What are the best ways to make your retirement recession-proof and avoid the losses many people suffered during the last major economic downturn? Nearly three-quarters of economists surveyed by the National Association for Business Economics said the U.S. could enter a recession by 2021. With consumer debt nearing 2008 levels, uncertainties on the health insurance front, and predictions of slower economic growth in the coming years, experts at Wharton note that Americans preparing for retirement should pay down debt, build an emergency fund and look for big and small ways to save money.
“The first thing I would advise, given that it’s the beginning of the year, is to start to think about getting your tax material together, and try to put together a summary budget,” said Olivia S. Mitchell, professor of business economics and public policy and executive director of Wharton’s Pension Research Council, on the Wharton Business Daily show on Sirius XM.
Mitchell suggested that people track where they spent their money last year, including looking at spending by category on credit cards and cash payments, as well as payments towards home mortgages, auto loans, education costs, utilities, taxes, insurance and so forth. From there, individuals can determine their average monthly spends. “That will give you an idea of your current trajectory. You’d be surprised how few people do a budget.”
Consumer debt is approaching 2008 levels after adjusting for inflation, noted Kent Smetters, Wharton professor of business economics and public policy, and director of the Penn Wharton Budget Model, a nonpartisan research initiative that analyzes the impact of government policies. “We project that [consumer debt] will continue to increase over the next decade. However, mortgage defaults (around 1%) and delinquencies (around 5%) are low and have not increased like they did prior to 2008.”
Credit card debt has not changed much, Smetters noted. “Student loan and auto debt are larger drivers.” The total outstanding student loan debt in the U.S. reached $1.6 trillion, owed by some 45 million borrowers, as of the first quarter of 2019, according to a report citing latest data from the Federal Reserve Bank. Auto loan debt was $1.28 trillion, while credit card debt was $848 billion in Q1 2019.
“The potential rising cost of health care is … one of the biggest unknowns” that people heading into retirement ought to consider, Mitchell said. “You can project, perhaps, your rent, your cost for autos, your cost for vacation — if you have enough money to take them — and how much money you want to give your grandchildren, if you like them. But the health care unknown is absolutely frightening.”
“The potential rising cost of health care is … one of the biggest unknowns.” –Olivia S. Mitchell
Mitchell pointed out that in the current political scenario, it is hard to predict what the health care system will be like over the next 25 to 35 years. “It makes it very unclear as to how much you actually need to save to cover out-of-pocket expenses, costs that are not covered by your medical insurer, and treatments that don’t even exist today.”
Emergency Funds and Debt Payments
The next step would be to “make sure you have an emergency fund,” Mitchell said. Most people suggest that emergency funds should have about six months’ worth of income. “That’s not going to save your life if you lose your job and we have huge unemployment, but it will give you some options and opportunities to make the adjustments.” Many people found themselves in financial trouble during the last recession when they lost their jobs and had no reserve funds, she added.
Mitchell’s third nugget of advice was to try and pay down loans such as home mortgages. In the last recession, many people who faced a financial crunch “had very expensive mortgages,” she pointed out. “That’s why there were so many foreclosures. People lost their homes. They really had no way to pay their bills.” Paying an extra hundred dollars a month towards a home mortgage may be one easy way to lower principal balances, and pay less interest over the life of the mortgage.
Similarly, paying down credit cards also helps reduce financial stress. “A lot of Americans pay only the minimum; they don’t realize this is mounting expensive debt, and it’s getting them into more and more trouble,” Mitchell continued. She noted that even though the prevailing overall interest rates are low, credit card interest rates are among the highest they’ve ever been.
Cut, Postpone, Prepare
Mitchell had ideas on how to retain more cash in the bank. Cutting back on big durable purchases, putting off major kitchen improvements and delaying car upgrades are among the obvious ways to save. “If your car is eight years old, try to make it go to 10 years old — that’s my motto,” she said. “Even if you want a new kitchen, if you can make it do for another couple years, that could put you in a better position.”
Prudent personal financial management means not just tracking last year’s expenses and putting off major expenses, but also making sure money is available for expenses that cannot be postponed, said Mitchell. “Your roof will probably need replaced every 20 years or so, and your furnace [maybe] every 15 years or so.” She emphasized that it is not enough to merely keep “mental accounts, but real savings accounts so that you can cover the needs when they arise.”
According to Mitchell, other small changes that add up to sizable savings include decisions on whether to subscribe to fewer cable channels or cut the cord and switch to a streaming services operator like a Netflix or Amazon, as well as deciding to do away with one’s landline if a mobile phone works just as well.
