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Minnesotans need to think differently about saving for retirement

Minnesotans need to aggressively save more money for their retirement life needs than they’re currently saving.

Minnesota has a pension problem. Most Minnesotans haven’t saved enough money to adequately and securely fund their retirement. More than half of Minnesotans can’t count on a pension as a retirement funding mechanism because they don’t have one.

That’s a problem.

John Van Hecke
 John Van Hecke

Minnesotans need to aggressively save more money for their retirement life needs than they’re currently saving. Making this observation is much simpler than changing saving behavior. Retirement security savings shortfalls call every social safety net assumption into question. Without change, can people actually count on a secure retirement?

Pensions are a form of retirement savings designed, through working life contributions, to provide a retirement revenue stream. It’s the money that you live on after you’ve stopped working. Pension principal grows through paycheck contributions and pension fund investment returns. Pension funds are invested in some combination of stocks and bonds carrying a diverse range of financial risk, using strategies designed to preserve and, ideally, improve the contributed funds’ purchasing power.

Pensions: Incentives to stay with employer

Pension popularity rose with the middle class’ growth in the 20th century. Pensions are a work benefit that, along with health insurance, created a stable, low-turnover work force by financially incentivizing workers to remain in an employer’s long-term employ. The pension, along with other non-wage benefits, created greater compensation value than wages alone.

Rapid growth of non-wage work benefits occurred in fast growing, post-World War II manufacturing industries. Rapidly expanding consumer demand in, for example, the automotive industry, induced company owners and managers to preserve worker experience and extend tenure by creating a host of non-wage benefits. Pension and health-care costs, companies discovered, could be managed efficiently by leveraging group purchasing. This lowered employers’ non-wage costs while creating greater benefit value for workers.

This idea works best when the economy is expanding and sales are exploding. Growth tends to disguise the true nature of genuine problems, making it harder to implement long-term solutions. Unchecked expectation of never-ending growth and growth’s reward are chief among those.

There are two principal pension forms, defined benefit plans (DBP) and defined contribution plans (DCP). They may sound similar but more separates them than a single word of three.

Comparing the plan types

The defined benefit plan is the worker’s best option yet it carries a small but significant long-term risk. As a retirement benefit, DBPs creation, management and fund responsibility fall to employers. The employer is responsible for fund shortfalls if the portfolio underperforms. Employees receive a fixed monthly disbursement, adjusted per terms of the labor contract but generally increasing to meet rising inflation costs. The employees’ risk is catastrophic risk of business failure and, with it, company-linked retirement savings plans. A dying business tends to take the pension fund down with it, leaving workers with no or few retirement savings.

Defined contribution plans are typified by 401(k) savings accounts. They’re tax-deferred retirement savings plans, principally funded directly by workers, although employers may contribute to the employee’s account. Apart from facilitating direct deposit and possibly contributing to an employee’s retirement account, employers have little else to do with DCPs. Outside of government, DCPs have replaced DBPs as retirement savings plans.

By moving to DCPs, companies have, in effect, discounted the long-term benefit of an experienced, stable workforce. They’ve shifted worker retirement costs to government while benefiting from worker productivity gains.

Both DCPs and DBPs rely on accurate risk calculation to determine retirement fund health and obligation.

Calculating life span and associated outcome probabilities is a branch of mathematics called actuarial science. While perceived as duller than playing poker for a living, actuarial sciences make the same risk assessment judgments, assigning a monetary value to probable outcomes. Popularly associated with the insurance industry, actuaries are found wherever financial risk is managed.

Coming up short

Workers with a properly funded and managed DBP pension are in better retirement financial shape than DCP holders. Underscoring retirement life’s growing insecurity risk, however, Minnesota’s largest and most secure public pension plans are coming up short when it comes to contributing to retirees total expense needs.

According to Minnesota’s Public Employees Retirement Association, their 2012 annual report calculated the General Plan fund’s market value at 73 percent, which meets Morningstar’s “fiscally sound” threshhold. That means, given reasonable retirement life span projections, and if current employees made no further contributions, the fund will be able to pay 73 percent of its commitment. Market returns and younger workers will continue to replenish recessionary period market depleted fund value. MPERA also notes, however, that 75 percent of pensioners are receiving less than $2,000 per month, which for many families will not meet retirement needs.  Despite holding up their end of the contract, retired public workers will have to come up with rest of their money from somewhere else.

