The Risky Business of Retirement

It's not your imagination: Americans are facing a lot more risk these days. Gone are the sense of national invulnerability and the notion that we are widely beloved because of our prosperity, our movies, our Bill of Rights, even our McDonald's. We find ourselves more alone than we have been, perhaps ever, with an unfamiliar sense of physical fear. We've also been hit over the head with forceful reminders that job markets and stock markets go down as well as up. And as if there weren't enough stress, we are beginning to realize that, when it comes to a secure retirement, most of us have neither earned enough nor saved enough to have the life we imagined for our last act.

Planning for retirement, of course, has always involved multiple uncertainties. For that reason, retirement experts believe that most workers should have a "three-legged stool" to fall back on: personal wealth, a government-backed safety net of social insurance (composed in the United States of Social Security, Medicare and Medicaid), and job-related pensions. But nowadays all three legs seem wobbly. We are told that Social Security cannot -- and, some even argue, should not -- be saved. And employers, we're finding, are increasingly unwilling to adequately fund pension plans. With the collapse of Enron, US Airways and a host of other corporations, as well as shortfalls and cutbacks in pension contributions from still viable firms such as Charles Schwab and Ford, reliance on an employer for retirement income has become yet another bit of risky business. Today less than half of private-sector workers have any pension coverage.

Life in an Older America

The next generation approaching retirement, 76 million baby boomers, is so large that these issues cannot be ignored. The segment of Americans over the age of 65, currently 13 percent of the population, will grow to more than 20 percent in 2029, when the youngest boomers reach that age. To understand what life will be like in an older America, we have to ask, "In terms of overall retirement adequacy, how are the boomers doing?"

Some quick facts about each leg of the stool will help answer that question:

Personal Wealth. Overall, net personal savings apart from pensions have been close to zero for a dozen years, with private debt ballooning to $8.5 trillion.

Only 6 percent of workers eligible for tax-subsidized individual retirement accounts take advantage of them.

There has been a steady increase in wealth inequality in the United States for a generation. During the economic boom from 1993 to 1998, the richest 1 percent garnered 53 percent of the total gain in marketable wealth. The "bottom" 80 percent received only 9 percent of the gain. Less than half of households holds stock worth more than $5,000.

Inheritance won't help most boomers. William Gale of the Brookings Institution estimates that the "typical boomer will likely gain ... perhaps on the order of $10,000 to $30,000 from inheritance."

Even the potential to realize cash for retirement by selling one's house is fading. Americans are going to do that well before retirement. As Federal Reserve Chairman Alan Greenspan recently pointed out, in the last year alone homeowners took out $200 billion in home-equity loans, cashing out almost 3 percent of the total worth of their houses.

Social Security. While some assert that Social Security is unsound, its reserves are in fact invested in Department of the Treasury obligations, which by normal market measures are the safest sources of retirement income.

Contrary to the scariest claims, Social Security won't run out of money even if nothing whatsoever is done to change it. But without some fixes, the program in 40 years will have only enough money to pay for about 75 percent of currently promised benefits.

The need for this social insurance will remain. Today 64 percent of the elderly depend on Social Security for at least half their income. Without it, 40 percent would be below poverty level. Among elderly women living alone, a growing group, more than a third rely on Social Security for 90 percent of their income. And so far there is strong evidence that the aging boomers will have a similar pattern of dependence on Social Security.

Private Pensions. U.S. employers aren't required to provide pensions, and there is no assurance that those who now do so will continue to. Companies also can and do change the terms of their pension plans.

Two-thirds of pension benefits currently go to the 15 percent of households with more than $100,000 in annual income.

While 58 percent of private-sector employees work in firms that provide pensions, only 44 percent are actually covered. The lower an employee's income, the less likely he or she is to be covered. Just 6 percent of workers earning less than $10,000 a year participate in pension plans.

The median 401(k) account was worth only $16,000 in 1998, according to the Federal Reserve.

In sum, with the leading edge of the baby-boom generation only a decade away from retirement, we know three things: Wealth and savings will be of great help only to the country's top earners; Social Security is still the most secure source of retirement support, but it needs a significant fix; and private pensions do not cover enough workers or provide enough resources to fill in the gaps.

We also know that in the stock-market binge of the past decade, bad judgment, opportunism and cynicism by many of those managing private- and public-pension funds greatly weakened retirement security. Counting on sky-high investment returns, they took money out of pension funds and reduced employers' annual contributions. The resulting hole is still getting deeper. The federal Pension Benefit Guarantee Corporation (PBGC) insures some 32,500 private-sector plans that promise a guaranteed retirement benefit. This is down from about 114,000 such plans that existed in 1989, and last year the PBGC lost $11.4 billion as companies defaulted on pension obligations. The PBGC estimates that 360 of the 500 biggest companies have underfunded pensions today.

There were also public-sector players who engaged in Ponzi-like schemes. For example, Christie Whitman, as governor of New Jersey, got the pension funds to borrow $2.8 billion (for 35 years at an interest rate of 7.64 percent) rather than making full annual contributions to state employee pension funds. Investment returns, she promised, would more than cover the interest costs. While this gimmick helped to finance her income-tax cuts, the debt has now resulted in huge shortfalls in the state pension funds just when New Jersey is suffering severe general revenue woes.

