NB Financial Health
How Latino Entrepreneurs Can Fight Intergenerational Poverty: The Impact of Retirement Plans
Hispanics in the United States today are a young and vibrant segment of the population, a source of economic and demographic growth, who in 2016 had an estimated buying power of $1.4 trillion; a figure higher than the GDP of Mexico and all but 14 countries globally and about 10 percent of America’s buying power.
That impressive purchasing power hides the reality of economic inequality. Hispanic median income is 72 percent of non-Hispanic whites, and yet it does not fully explain the economic inequality among Hispanics, 21 percent of whom live in poverty.
With the passage of time, the Hispanic population will not only grow to represent 29 percent of the U.S. population by 2060, but it will also grow older. Latinos currently represent 8 percent of the U.S. population 65 and older, but their presence will grow to 15 percent by 2040, and 21 percent by 2060. As their representation in the elderly segments of the population increases, likely so will their impact on poverty levels nationwide.
Poverty rates are substantially higher for older Hispanics compared with non-Hispanic whites. In 2013, 19 percent of Hispanics 65 and older had incomes below the Federal Poverty Level (FPL) compared with only 7 percent for older non-Hispanic whites. Poverty impacts unmarried older women more than any other group. Among Hispanics 75 and older, 25 percent of widowed, 33 percent of divorced or separated, and 40 percent of never-married women had incomes below the FPL. In an optimistic projection where poverty rates for older Hispanics do not increase, we would expect close to 23 million older Hispanics living in poverty by 2060.
Since older people’s ability to work decreases, older Latinos need to have other sources to replace their income. Social Security, employer-sponsored retirement benefits and personal savings are the three common sources of income at retirement. They are usually referred to as the “three-legged stool.”
For Hispanics, Social Security will hardly be enough. It will fall short in both coverage and income. Almost three-quarters of Hispanics 65 and older receive income from Social Security, and for almost one of every four (23.7 percent) this represents 90 percent or more of their income. This income is not enough to lift them out of poverty. The average monthly retirement pension for Hispanics in 2014 was $1,107 for men and $994 for women, which compares with an FPL that year of $972.
Personal savings are usually low or nonexistent. Financial security at retirement depends to a large extent on how much people earned when they were younger, and Latinos show lower lifetime incomes. In addition, for low-income Latinos the lack of access to products and services tailored to their specific financial needs have many resorting to expensive informal products, alternate forms of credit and risky forms of savings. It is unlikely that with the high cost of these financial products in the early part of their lifecycle spending, low-income Hispanics will ever develop the capacity and confidence to accumulate enough assets to cover their future needs.
Regarding employer-sponsored retirement plans, Latinos have the lowest participation in these of all ethnic groups. Although retirement programs and participation have been shrinking for all races and ethnicities in recent years, the Economic Policy Institute shows that in 2015 only 22.4 percent of Hispanic workers had employer-provided pension coverage. For smaller employers (fewer than 10 employees) only 6 percent of Hispanic employees participate in a retirement plan.
With small Social Security incomes, small capacity for personal savings and lack of employer retirement plans, older Hispanics need support. That support usually comes from family, who, regardless of the impact on their own finances, traditionally take responsibility for the support of their elders, making it difficult to break intergenerational poverty cycles.
Intergenerational support is well engrained in Latino culture. For Americans, personal savings shows accountability for old age, but for Latinos retirement is structured around the way they care for family, and in particular the care for their elders. This cultural influence is strong in immigrant communities and fades in second and third generations. In the results of the latest survey conducted by Hispanic Wealth, among Mexican immigrants, 65 percent of respondents are currently contributing to the retirement of their parents or in-laws, and 67 percent expect their children to contribute to theirs.
There is an erroneous belief that Latinos do not contribute to a retirement plan. The majority of them do, but contributions go toward their elders’ expenses. This is done from current cash flow; no fund is created for this event, and no tax benefits are captured. This is very inefficient and leaves little or no financial capacity to save for their own retirement, reinforcing the need for support from the next generation.
This is not an easy problem, but how can we break the cycle?
The challenge and opportunity for Latino entrepreneurs
I recently learned of a trend developing over the past few years that looks promising. Entrepreneurship among Hispanics has been increasing significantly. In the “Report on Latino Entrepreneurship” published by Stanford University, the authors noted that between 2007 and 2012 new business in the Latino community grew by almost 47 percent, in contrast to a growth of less than 1 percent for non-Latino-owned businesses. Latinos have become a driving force among small business, growing at three times the rate of the national average.
The Census Bureau, in its 2012 Survey of Business Owners, tallies 3.3 million Hispanic-owned businesses in the U.S. Most of these are modest, family-owned and -operated businesses, with an average of 8.6 employees per firm and $155,806 of annual sales. For many Hispanics, entrepreneurship is an alternative to elusive employment opportunities and for building sources of revenue that spread to other members of their extended family and across generations.
For those immigrants who leave their countries in pursuit of the American dream, becoming entrepreneurs allows them not only to feed and clothe themselves but to extend their economic influence to their families and employees. Their focus is centered on growing the business, at the expense of almost everything else. When questioned about their retirement, they believe the assets will come from selling the business or transferring it to the next generation. They have not considered the benefits of building assets outside of their businesses.
Hispanic entrepreneurs should explore building a third alternate end-game for themselves and their employees by establishing retirement plans. With a systematic approach to building wealth for retirement, entrepreneurs can do well for themselves and alleviate the poverty cycle in many of their employees’ families.
Why the emphasis on retirement? What’s at stake?
The lack of retirement savings among Hispanics is an important issue to address since it reinforces the cycle of intergenerational support to elders. This can be observed today in second-generation Hispanic Americans, and it hinders social mobility among Latino families.
Hispanic entrepreneurs are the group with the greatest capacity to break the cycle. By establishing retirement plans and diversifying their wealth, and by taking advantage of tax incentives, they will increase the chance of providing stability to their families and their employees, in this and future generations.
For the entrepreneur, this is a smart path. Creating a company retirement plan helps diversify wealth and leverage tax advantages. For most Latino-owned small businesses, the tax benefits captured by the entrepreneur and immediate family make up for most, if not all, of the costs of extending the plan to the other employees. Establishing a retirement plan is a tax-efficient way to transfer wealth not only to their future selves but to their families and employees.
Establishing a retirement plan does not need to be only for big companies.
What are the retirement plan alternatives?
The concern about establishing a long-term commitment and its impact on cash flow can be addressed by starting with a profit-sharing plan, which allows the business owner to fund a retirement program with high flexibility, deciding each year whether and how much to contribute. The concerns about ERISA compliance can be mitigated by establishing either safe harbor 401(k) plans or establishing plans that were designed using IRAs at their core and are alternatives for small employers, like SEP IRAs, used mostly by self-employed people, or SIMPLE IRAs, which allow employees to contribute pre-tax to their own individual accounts.
By establishing a retirement plan from among the many alternatives available to them, entrepreneurs have the potential to diversify their wealth, stabilize their future income, take advantage of tax benefits and build a solid foundation for their future wealth as well as that of their employees and extended family. With simple plan designs, doing so is within the grasp of the small Latino entrepreneur, it is tax efficient and it further benefits the employees, alleviating poverty in old age.
I hope to see the day when Hispanics have secured income for their elders, making it possible for intergenerational transfers of wealth to go in the opposite direction, to the children, to help make a down payment for a first home or offer startup capital for a new business.
Manuel Carvallo is the founder and president of Hispanic Wealth, a consulting company based in Atlanta, GA focused on serving the wealth-creation needs of Hispanics in the U.S., with particular emphasis on the retirement needs and expectations of immigrants.