Retirement Insecurity: A Problem that Needs a Solution (so here’s one!)

March 18th, 2012 at 12:55 am

I’ve been remiss.  While I’ve written a fair bit on Social Security, I’ve not paid enough attention to other dimensions of retirement security, in particular, pension reform.

I was reminded of this omission upon reading this great oped by one of my favorite pension experts, Teresa Ghilarducci (hey, some folks have favorite ballplayers, others have favorite pension experts).

Here’s the basic lay of this troubled landscape: First, based on long-term wage erosion, low savings, and the shift from defined benefit (DB) pensions to defined contribution pension plans (DC)—see figure—there are a lot fewer people who will reliably be able to replace enough of their lost earnings when they retire.  DB plans guarantee a pension benefit; DC plans are individual retirement accounts that fluctuate with the markets; thus, the figure shows the locus of risk in retirement security shifting from employers to workers.

Source: Economic Policy Institute

Second, some pension plans held by public workers—and thus a liability for their public sponsors, like municipal governments—are in trouble, often due to a collision of irresponsible funding practices and the Great Recession.  Though cases facing potential defaults dominate the headlines—including today’s—they are the exception.   Yes, there exists a serious funding shortfall in many public plans, but no, that doesn’t imply the need for massive restructuring, benefits cuts, and defaults.  In fact, on average, states, cities, and towns devote less than 5% of their operating budgets to funding their pensions.

Moreover, most—not all—have time to fix the problem through funding increases, along with some sensible eligibility and benefit reductions (from the CBPP link above):

As Alicia Munnell, an expert on these matters who directs the Center for Retirement Research at Boston College, has explained, “even after the worst market crash in decades, state and local plans do not face an immediate liquidity crisis; most plans will be able to cover benefit payments for the next 15-20 years.”

A far bigger problem is the fact that too few of today’s workers have any sort of pension at all.  Half of private sector workers do not participate in any retirement savings plans, and as you’d expect, participation is a function of your wage level.  For low-wage workers—those in the bottom 25% of the wage scale—20% participate in plans; for those in the top 25%, it’s 75%.

That’s how you get findings like these from Teresa G (that’s what she’s called in her music videos):

…over a third of New York workers, both public  and private, approaching retirement age have less than $10,000 in liquid assets. As a result, those workers are projected to be poor or near poor in retirement, with an average budget of about $7 a day for food and approximately $600 a month for housing.

So scholars and advocates are thinking about ways to cover a lot more people, and a bit of a consensus is forming around a hybrid between DBs and DCs that involves pooling over large numbers of workers—as with health care reform, pooling risk is the best way to dilute it.  Here’s the way something like this might work:

–state or federal governments would set up public pension plans that guaranteed a modest return—more of a supplement to Social Security than a DB replacement (as the latter could place new, large liabilities on the public sector) in which all workers could participate.  In other words, the plan would be organized and managed by the state or federal sector, as they have by far the greatest capacity to pool and manage large plans; but any employee, not just public sector workers, could participate.

–these city, state, region, or even nation-wide funds would be managed by independent expert boards instructed to meet modest targets through safe investments like index funds and  TIPS (inflation-protected bonds).

–employers and employees could make tax free contributions to these pension plans, just as with today’s IRAs or employer-provided DC plans.  The plan would be fully funded by employer and employee contributions and thus not backstopped by a government guarantee.

Why go there?  What’s the advantage to this kind of plan?  First, with its large participation base and not-for-profit management structure, fees would be very low relative to the current DC system.  Second, this could be set up as an opt-out system, where employees would automatically contribute (pretax) some small portion of their paycheck unless they actively choose to opt out.  Behavioral research has shown that lots of folks who want and would benefit from a plan like this often won’t sign up based on simple inertia.  But if they’re put in automatically, they’ll stay in.

What are the downside risks?  Private DC providers won’t like the competition but they’ll still be able to offer plans that are much more aggressive than this public option.  Problem is, there’s a real market failure here.  The way things are currently set up, the marketplace just isn’t providing future retirees with affordable options.

Social Security, of course, addresses that market failure, but with an average benefit of under$15K per year, it’s a partial solution.  The retirement stool has always been conceived of as having three legs: Social Security, savings, and pensions.  It’s the loss of the latter two that militate the need for a broad, inclusive solution of the type suggested above.

