Review of Retirement Heist

Review of Retirement Heist:  How Companies Plunder and Profit from the Nest Eggs of American Workers

Ellen Schulz describes the different ways companies have reduced worker’s pension benefits in order to increase profits, manipulate earnings, cut costs, or fund pension benefits for top managers instead of workers.

http://www.amazon.com/Retirement-Heist-Companies-Plunder-American/dp/B00AK3WCZ8

Some highlights:

Chapter two describes how companies cut or froze benefits in the traditional defined benefit plan without antagonizing workers or creating bad publicity for the firm.   The replacement of a generous defined benefit plan with a new less generous plan is generally introduced in a way where changes are not transparent to workers.   Phillip Strella a lawyer with Mercer consulting advised the industry to “Pick your words carefully.  The law doesn’t require you say, “We’re significantly lowering your benefit,” “

Chapter three discusses how pension reductions allow companies to report greater earnings to shareholders. Management has a strong incentive to report good and stable earnings because their compensation is often tied to the stock price of the firm.  Pensions are often cut to increase earnings when the company suffers losses from its core business activities.  One of the main problems is that actuaries have great latitude in the assumptions used to price health and retirement benefits hence; official accounting standards allow management to reduce or increase the value of pension and health benefits in order to report whatever income figure it needs to report.

The drop in pension and health benefits and the increase in health premiums have significant impacts on workers, retirees and their families.  The most difficult situations revolve around the loss of health benefits because Medicare does not begin coverage until age 65.  According to a Department of Labor Review cited by Schulz by the late 1990s around two-thirds of retired workers with employer sponsored health coverage were dropping coverage when costs of the health plan rose.  The departure of individuals from employer sponsored health plans resulted in adverse selection or a “death spiral” because sicker workers and families tended to maintain coverage while healthier workers tended to exit.  One of the more important aspects of the still not fully implemented and tested Affordable Care Act was to fix this problem by mandating that all people be covered and by establishing age-rated premiums that will be unaffected by health status.

Schulz’s book includes a lot of personal stories.  Some of the anecdotes involved overpayments to workers that companies tried to reclaim.  Often companies that acquire other firms and their pension obligations look for past overpayments to retirees in order to claw the overpayments back.  This can create large problems for households who created a budget based on their anticipated and previously receive pension.

Chapter 11 discusses denial of benefits with a focus on disability claims in two industries -– energy and football.  The discussion of how the NFL aggressively denies claims to injured players was especially revealing.  It demonstrates that even in a small high-profile industry with a strong union the system is rigged against workers.

The pension system based on company-run defined benefit plans is experiencing a slow death.  The 401(k) has become the dominant pension vehicle for current workers.  There are a lot of problems with 401(k) plans including inadequate contributions by workers and a high degree of investment risk.  Schulz’s disturbing book vividly reminds us that there are also problems with traditional defined-benefit pension.

Understanding the four percent rule

Question:   Is the 4.0% rule an appropriate guideline for determining the amount of savings a retiree should spend each year?

Background on the 4.0% rule:  Under the four percent rule (as I understand it ) the retiree’s expenditure in her first year of retirement is four percent of wealth in certain accounts.  It is more difficult to apply the 4.0% rule to total household wealth because house equity, a major component of wealth is not liquid.  (The application of the 4.0% rule to total wealth including house equity would at some point require the sale of the home.)

Whether strict adherence to the 4.0% rule leads to a smooth, stable, and sustainable consumption pattern for the household depends on asset returns, inflation, and the timing of inflation and asset returns.  A sharp decrease in returns at  the beginning of retirement could lead to a relatively quick depletion of assets.  A sharp increase in returns at the beginning of retirement could allow retirees to spend more than allowed or provide a bequest to heirs.

The 4.0% rule may result in retirees too quickly depleting their resources in the current financial environment where the risk free return is lower than inflation.

http://financememos.com/2013/02/15/chasing-yield-by-investing-in-long-term-bonds/

Illustrating the 4.0% rule:  We consider four scenarios — (1) 2.00% returns and 3.0% inflation all years, (2) 4.0% returns and 3.0% inflation rate for all years, (3) a -20% return the first year followed by 2.0% returns and 3.0% inflation, and (4) -20% return the first year followed by 4.0% return and 3.0% inflation.

We calculate the number of years it would take for the retiree to deplete all assets under the four scenarios.  Results presented in Table Four indicate that years until depletion range from 19 years for scenario three to 30 years for scenario two.

Adequacy of resource for 4% rule under four scenarios
Shock Return Inflation Rate Year Balance goes to $0
None 2.00% 3.00% 23
None 4.00% 3.00% 30
-20% first year 2.00% 3.00% 19
-20% first year 4.00% 3.00% 23

I suspect that these calculations understate the financial risk associated with adherence to the 4.0% rule.   Some analysts suggest that investors who use the 4.0% rule should maintain a larger portion of their portfolio in equites.  I disagree.  The worse case scenario for the 4.0% rule involving poor stock returns in a period of inflation actually occurred during the 1970s.

Initial Balance $100,000
Disb. Rate 4.00%
Rate of return Inflation rate Real Value of initial balance Beginning of year balance Disbursement End of year balance
1 2.00% 3.00% $100,000 $100,000 $4,000 $98,000
2 2.00% 3.00% $103,000 $98,000 $4,120 $95,840
3 2.00% 3.00% $106,090 $95,840 $4,244 $93,513
4 2.00% 3.00% $109,273 $93,513 $4,371 $91,013
5 2.00% 3.00% $112,551 $91,013 $4,502 $88,331
6 2.00% 3.00% $115,927 $88,331 $4,637 $85,460
7 2.00% 3.00% $119,405 $85,460 $4,776 $82,393
8 2.00% 3.00% $122,987 $82,393 $4,919 $79,122
9 2.00% 3.00% $126,677 $79,122 $5,067 $75,637
10 2.00% 3.00% $130,477 $75,637 $5,219 $71,931
11 2.00% 3.00% $134,392 $71,931 $5,376 $67,994
12 2.00% 3.00% $138,423 $67,994 $5,537 $63,817
13 2.00% 3.00% $142,576 $63,817 $5,703 $59,390
14 2.00% 3.00% $146,853 $59,390 $5,874 $54,703
15 2.00% 3.00% $151,259 $54,703 $6,050 $49,747
16 2.00% 3.00% $155,797 $49,747 $6,232 $44,510
17 2.00% 3.00% $160,471 $44,510 $6,419 $38,982
18 2.00% 3.00% $165,285 $38,982 $6,611 $33,150
19 2.00% 3.00% $170,243 $33,150 $6,810 $27,003
20 2.00% 3.00% $175,351 $27,003 $7,014 $20,529
21 2.00% 3.00% $180,611 $20,529 $7,224 $13,715
22 2.00% 3.00% $186,029 $13,715 $7,441 $6,548
23 2.00% 3.00% $191,610 $6,548 $7,664 -$985
24 2.00% 3.00% $197,359 -$985 $7,894 -$8,899
25 2.00% 3.00% $203,279 -$8,899 $8,131 -$17,208
26 2.00% 3.00% $209,378 -$17,208 $8,375 -$25,927
27 2.00% 3.00% $215,659 -$25,927 $8,626 -$35,072
28 2.00% 3.00% $222,129 -$35,072 $8,885 -$44,659
29 2.00% 3.00% $228,793 -$44,659 $9,152 -$54,704
30 2.00% 3.00% $235,657 -$54,704 $9,426 -$65,224