The more I think about the funding shortfalls with Social Security and Medicare, the disappearance of traditional defined benefit pension plans, and the lack of Americans’ saving for retirement, the more I realize that there will likely be some major changes in the future of retirement and retirement planning. Everyone talks about entitlement reforms like raising the Social Security retirement age and reducing Medicare benefits. But here are 5 other possible changes affecting retirement that you may not have heard as much about and some things you can to prepare:
1) Phasing out of pre-tax retirement plan contributions. The federal government is already running record budget deficits and that’s before Social Security and Medicare spending really start adding to it. Democrats don’t want to cut spending much and Republicans don’t want to raise taxes. One potential solution that could satisfy both sides is to eliminate pre-tax retirement contributions and replace them with just after-tax Roth contributions. That would boost tax revenue immediately without raising taxes overall. Of course, it would make the government’s deficit problems worse when future retirees start withdrawing their retirement money tax-free but by then, the current politicians will be out of office and will have passed the buck on to someone else.
Tip: For tax planning in retirement, it’s best to have a mix of pre-tax and tax-free money so take advantage of pre-tax contributions while you can.
2) Slower growth in Social Security for higher income workers. Known as “progressive price indexing,” this is a solution to the Social Security shortfall that already has support on both sides of the aisle. Democrats like that it preserves current benefits for low income workers, who often can’t afford to retire later or with lower benefits. Republicans like that it’s a spending cut rather than a tax increase. Unlike other forms of means-testing that could disincentive saving by reducing benefits based on how much you’ve saved, it actually encourages saving among the high income workers who can most afford to do it since they would need to make up for the lower Social Security benefits.
Tip: When deciding how much to save for retirement, expect to get no more than 75% of your estimated Social Security benefit and maybe even less than that if you’re a high income earner.
3) More real assets in retirement plans. We’ve already been seeing more of our client companies offering real asset funds that invest in things like real estate, commodities, and TIPS in their 401(k) plans. These assets could provide a hedge against rising asset inflation, which can hurt both stocks and bonds. I suspect that we may be seeing more of them in asset allocation guidelines.
Tip: Get ahead of the curve and start incorporating real assets into your portfolio. If they’re not available in your employer’s plan, purchase them in an IRA account since they don’t tend to be very tax efficient.
4) Greater use of immediate annuities. Given the lack of traditional defined pension plans and the shortfall in employee savings, lots of future retirees could run the risk of outliving their savings. One solution would be to annuitize a portion of their nest egg, essentially buying their own pension. This also has the benefit of protecting those retirement assets from having to be spent down to qualify for Medicaid coverage of long term care costs, another area where many Americans are unprepared. The interesting question is if and how the government will promote or even incentivize the purchase of annuities in some way.
Tip: Keep an eye out for government annuity incentives like the state long term care partnership programs that allow you to qualify for Medicaid coverage while retaining assets equal to the amount of long term care insurance you purchase through the program.
5) Retiring abroad. In addition to getting more income from their retirement savings, many retirees will need to reduce expenses dramatically. One way to do this is the same way we reduce so many of our other costs: outsourcing. There is already a growing number of Americans going overseas to retire or to at least get quality medical care for a much lower cost. As this trend develops, there will likely be more expat communities that will make it easier and more comfortable for other Americans to join them
Tip: Consider retiring overseas and even purchasing real estate in advance as the prices can move up significantly once others start getting the same idea.
What do you think? How likely do you think these potential changes are? Do you have predictions of your own? Leave your thoughts in the comments section below.