4 Dangerous Trends Affecting University Retirement Plans
- Very few in academia will enjoy a pension upon retirement
- Low interest rates make finding a safe depository for retirement assets difficult
- Be careful of 30-year U.S. Treasury bonds
- More custodians and investment options can prove to be counterproductive
Four dangerous economic trends are converging upon all university professionals at a time when they are ill-equipped to meet them.
This year, thousands of university faculty, administrators, and staff will retire and leave their salaried careers for a very uncertain financial future. Less than 10 percent of all university retirees will enjoy a guaranteed monthly pension income.
The day of the guaranteed pension was lost long ago in the corporate world and now is quickly disappearing in the realm of higher education.
A combination of high costs, overzealous funding assumptions and mismanagement has caused all but a few pension plans to be discontinued. Of those that still remain, some are suspect and may not be able to continue to pay the promised benefits to future retirees.
In an environment with very few guarantees of retirement security, most retirees have to figure out how to live comfortably, for the rest of their lives, on the amounts they have accumulated in their university retirement accounts. There is no safety net. The full risk of success or failure is squarely on the retirement plan participant’s shoulders.
It’s important to be aware of the following four trends:
1. Low interest rates
This brings us to the first trend: low interest rates at the bank have been a boon for borrowers over the past 10 years. Many individuals have been able to borrow at low interest rates to purchase homes.
Despite an increase in interest rates recently, they are still historically low. These low interest rates paid on savings accounts, money market accounts, certificates of deposit, Treasury bonds and fixed annuities have made it increasingly difficult for university retirement plan participants to find a safe depository for their retirement funds and keep pace with the cost of living.
Thirty years ago, a 30-year Treasury bond would have paid the holder 15 percent interest annually and have unparalleled safety. The current interest rate on U.S. Treasury bonds is near 3 percent.
To make matters worse, as interest rates have begun to rise again, the value of U.S. Treasury bonds fell. This is because bond prices have an inverse relationship with interest rates. So, the $64,000 question for retirees is, “Where can I invest my money when stocks are very volatile, bank savings account interest rates are very low and bonds are at risk of going down in value?”
2. Lower stock returns
In lockstep with low interest rates and declining bond values are lower expected returns in the stock market going forward. In the five years between March 2013 and March 2018, the average annual return from the CREF Stock Fund was 10.58 percent. That compares to its all-time average of 9.86 percent since its inception in 1952. Over the same period, the average return in the CREF Bond fund was 1.97 percent. So a portfolio split 50/50 between these stocks and bonds would have returned a 6.275 percent annual average.
We remain optimistic over the long term for stocks, but investors should expect lower returns over the next 10 to 15 years. J.P. Morgan Asset Management estimates that U.S. large cap stocks will return 5.5 percent and bonds will return 3 percent over that time horizon.
In that environment, a balanced portfolio of 50 percent large-cap stocks and 50 percent bonds is expected to return 4.25 percent.
When inflation is factored in, along with retirees withdrawing from their retirement accounts, this can be very concerning. It begs the question of whether or not future retirees have the correct allocation of assets and will stay the course with their stock allocation in this very volatile environment.
3. More custodians, investment options
This third trend of university retirement plans increasing the number of custodians and investment options, while well-intended, too often leads to bad outcomes for retirement plan participants. Fifty years ago, TIAA Traditional and the CREF Stock Fund were the only two investment options available. TIAA Traditional, with its guaranteed principal, and the CREF Stock Fund were complementary and university professionals more often than not put 50 percent of their contribution into each and that was it.
Over the last several years, universities have tried to help their retirement plan participants by making more custodians (e.g. Fidelity, Vanguard, etc.) available. This increase in custodians started out gradually, but has drastically increased over the last few years.
Now, with so many choices available, plan participants will often do nothing at all and end up with the default option. Or, in an attempt to diversify, they will choose several funds from more than one custodian. Unfortunately, the funds they select often do not complement one another, but instead are duplicates of each other.
Research done by Columbia Business School and the University of Chicago Booth School of Business indicates that retirement plan participants who are faced with multiple investment options ultimately make decisions that can adversely impact their retirement, choosing asset allocations that are unbalanced or choosing to do nothing at all and leaving their money in cash.
4. Income tax burden
Funds which professors have accumulated in their retirement accounts have escaped income tax temporarily. All of the deposits that the university has made and all of the matching and voluntary contributions made by the university retirement plan participant went into the plan with no income taxes paid on them.
In addition, all of the earnings on these contributions, whether they come in the form of interest, dividends, or capital appreciation, have also escaped both federal and state income tax; but only for the moment.
You see, university retirement plans are not tax-free; they are income-tax deferred. As professors begin to withdraw those funds, income tax will become due. When retirement distributions are made from the plan, income taxes must be paid. This means that all university retirement accounts have a very real liability shadowing them of perhaps as much as 35 percent or more of the account’s assets.
The challenge facing professors
How does one manage limited resources in a volatile stock market and low-interest-rate environment, pay one third or more in income taxes on any distribution, and still have enough to enjoy retirement?
More importantly, how does one accomplish this daunting task when the life support of a steady salary is no longer present and there are no guarantees?
What makes the difference between a successful retirement where there is more than enough income to do the things you want and a retirement in which having enough income is a constant worry?
The answer is not any one investment product or service.
Recent market volatility, combined with these four economic trends, mean that future retirees, now more than ever before, need expert guidance provided by an experienced fiduciary adviser.
Only a fiduciary adviser is legally bound to hold the best interest of the university professional above all other interests; including that of the adviser. This safeguard ensures that professors will not be swayed toward one investment decision or another for the adviser’s profit or for the profit of a retirement plan vendor. For more information on fiduciary advisers, please call 800-431-9740 or visit www.filbrandtco.com.
About the Author
Michael J. Filbrandt, CLU®, ChFC®, is the Chairman of the Board of Filbrandt & Company. He is a frequent lecturer and author on financial matters.
- To learn common retirement mistakes university professionals often make, read this report: Retiring in the Next 10 Years? Beware the "Six Traps"
- To learn more about our investment process, read this report: The 3 Hidden Risks of Consolidating Your Retirement Accounts
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