What the Detroit Bankruptcy Means to Your Retirement Plan

In the past few days we been hearing and reading much about the Detroit bankruptcy. Most of us, I suspect, are dismissing the plight of Detroit, certain that it doesn?t affect us. After all, Detroit has been in decline for decades, and the fact that it has finally filed for Chapter 9 bankruptcy protection is hardly a surprise.

But don?t be too quick to dismiss Detroit?s problems as irrelevant to your own situation. Unfortunately, Detroit may only be the latest and most extreme example of a situation that is playing out with retirement plans across the country, but to varying degrees.

This is an excellent time for everyone who has a retirement plan of any sort to step back and consider the potential threats to their plan. And, more important, to develop a strategy to be prepared should the worst happen.

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Detroit isn?t the only troubled pension system

What the Detroit Bankruptcy Means to Your Retirement Plan
What the Detroit Bankruptcy Means to Your Retirement Plan
The Detroit bankruptcy is just the tip of the iceberg. Dozens of major cities ? and many smaller ones ? are dealing with troubled pension systems to one degree or another. Many states are also dealing with under-funded pensions creating clouds over much larger retirement systems. In fact, well over 22 million people are covered by government pensions, representing a large swath of the potential retirement population.

And while all?s quiet on the corporate pension front (partially because there are so few left!), high stock market returns may be covering short funding patterns.

What makes the situation even more troubling is the fact that it continues four years into a supposed economic recovery, and with the Dow Jones Industrial Average in the 15,000+ range.

Don?t assume it can?t happen to your retirement plan

And for those reasons, we also shouldn?t assume that we are immune to retirement troubles simply because we are not members of government or corporate pension funds. If you have a 401(k) plan, or any other type of self-directed retirement account, you face a host of potential threats to your retirement that can?t be ignored. Consider some of the following:

  • Safety of principal. In order to build a large retirement plan, you must invest your money primarily in risk-type investments. That means you have no guarantee that you will have enough money by the time you reach retirement, or that your portfolio will continue to grow once you do retire.
  • A market crash just before retirement. It?s one thing to sustain a market crash when you?re in your 20s or 30s, but quite another if it happens when you?re 55 or 60. Worse would be a crash that occurs after you retire. At an earlier age you will have time to recover from a crash, but when retirement is just a few short years away ? or you are already retired ? there is no recovery time. Ironically, the likelihood of a crash is much greater in times like now when the market is flying high.
  • The loss of a job past the age of 50. The success of virtually all retirement projections is based on steadily funding your account and earning a consistently high rate of return over many, many years. But if you lose your job past the age of 50 ? a time when it is typically difficult to replace it ? your funding plans could be interrupted for good. Worse, if the job loss is accompanied by financial distress, you may even begin drawing down on your retirement assets early.
  • Outliving your retirement plan. With people living longer in retirement, this possibility is looming larger all the time. It?s one thing to prepare for a retirement that may last 10 to 15 years, but quite another when you?re talking about 20 or 30 years.

Moral of the story: just because your situation is not currently under the media microscope doesn?t mean that you are immune to similar problems. What applies to Detroit and its pension system can one day apply to us all, even if it happens in a different way. Take Detroit as a wake up call.

The lesson from the Detroit bankruptcy: Don?t keep all your eggs in one retirement basket

So surprise ? retirement planning has risks. But the more important issue is what can we do to offset those risks? It isn?t possible to completely eliminate risk from retirement planning entirely. Retirement planning, just like the rest of life, is inherently risky.

How do we at least minimize those risks, then?

Never assume a storybook outcome. Right now, with the stock market rising, all things seem possible when it comes to retirement. But back during the stock market slides of 2000 – 02 and 2007 – 09, many people were beginning to question if they ever would be able to retire at all. In fact, many people are only now, with a 15,000 Dow, recovering fully from those losses. Continue to save money, and to invest, but don?t assume an ever-rising stock market.

Invest outside your retirement plan – and beyond stocks. If all or most of your retirement money is in your 401(k) plan, you could be setting yourself up for disaster. Save some money outside your plan, that way you?ll be able to access money without draining your retirement account. And look beyond stocks. Real estate can be a viable alternative, and there is no place like money market funds when interest rates start to rise. At a minimum, non-stock investments will help protect your capital from a major downturn in stocks.

Plan to maintain a contingent income source. None of us know precisely what the future holds, and one of the best income diversifications is having an earned income source at least waiting in the wings. This can be some form of reduced continuation of your current job, moving into a new job, or starting a business of your own. It doesn’t have to be full-time either – part-time can get the job done.

Creating a retirement business – a quadruple win

Having a retirement business offers four distinct advantages:

  1. It?s an additional source of revenue to supplement your retirement income
  2. It?s a source of retirement income diversification: Social Security, retirement plan income, and business income – that?ll give you some serious peace of mind
  3. If you start it before retirement, it can provide an additional revenue stream to help fund your retirement
  4. Some businesses can be sold, providing a big chunk of extra money for retirement

Since it can take several years to get a profitable business up and running, now is the best time to start, even if you?re only in your 20s or 30s – think about all the additional retirement contributions you can make if you start that young. Also, you?ll want to have a business that can compliment – or expand on – what it is you now do to earn a living. Here are some suggestions:

Any of these are businesses you can begin in your spare time, and you can take as much time as you need to make them happen. Retirement has risks, and the best way to address those risks is by creating additional income sources. Don?t wait until you retire to start making that happen.

What other ways can we minimize retirement risks – especially the kind that might threaten your retirement plans

( Photo by 404(K) 2013 )

2 Responses to What the Detroit Bankruptcy Means to Your Retirement Plan

  1. Nice post Kevin! I could not agree more that we should not just write it off. Far too many cities are dealing with major fiscal issues that could easily go south. I was actually reading yesterday about Chicago having increasing fiscal problems and they’re much larger than Detroit. My mother-in-law actually works for the county of San Diego and is quite nervous that her pension will be gone when she retires in a couple of years. Thankfully my father-in-law has done a great job of managing their investments.

  2. Hi John – I have several public employees in my family and I’m hearing the same stories, lots of uncertainty. The fact is, public pension systems have promised big time benefits to a lot of people that the tax base can no longer support. We should expect downgrades in benefits as the years go on. It will be interesting to see if Detroit’s bankruptcy causes a major downgrade in benefits, or if some other solution will be worked out.

    No matter what, we should all take this as a wake up call on retirement. There’s a bit too much sunny optimism with retirement projections, even with 401(k)’s and IRA’s. That optimism is largely what has caused problems in the public systems.

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