Alamy In a recent Morningstar interview, a noted investor warned that “the retirement system in the United States … is facing three train wrecks, all of which have to be fixed.”
That chilling admonition came from John Bogle, founder of The Vanguard Group (an investment company with over $2 trillion in assets), legendary advocate for low-cost investment vehicles like index funds, and prolific investment author.
Yet as troubling as his prediction is, there are several precautions you can take to avoid these train wrecks in your own retirement planning.
Here’s What’s Coming Down the Tracks
The first train wreck is probably the most obvious: The Social Security Trust Fund is shrinking fast. As Bogle says, “It’s just underfunded.”
At some point within the next few years, our government will have to figure out whether to lower payments, raise the minimum ages for eligibility to collect benefits, or raise taxes. Any of those actions would be tough politically — but a change will come and it will impact many retirees and those planning to retire someday.
The second train wreck comes from pension plans. Although they are quickly become a relic of the past, many corporations and government entities still have outstanding pension obligations. The problem is that these obligations are grossly underfunded.
Wilshire Consulting estimates that 94 percent of corporate pension plans are underfunded. Bogle says state pension plans pose an even bigger problem because “they’re using an 8% future return” — a predicted annual average rate of return which he believes is too high.
The final looming train wreck is perhaps the most shocking: company-sponsored 401(k) plans. His criticism is not with the principle of regular, disciplined investing. Rather, it’s because of the flexibility these plans allow.
An investor in them has the option to take out loans on his retirement savings or cash out a portion completely to deal with life emergencies. And this easy-to-use ability can prove disastrous for someone responsible for funding their own retirement.
3 Proactive Moves to Make Right Now
As worrisome as these predictions certainly are, there are several steps you can take to prevent them from affecting you — or at least to lower their effects.
1. Social Security. If you’re retiring within the next 10 years or so, you can reasonably expect to receive the benefit you’ve been promised. If you’re going to be working any longer than that, you’ll still receive a benefit, but it will likely be lower, or you’ll have to wait longer than you expected to become eligible to claim it.
If you are near retirement age, it behooves you to postpone taking Social Security to beyond “full retirement age.” As it stands, a retiree’s Social Security payout could be as much as 76 percent higher if she waiting to claim benefits at age 70 instead of filing early at age 62. And in the future there will likely be an even greater financial incentive to wait.
2. Pension plans. If your company (or governmental employer) has promised you a pension, you should be conservative when estimating how much you will actually receive. Federal plans are still considered quite safe because the U.S. government backs them, but everything else is up for grabs.
The Pension Benefit Guaranty Corporation is a government-sponsored agency that guarantees most pension plans. Unfortunately, this agency’s financial straits are nearly as dire as many companies’ pension plans. In 2008, its director boldly admitted that it doesn’t “currently have the resources to keep all our future commitments.” And this situation has only gotten worse since then; at the end of 2012, the PBGC’s deficit reached an all-time high of $34 billion.
So you’d be wise to assume the worst: You might not get the entire pension you’ve been promised. The alternative? If you are eligible to do so, set up an IRA or take advantage of your employer’s 401(k) plan to save a regular percentage of your salary. This is your own money that your employer can’t take from you, even if it does file for bankruptcy.
3. 401(k) plans. Although 401(k) plans are arguably the easiest way to ensure for yourself that you’ll have enough money to retire on, they aren’t without their potential problems. As Bogle pointed out, there are countless loopholes that permit you to withdraw money in an emergency — to the ultimate detriment of your goal to amass a large nest egg for retirement.
Unfortunately, any money you take out using a “hardship” withdrawal will be taxed at your ordinary income rate, as well as be hit by a 10 percent early withdrawal penalty. So even if you’re in a bind, you’ll wind up handing over a hefty sum of money you’ve wisely saved to the IRS. And because we’re talking about money meant to fund your retirement, this move will open up even more problems down the road.
A 401(k) loan is less risky, but not completely without risks. Although you pay interest to yourself, if you leave your company (or lose your job), you’ll be required to make a lump-sum repayment — or face the same early withdrawal penalties mentioned above.
It’s clear that a 401(k) is the one of the better ways to put yourself on track for a comfortable retirement. But you must view it as what it is: a tax-advantaged tool that exists solely to fund your retirement over time. Resist the urge — as tempting as it may become — to use it as a rainy-day fund or emergency savings account.
Your Best Defense
Given the tenuous state of our current retirement funding system, the best thing you can do to ensure your financial future is to take matters into your own hands. The status quo isn’t likely to stay that way for long.
If you regularly save a decent percentage of your paycheck, invest in low-cost investment vehicles like index funds, and avoid touching the money until the day you retire, you should be able to retire without having to cross your fingers and hope that today’s pension and Social Security problems get solved.
If you’d like even more information on planning for a stress-free retirement, click here for a FREE report from The Motley Fool sharing even more tips.
Adam Wiederman is a Motley Fool contributing writer.