Thinking differently — and a simple solution

I raise this example because even under the very best circumstances — a worker-organized, negotiated and publicly administered defined benefits pension plan — workers aren’t saving enough money to fully secure their retirement. This means that we need to think differently about how we save for retirement, putting middle- and low-income-earning Minnesotans’ working and retirement life needs first.

The solution is remarkably simple. Minnesota needs a publicly guided retirement savings plan that uses its financial weight to only serve its member savers. It should fall somewhere between current DCPs and DBPs; allow for direct payroll contribution regardless of employer’s retirement benefits plan; charge the absolute fewest, lowest fees possible; and be created no later than next year.

The best crisis outcome is the one that, with quiet, determined work, largely fails to materialize. We can do this in Minnesota.

John Van Hecke is the publisher of Minnesota 2020, a progressive, new media, nonpartisan think tank on whose website this commentary originally appeared.

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Comments (8)

  1. Submitted by carly torino on 07/02/2014 - 05:26 am.

    Retirement

    The best way to retire on your terms is to start planning and saving/investing early in life, do it with every paycheck and take advantage of any opportunity to increase your nest egg (employer matching plans, catch up contributions when you reach 50,etc.). I just read several great guest posts on the site Retirement And Good Living by recent retirees and what they are doing during their retirement. Some are working part time, starting businesses based on hobbies, sailing full time, RVing, volunteering with the Peace Corps, retired overseas and more. It give you a good perspective of the possibilities. All are not working and they are definitely not sitting on the porch in their rocking chairs.

  2. Submitted by Alex Seymour on 07/02/2014 - 09:02 am.

    details

    Two points,

    First, “Market returns and younger workers will continue to replenish recessionary period market depleted fund value.” If the market returns are what the state projects (which are on the optimistic side) we will end up at 73%. While younger workers will increase contributions they will also increase the funds liabilities. The only way to decrease the shortfall is to have a unexpected prolonged market rally, increase contributions, decease payouts, or have people quite the pension plan faster than expected. These are grim choices.

    Second, why Secure Choice. It is laid out as a option but ti’s virtues are not really explained. Reading up on it it looks like a cross between a defined contribution pension plan and a annuity. Annuities are already available to workers of small businesses. Last I check the US already has 14 different flavors of retirement plans. What is the advantage that this plan will bring that is worth the extra complexity?

  3. Submitted by Kelly Guncheon on 07/02/2014 - 09:23 am.

    Good point, but how to execute?

    Mr. Van Hecke’s observation are by and large right on, although his descriptions of DBPs and DCPs are a little muddled. DCPs don’t use or rely on actuarials, for example.

    Nevertheless, his point is right on: Many if not most people are not prepared for retirement. As a Certified Financial Planner who services 401k and 403b plans, I see this all the time when I meet with employees. There are myriad reasons for people are unprepared. For many young people, retirement is so far away that they see no point in doing anything right now. For older folks, they feel that they are so far behind that it’s hopeless to start now.

    But I see two major reasons for the global situation. First is that those who are most unprepared usually don’t have any discretionary income to put away for savings, and they live paycheck to paycheck. They simply aren’t paid enough to accumulate any significant savings. Yes, some squander their money, but even forgoing the $10 a week that they spend at Starbuck’s is better than nothing, but it certainly doesn’t put them in a position to retire.

    But the biggest obstacle to saving for retirement is that many employers don’t offer retirement plans to their employees at all, leaving those employees with IRAs as the only tax-deferred option for retirement savings. But they can only put away $5,500 a year ($1,000 more if they’re over 50). And then there is the most intimidating, off-putting question of how to invest the money–something that 90 percent of the people I meet with struggle. IRAs are a start, but they hardly are a solution. One could question why the limits are so low, but that’s another conversation.

    Mr. Van Hecke’s suggestion is an interesting one. Having a government-run defined-benefit plan option for those whose employers don’t offer retirement plans. It would allow them to set aside more money than they currently can, and they would not have to worry about how to invest the money because a DBP’s fiduciary handles that for them. There will be push-back from the anti-government folks, but there are numerous examples of successfully run government pensions (e.g., CALPERS). Plus, they should offer an alternative. The status quo is unacceptable.