The biggest objections I’ve heard are twofold.  First, such retirement products as a large public plan like this would offer are already available—you can already build your own retirement account (tax-free, through IRAs) in index funds or inflation-protected bonds.  But it’s neither cheap nor easy for folks to do so, which is why, in reality, you see so many middle and low-wage earners without any pension plan at all.  This idea–more of a cheap delivery mechanism, really–should make it cheap and easy to have a pension through work.

The more serious objection is that, like the GSE’s (Fannie and Freddie), a plan set up by the government, even one that’s pre-funded by workers and employer contributions and run by private entities, would implicitly be backstopped by the government.  If it got into trouble, it would be “too big to fail,” and thus to create it is to invoke bailout liability.

One way to solve this would be to have the guaranteed return be variable within a given range, so that when the fund was stressed, say in the midst of a financial meltdown, it would pay out less (that would make it more of a hybrid than a true DB plan).

But the bottom line here is that unless we as a society are willing to accept vastly increased economic insecurity in retirement, we can’t afford to sit on our hands, cast aspersions at public sector pensions, and argue that it’s a you’re-on-your-own world, where you bear all the risk.  I think it’s fair to assert that in the world’s richest, most advanced economy, our retiree generation is also too big to fail.


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18 comments in reply to "Retirement Insecurity: A Problem that Needs a Solution (so here’s one!)"

  1. Hayk Nahapetyan says:

    Congratulations! Nice Article

  2. pjr says:

    This sounds a bit like the current federal system for employees, which has a DB plus TSP. TSP is far better than most 401-k systems, with little overhead costs. The retirement system was changed in the 1980s in favor of TSP rather than a large DB plan. Every civil servant knows that the old system was better for them, but TSP isn’t bad.

  3. Cat says:

    The lack of DB plan or lack of DC plan participation is a symptom of the war on workers and their salaries and has nothing to do with the workers not being motivated to save for retirement more.

    Once those workers save more for retirement how are they going to afford to help send their kids to college at even a mediocre state college where tuition is approaching 10k a semester?

    The political cronyism of officials will subvert the low cost and low risk once these funds get big enough.

    Your archetypal 90% worker isn’t casting around hoping for low cost retirement plans, they are trying to stay afloat.

    • Fred Donaldson says:

      Individuals and employers pay into SOcial Security. Add government into the mix at 6.2% and you can increase benefits by nearly one-third and still be a stable system.

      But…do you really think the rich want the poor to have enough money so they have time to think about inequality, instead of just working themselves to death?

  4. Chris says:

    Nice article I have been saying for the last few years that when my generation (entered the work force in 1980) realizes that the policies of R.R. and his followers has made retirement an impossibility for most of us I hope the anger is directed at the correct people. When I hear conservatives say that it is everyones responsibility to save for retirement I have to burst out laughing, since 1980 wages have been stagnant for most workers, how a family of four at the median income is supposed to save is just laughable. I realize that my first day of retirement will be the day after I die. I figure it will be a successful life if I can avoid the door greeter at Walmart as my final gig!

  5. D. C. Sessions says:

    First, such retirement products as a large public plan like this would offer are already available—you can already build your own retirement account (tax-free, through IRAs) in index funds or inflation-protected bonds.

    The maximum tax-exempt contribution for IRAs is so low as to be meaningless. It’s less than 20% of the cap on a 401(k), and employers can put as much into a 401(k) as, for instance, bonuses as they like. According to reports Intel put tens of thousands into engineers’ 401(k) accounts in some years.

    So, yes, workers can set up IRAs. They just can’t put enough into them to make a significant difference in retirement income (unless they’re rolling over a 401(k), which isn’t really the same thing.)

  6. Skyman123 says:

    The real problem here, I think, is what happens to these people? We’re not going to let them become homeless or starve, which means that the public assistance rolls for the elderly will skyrocket in the near future. So anyone assuming that this will either just go away or that we’ll be able to reduce funding to these programs is just lying. Or anyone thinking that Social Security will be changed is also being disingenuous.

    The lower wage workers can’t save. Period. The middle upper can’t really save in the amounts needed either. Period. So relying on any sort of personal savings is just simply out of the question for a vast swathe of the population, no matter what they say or how they vote because we’re going to spend money taking care of them after they retire one way or another. This means we should be focusing attention on spending the money throughout their work life which means forced savings in the form of some additional retirement “tax” which is put into a fund as described here that slides as the person gets older based on wages. Perhaps with some government matching to sweeten it. To me, this seems to be the right solution as it puts money in as a person is working, much like SS, but slides upwards and is designed to boost income in retirement to keep people off the public dole. It’s sensible, which is why it won’t be considered in this political climate.