Vulnerable in Retirement
The pains of the last recession do not seem to have chastened most Americans to the degree one may have expected. “I wish I could say that I thought that Americans were doing a better job planning for many eventualities, including a recession, retirement, you name it,” said Mitchell. “I don’t see a lot of evidence. I do see that especially older Americans have ended up taking out more debt and they are incurring and keeping that debt into older and older ages.” She pointed out that about a decade ago, it was normal for people to have a goal of paying off their mortgage before they retired. But that is not the case with the current generation of people heading into retirement. “That means they’re going into retirement on, more or less, a fixed income with this heavy mortgage burden, which, by the way, could grow if interest rates do start rising again. So, older people are particularly vulnerable to changes in economic circumstances, in ways they weren’t necessarily two decades ago.”
After having set aside a cache of funds for retirement, it is not the best idea to keep tapping into that for some tempting purchase or the other. “Retirement savings should be held sacrosanct for retirement. Unless, for some very unfortunate reason, you receive notice from the doctor that you have six months left to live and you won’t have a retirement,” said Mitchell.
“Mortgage defaults and delinquencies are low and have not increased like they did prior to 2008.” –Kent Smetters
“But most of us expect to live some portion of our lives without working,” she continued. “The danger of either taking the money out of your retirement account or borrowing from it is that you’re forgoing the investment earnings you could have made on those retirement assets. So, you’re really robbing your future self in order to cover your present self. Also, most people who borrow from their 401(k)s and lose their jobs end up paying a big penalty and a big income tax on top of it.”
Mitchell added that it’s helpful to keep retirement savings untouched for those who may have a bankruptcy, because those funds are not subject to a lien in such eventualities and stay protected.
A big part of sound retirement planning is wisely choosing the investment securities to store those funds. For instance, those who expect a big economic downturn might want to reduce their equity holdings and invest in safer securities like government bonds, said Mitchell. Other avenues she pointed to include going online and finding banks that will pay 2% or more on simple savings accounts. “Every little bit helps,” she added. Many economists have projected that the markets are not expected to be robust for the next 30 or 40 years, she noted.
New-age Tools and Mindsets
Fintech is making advances into retirement territory, with so-called robo-advisors helping people find the best options to allocate their savings, Mitchell noted. However, retirement planning involves raising complicated questions like when should one start drawing on social security benefits, or the specific impact of home ownership, one’s health and other considerations that may not be easy for a robo-advisor to grapple with, she said.
Younger people seem to be more aware of the need for retirement planning, and have very different approaches to it than their parents’ generation, according to Mitchell. “The millennials and the generations after them went through a very cold-water bath seeing their parents suffer during the great recession,” she said. “However, also within those groups, I hear the mantra of FIRE (Financially independent, retire early) theme.” She noted that many younger people, including her own children, are talking about trying to retire in their fifties or even late forties. “[Their plan is to] work really hard until then, and then maybe go off to a teepee somewhere.” However, she did not think that was a practical approach. “We’re living longer and longer. And so you can’t expect to live for 50 years on what you’ve earned in 25 years. It’s just very unreasonable.”
“Older people are particularly vulnerable to changes in economic circumstances, in ways they weren’t necessarily two decades ago.” –Olivia S. Mitchell
The theme of people living longer has found its way into legislation that aims to help people stave off a retirement savings crisis. The Secure Act, which President Trump signed into law in early January, has numerous provisions intended to strengthen retirement security, and also to help protect workers who don’t have access to workplace retirement accounts, according to a MarketWatch report. Significantly, people can withdraw from their 401(k) plans from the age of 72 instead of the previously mandated 70.5 years. The act also enables more employers to offer annuities as investment options within 401(k) plans, among other benefits.
Mitchell welcomed those changes, but she also called for “an overall overhaul of how we look at age within our legal and regulatory structure.” For instance, with increased life expectancy and longevity exceeding 100 years in many cases, “the notion that you’re old at 62 when you can take your Social Security benefits is really not apt anymore,” she said. “[The onset of old age] is more like 75 or 80.”
According to Smetters, the Social Security Trust Fund will stay solvent until about 2035. “When the trust fund is exhausted, benefits will be reduced to about 75% of current levels, unless Congress acts sooner.”
Smetters does not see signs of “an imminent recession” in the current economic environment. “However, people saving for retirement should always estimate their cost in retirement, save adequately and not try to time the stock market. Investments are less important than making sure you have enough money saved.”