  4. Submitted by James Hamilton on 07/02/2014 - 09:37 am.

    Questions

    1. Does this proposal anticipate the use of pre-tax or after-tax dollars?

    2. Does it anticipate tax-free growth?

    3. Why defined benefit?

    4. How will it avoid the problems encountered by so many other defined benefit programs?

    5. Can’t the same thing be accomplished using an existing program (e.g., IRA)?

    6. How do you intend to increase worker participation when so many fail to make us of existing options?

    • Submitted by Kelly Guncheon on 07/02/2014 - 01:13 pm.

      Some answers

      Until someone who works specifically on the idea responds, here’s what I know:

      1. Pre-tax

      2. Tax-deferred growth, not tax-free.

      3. Eliminates the need for participants to make investment decisions and offers a guaranteed benefit rather than an uncertain one, which is what defined contribution plans offer.

      4. If it’s piggybacked onto or administered by those who administer well-run pensions (e.g., CALPERS), it can work.

      5. No. IRAs do not address the obstacles that cause people to not save, otherwise we would not have the problem. And the proposed plan specifically targets those who aren’t offered a retirement plan at their place of employment.

      6. As I understand it, it would have an auto-enroll feature similar to what some retirement plans have now. People wouldn’t opt in; they would have to opt out.

      Hope that helps.

  5. Submitted by Jon Lord on 07/02/2014 - 02:42 pm.

    What?

    Pension plans? Yeah, they’ve worked out fine in the past haven’t they? Most employers are getting out of the business of pension funding. Always to the detriment of the employees.

    Half the population (I would guess far more than that) is living borderline anyway so trying to save isn’t going to help them. In fact it’ll hurt them. You’ve got your underemployed, contracted workers which is growing more pervasive every year, and minimum wage earners. Those, for some are life-time positions. For those people, some kind of tax-relief-savings plan available then only on retirement is the only way they could possibly save anything.

  6. Submitted by Todd Hintz on 07/02/2014 - 04:23 pm.

    Perspective

    Let me add a little perspective to this discussion from a lay person’s point of view. From my point of view you guys are all brilliant as you know how these things work, whereas I don’t know a DCP from PCP.

    I’ve struggled to maintain a basic middle class lifestyle for the past thirty years, with very few vacations in there and very little money at the end of the day. There are no coffees from the corner shop in the morning and I’ve owned exactly one new car my entire life.

    Throughout that time I’ve saved for retirement, putting away a little here and a little there. When I get a raise, the new money has gone straight into a retirement plan rather than a lifestyle increase. After all that, I’m in my 50s and there’s about $100,000 in the retirement accounts out of the $2,000,000 the advisers say I should have to comfortably retire on. Assuming zero taxes and no expenditures, I might be able to get that saved up after forty years of working.

    It’s simply not realistic.

    At the current job I haven’t had a raise since I started here. The economy is tough in my sector and a lot of jobs are being outsourced to Asian countries. I’m doing well to just have a job.

    There’s a little background. As for retirement plans, I don’t have the excess bandwidth to learn the nuances between a back-end loaded GDP indexed managed tax-deferred fund and a front-loaded Roth IRA. Nor do I care to learn them. I simply want to put some money into a fund and let it ride. At retirement age, I’d like to step up to the counter and start drawing it down.

    As far as finances go, I’m a bit above the average user. I have more disposable income than someone working in the service industry, I have a college degree and am sharp with numbers (math major), and I can manage a checkbook like nobody’s fool. Yet here I am struggling with retirement goals just like everyone else, partly because it’s too complex and part because it’s simply not realistic. $5500 per person for a Roth IRA? You might as well ask me to walk a flag over to the moon and plant it in the soil.

    I’m not sure Mr. Van Hecke’s plan is realistic. Where are people going to get the money to put in these plans? Most people are struggling to pay the rent, put food on the table, and buy shoes and a few medications for their children. There’s no money left over at the end of the day for anything luxurious like dinner at Perkins now and then, let alone a retirement plan that will mature forty years from now.

  7. Submitted by Dennis Tester on 07/02/2014 - 06:56 pm.

    “I have enough money to last me the rest of my life

    As long as I don’t buy anything.” – Woody Allen

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