  7. Will says:

    I’m 25. I work for a company that offers a fairly generous DB pension plan along with a decent matching contribution on 401k. However, in every one of the 3 years that I’ve worked there, I’ve seen my benefits get cut sharply each year.

    This year, they’re eliminating the DB pension plan for all newly hired employees and replacing it with a DC “pension” (it’s actually just an account that’s pegged to treasuries or a minimum of 1.5%, whichever is higher). For current employees the company is offering a strong incentive to switch to the new “pension” plan.

    With the way even the company is acting, I have little faith that any pension will exist by the time I’m planning to retire, I’ve internalized the YOYO mentality and am planning for my retirement via cash flow investments today.

    I know, sadly, that this option is not available to all Americans, but I need to look out for my own retirement security and cannot depend on the government or employers to take care of me when they have repeatedly demonstrated that they have no intention to.

    • Cat says:

      “…but I need to look out for my own retirement security and cannot depend on the government or employers to take care of me when they have repeatedly demonstrated that they have no intention to.”

      This statement isn’t accurate. A lot of democrats want society and the government to take care of the less fortunate, its the GOP who feel the less fortunate earn their misery and shouldn’t be given an helping hand are are actively trying to cut the social safety net programs like SS.

      • Will says:

        Unless we get a Democratic super-majority and / or reform the filibuster, I won’t hold my breath. As far as I’ve seen, Democratic and Republican legislators disagree on how deeply we should cut benefits, not on whether or not we should cut.

        I’m reminded of an old joke: The difference between Republicans and Democrats is the Democrats truly care about the people their policies are hurting.

  8. dougfir says:

    I likewise work at a company that cut benefits the last several years as part of their “war on costs”. I might add the company has had record profits the last several years as well. They do have a 401(k) match up to 6% but we wonder how long that will last. I hope to retire in 14 years when I turn 70 and my best planning hope is that Social Security is still here. As the saying goes, hope is not a plan. But for those of us not making enough to save sufficient amounts to live on, it’s all we have.

  9. readerOfTeaLeaves says:

    IMVHO, it’s probably not feasible to address the Social Security problems in the current environment of distrust created by perceived corruption of government and its failure to address and prosecute serious, massive financial crime.

    I don’t think DC has a lot of credibility on economics or finance; neither does Wall Street. (At least, not in my neighborhood.) That seriously complicates any attempts at solutions (other than making a non-profit, non-Wall Street, state-based option far more appealing).

    As for personal savings… it feels as if the Fed is sticking it to a small person like myself, in order to keep the big banks and Wall Street afloat with cheap money. All of which circles back to the lack of trust for DC, which diminish the odds of a reasonable solution.

  10. leo says:

    I’m one of the 1980 crew. My current job with a state agency pays no pension but is not obliged to pay social security either (see 1935 exemptions). Needless to say, the amount of income I get doesn’t allow me to pack away anything beyond the basic minimum as a 401k.

    I’m looking at a lifetime of having to do this. As Chris put it, retirement will come when I kick the bucket.

  11. davesnyd says:

    Why set up a new system? Why not somehow use annuities as the DB/DC hybrid?

    Aren’t they already tax advantaged?

    Is there any way to make them more attractive? Is there a sensible way to subsidize them?

    –> Maybe this is an appropriate one for the next YAIA.

  12. Where to Retire says:

    A closer-in solution is called sharing, a concept that many Americans do not understand (but will need to). Today we all live in single houses, drive single cars, etc. In fact, this trend of living alone is increasing. But as we age, sharing a home, sharing a car, sharing utilities, much as we did in college, reduces expenses and loneliness, something many seniors face. The idea of sharing might solve a lot of problems as we age.

  13. Ryan Tull says:

    Love the blog. But on this particular entry, what am I missing? Seems like what your trying to do could be accomplished most efficiently by just bumping up the Social Security withholding %, which would expand the invested amount and subsequently increase the average benefit stream. Or is the debate how to get there by keeping private sector investment houses involved and individuals some limited choices so it’s more politically acceptable?

    • Jared Bernstein says:

      You raise a good point but the traditional approach here is to have Soc Sec, pvt pension, and savings all working together to provide more retirement security. This idea is a reaction to the fading of private pensions by trying to construct an easy, cheap, safe delivery system for them.