Matters Column

Retirement savings and looming Social Security issues

January 24, 2014
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January is often the time for resolutions, including exercise regimens and diet, or other personal or professional items. Often forgotten are personal finance resolutions.

Personal finance resolutions may relate to savings or retirement goals. One not always considered is retirement savings. One resolution most of us should consider is to review our elective salary deferral percentage in a retirement plan.

The IRS announced in late 2013 that for the 2014 tax year, 401(k), 403(b) and elective profit-sharing annual deferral limits are increased to $17,500. Those 50 years and older can also elect to defer an additional $5,500. The current limits offer opportunity for many of us to enhance our individual retirement savings. We should take advantage of this opportunity.

Retirement savings is an important financial asset for many of us. In fact, retirement savings and a home are typically an individual’s two largest assets. For many, increases in retirement plan balances have grown faster in recent years than home values as a result of stock market related gains.

Participants in such plans often don’t take full advantage of employer math arrangements that provide an immediate return on the investment to the participating individual. Retirement savings may be very important, given our country’s national debt and budget deficit issues. We are all aware of the looming issues of the financial security with Social Security.

Yes, there is the trust fund with trillions of dollars in the fund earmarked to pay future benefit obligations. However, those funds were lent to the federal government to fund government operations over the years, so there isn’t ready cash available to draw upon. This differs from some other retirement benefit systems — for example, Canada.

I took some time recently to review the annual report for the year ended March 31, 2013, of the Canadian Pension Plan Investment Board. The CPPIB manages the investments of the Canadian Pension Plan, the Canadian version of Social Security. Canada does what many have proposed in the U.S. — that is, invest funds in something other than U.S. Government IOUs (Treasury securities). The Canadian Pension Plan and its counterpart in Quebec, the Quebec Pension Plan, provides retirement benefits to Canadians.

The CPPIB report indicates the plan has obtained returns that are 5.3 percent ahead of inflation over the past 10 years. This rate of return exceeds the real rate of return required (4 percent) to sustain the CPP under the demographic and actuarial assumptions for Canada. Given the strong equity performance in 2013, one may expect the returns for the trailing 10 years to increase for the CPP in this year’s annual report.

As I read further, I found the investment allocation and portfolio information interesting in the CCPIB report. In 2000, 95 percent of the portfolio was invested in fixed-income securities. Equities made up the remaining 5 percent. This changed over the next 13 years. In 2013, the mix was 50 percent equities, 33 percent fixed income and 17 percent real estate. For the latest year (March 31, 2013) investment income produced a 10 percent return in the CPP.

More than 60 percent of the assets managed by the CPPIB were invested outside of Canada. This included Europe, Asia (split between Japan and the rest of Asia) and the U.S. In addition to sovereign risk, such investments also add currency risk to the portfolio.

The CCPIB report also provided information between active and passive investments. In 2000, all investments were passive. In 2013, only 57 percent were passive; the remaining 43 percent were considered active investments. The active investments included private equity, infrastructure and real estate.

The investments in real estate properties are split almost 50/50 between North America and the rest of the world. The holdings include office, retail, industrial and multi-family. The office holdings in the U.S. were in largely New York City and Washington, D.C. A significant amount of retail holdings were located in California, Florida and Massachusetts.

The difference between CPP and the Social Security trust fund appears to be that Canada is using a lockbox strategy with the CCPIB and its funds. The CPPIB isn’t engaged in lending all of its funds back to the government for funding any federal budget shortfalls. My Canadian friends like this aspect of their system compared to the U.S. model.

The CCPIB report discusses sustainability of the CPP and the CCPIB’s role in that sustainability goal. The last time the U.S. had some frank discussion about sustainability and fixing some of the long-term funding and benefits issues with Social Security was in the early months of President George W. Bush’s second term. There was discussion of having more segregated accounts and looking at market returns as an option for the long-term sustainability of Social Security.

The investment model used by Canada with the CPP does have some appeal. Segregating funds from the whims of politicians and having professional fund management is something that perhaps should be discussed. The fears of many for Social Security are already starting to appear. Just look at the legacy cost issues for the automakers (pensions and health care) that forced two of the three Detroit-based automakers into bankruptcy. We also see cities such as Detroit (also in bankruptcy) and states such as Illinois wrestling with legacy costs issues. And there likely will be more as time goes by.

There are no perfect solutions to such issues as Social Security reform. It has been nine years since Bush tried to have some discussion and dialogue on the issues regarding the long-term sustainability of Social Security. Unfortunately, the ideas became politicized and became wedges for political gain rather than having serious discussion about the real issues. Nothing meaningful was accomplished at and since that time.

Where does that leave us? With the current environment in Washington, any bold and out-of-the-box ideas don’t seem to be appreciated or even pursued. In business, we often observe and see what others are doing better and then seek to improve our own businesses. The opposite appears to happen in Washington, as in many cases it appears Washington tends to go to the lowest common denominator.  

When and if any changes are made to Social Security, there is always a risk someone may say, “If you like your Social Security, you can keep your Social Security.” And such a promise may doom any sorely needed reforms. In the meantime, we all should consider our own retirement savings as an asset base to continue to build. We all still have some control over that item.

Bill Roth is a tax partner with the local office of BDO USA LLP. The views expressed are those of the author and are not necessarily those of BDO. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult their professional advisers before acting on any items discussed herein.

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