn a hypothetical income of $8,333.33 a month—or $100,000 a year—in retirement, you will need to save about $2,500,000. That principal will then need to earn 4% every year you’re retired.
The problem is, there are no guaranteed-income investments (e.g., annuities, certificates of deposit, money markets, bonds) that pay anywhere near 4% returns. Rather, the interest rates on these investments might only pay about $1,500 a month ($18,000 a year). Stock dividends aren’t much better. In addition to providing relatively low returns in today’s market, stocks are inconsistent and pose a much higher risk to the principal.
The only option you have is to leave your 401(k) principal invested in riskier securities, and you’d be banking on the fact that it would earn at least 4% every year. Of course, in some years your principal might earn well over 4%. In other years, it might earn significantly lower. The point is: You can’t be sure.
4. Market Volatility
In a perfect world, an individual has planned well for their retirement. They’ve saved diligently for decades and built up a nest egg that, should everything go well, will sustain them for at least 30 years in retirement, if not 40.
But let us remember—we’re talking about the stock market. Things do not always go well. In fact, we’re taught to expect there will be times when the stock market doesn’t do well. And history shows us that in a period of 30 to 40 years, the markets may experience several downturns.
For investors who are in accumulation mode, that’s okay. They have plenty of time to ride the waves and watch their investments recover. But for investors who are in decumulation mode, they can’t always just ride out the markets. They have expenses to cover. So if they have to sell assets that are in decline to provide themselves with food and shelter, those dollars won’t ever get the chance to recover their losses.
Even if they’ve done everything right, market volatility can still devastate someone’s retirement. To me, that’s just not acceptable.
5. Longer Life Expectancies
As if these pressures on individuals’ future financial security weren’t enough, increasing life expectancies fan the flames even further. Life expectancy did decrease slightly in 2020 and 2021, but researchers expect this to be a temporary drop. As the globe recovers from the pandemic, life expectancies are expected to continue their increasing trajectory once more.
And while longer lives certainly sound good to some, they pose real challenges in terms of funding retirements and providing care for a larger, longer-living population. As life expectancies increase, people should expect both their careers and their retirement timelines to increase as well. And the four factors described above mean that the challenge to save enough to fund those longer life expectancies is immense.
So what is the average American investor to do?
The Answer: Income-Producing Assets
Income replacement investing is a strategy whereby you invest in income-producing assets (as opposed to growth assets) that produce steady income. While growth assets consist of traditional investment options like stocks, bonds, mutual funds, and ETFs, income-producing assets consist of alternative options like real estate, equipment leasing, other private equity investments, and so many more.
The majority of investment options in your 401(k) plan are growth assets, with the exception of dividend-paying stocks and a few other asset classes. But you have the freedom to invest in 34 asset classes—some of which may be able to provide much greater, more reliable returns. And with a self-directed IRA, you can invest in these income-producing assets with tax-advantaged retirement savings.
What Are Income-Producing Assets?
An income-producing asset is an investment that provides a regular stream of income in addition to growth appreciation. Some income-producing assets, such as annuities, require a very low-to-medium level of involvement. However, they don’t typically provide high amounts of income.
Other income-producing assets—the kind we’ll be discussing in this article—such as real estate, require more involvement on the part of the investor. These assets typically generate income through rental payments, lease payments, or interest earned on privately loaned money.
Because these types of assets are protected by rental agreements, lease agreements, and/or contracts, the income is usually more reliable and consistent than income generated through the stock market. While there are thousands of income-producing assets available to creative investors, some of the most common include:
In general, investing in income-producing assets requires more work on the investor’s part. You must do your due diligence to find and evaluate worthy assets, and you must become an expert in the specific types of assets you’re choosing to invest in. But in my opinion, the relative security and income you gain from well-chosen income-producing assets is well worth your time and effort.
The Case for Income-Producing Assets
The rates of return you can expect for income-producing assets vary widely. After all, you’re responsible for the viability and performance of these types of assets, and choosing wise investments requires a certain degree of skill and dexterity.
With that being said, the potential is huge. Take for instance David Swensen, the late manager of the Yale endowment. Swensen was known for developing the “Yale model” of investing, which inspired a generation of investors to move away from traditional stocks and bonds into more diversified investments such as real estate and private equity. Swensen is credited with producing some of the highest consistent investment returns with a 20-year annualized net return of 9.9%.
We don’t believe it’s out of the realm of possibility for you to expect 10% returns on real estate investments (or other alternative asset classes) if you invest wisely. By using 10% as the bottom benchmark for property investment returns, you would only need to invest about $750,000 in real estate with a 10% return to earn $100,000 a year in retirement (as opposed to $2,500,000 with an unreliable 4% return).
In our opinion, that’s a pretty big difference in savings, with the added benefit that you may have more security in retirement.
Investing Paradigm Shift
The pressures of the Perfect Storm are weighing heavily on today’s investors. Social Security will likely only make up a small fraction of their future retirement income. Defined benefit plans are on their way out. And the burden to save enough in a 401(k) plan to support a 30- to 40-year retirement is immense. Throw in the all-but-guaranteed risk of subjecting your principal to devastating market volatility, and that’s enough to make any young investor shake in their boots.
To overcome these obstacles, the investors of tomorrow are undergoing a paradigm shift. They’re moving away from a portfolio that is 100% invested in growth assets and diversifying to include more income-producing assets. Investors who fail to realize this paradigm shift are going to be left behind.
How Chicago Trust Administration Services Can Help
At Chicago Trust Administration Services, we help investors diversify their retirement portfolios to include income-producing assets through the use of self-directed IRAs. Alternative assets are subject to complex IRS regulations, which can make transactions difficult to complete.
As self-directed IRA administrators, we help you make your investment transactions quickly and painlessly so you can focus more of your energy on generating the returns you want to see.
To see how we can help you expand your portfolio with income-producing assets, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.