With Friends Like These

The Bush administration has never set forth a full-scale plan to ensure retirement security, but a series of measures proposed during the past three years show a consistent approach. Instead of addressing the shortfalls in savings by average working families, the administration has proposed reinforcing the advantages enjoyed by those in the top echelons of income and wealth. Estate-tax repeal and elimination of dividend taxation obviously fall into this category, but so do proposed increases in the amounts a person can put into tax-favored IRA- and 401(k)-type accounts. Meanwhile, President Bush's other retirement proposals pile on the risks confronting ordinary families.

The administration continues, for instance, to advocate private accounts to replace most of Social Security. Its primary argument (now that it's necessary to soft-pedal the "can't lose" claims of a few years ago) is that privatization would allow young people to escape the "burden" of paying for an increasingly costly Social Security system. But privatizers conveniently ignore the fact that in the long (70-plus years) transition to privatization, today's young workers and their children would end up paying for the retirement of two generations. Because Social Security has a large pay-as-you-go element, they would still be paying for those who retire ahead of them (who, in their turn, paid for those who retired ahead of them), and at the same time they would have to make contributions to fund their own new private accounts.

The privatizers are similarly misleading when they insist that Social Security is of little use to minorities. It's true that, on average, blacks and Hispanics don't live as long as whites, but because of the progressivity of the Social Security program, as well as the disability and life insurance it provides, there is actually little difference in the program's net benefits to whites, blacks, Hispanics and others. For blacks and Hispanics, who are more likely than others to have low-income jobs without pension benefits, Social Security remains crucial to a reasonable retirement.

Would some people make more money from a private-investment account? Quite possibly. Stocks have had good returns over the last hundred years. But for any individual retiree or investor, the timing issues can be devastating. In the very successful market of the 20th century, there were three 20-year periods during which the return on the stock market was zero or negative.

More risk for more people: The same premise that animates the Bush administration's scheme for Social Security also drives its ideas about private pensions. And the administration's tilt toward employers is apparent on such issues as "cash balance" pension plans. These are hybrids that combine the features of several traditional approaches while offering considerable flexibility for sponsoring companies. Employers typically manage the plan's assets, promising to credit each worker's pension "account" with earnings at a specified interest rate. But employers can change the rate, essentially at will. Because they are portable, these pensions could work to the advantage of younger and more mobile employees, and, unlike 401(k) accounts, they are government insured. In the past, however, some companies used the shift from a traditional pension to a cash-balance plan to reduce sharply the pensions they paid longtime employees. Workers had to file lawsuits, for example, against Citibank, IBM, AT&T, Xerox and others. The abuses were so serious and widespread that the Internal Revenue Service in 1999 halted conversions to cash-balance plans. It now appears that the administration wants to lift that ban. While cash-balance plans could, with the right sort of government oversight, be compelled to build in worker-friendly features, it requires quite a leap of faith to imagine that occurring during this administration.

Real Reform

In some ways the Bush approach to pension reform, as to tax reform, can be summarized as "reward the winners; give them more." Reform looks very different if we concentrate on widening the circle of secure retirees.

To start, we need to recognize that the present precarious situation is the result, in part, of the erosion of the very concept of insurance. Policy cannot be based on the unrealistic belief that everyone will be a winner, with a lifetime of solid employment, steady and strong investment returns, and smart choices about how to handle a retirement nest egg. Yet here, as on a host of other economic issues, 25 years of simplistic and self-serving propaganda from conservatives has coarsened the debate and befuddled the press, not to mention workers. The basic truth that capitalism is and ought to be our economic system of choice has been used to justify the notion that more risk -- individual and family -- ought to be the object of policy. Perversely, this doctrine has prospered even as the evidence has mounted that companies and senior managers have sought every possible means to reduce their own exposure to pension-plan risk.

Government needs to redress this imbalance, and it can do so by reshaping the major component of the pension policy already in place. As economist Bernard Wasow puts it, "Today's large assortment of tax breaks for saving toward retirement [is] confusing, overlapping and poorly targeted. Most of the benefits go to families who probably would set aside sufficient resources for their retirement even without tax incentives." If redirected, the $200 billion a year that currently goes to tax breaks for private pensions could buy a great deal more retirement security.

The solution is major surgery -- eliminating some existing tax breaks for retirement accounts and adding a new one, a tax credit (a direct reduction in taxes owed) that is "refundable" to those who earn too little to owe any net income taxes. These workers essentially would get a payment from the federal government to offset payments they made to a retirement savings account. The plan thus encourages saving for retirement, just as the widely lauded Earned Income Tax Credit for low-income families encourages work. Even better would be a truly progressive subsidy, which would not only be refundable but also would incorporate a larger tax credit for saving by poor and average-income families than for the same saving (relative to income) by the rich.

Another key reform goal should be simplicity. Few taxpayers can navigate the current system without the advice of experts who collect sizable fees. There are standard 401(k) plans and SIMPLE 401(k) plans, traditional IRAs and SIMPLE IRAs, Roth IRAs and SEP-IRAs, 403(b) plans and 457(b) plans, and every year more concoctions are added to the menu. Yet the present array of programs isn't helping an array of workers. As Alicia Munnell, director of the Center for Retirement Research at Boston College, points out, 60 percent of families have only 401(k)-style pensions, and most of those have relatively small balances in them.

Munnell favors numerous changes in current retirement policy. She argues, for example, that because employees already have their jobs at stake in the firm for which they work, their company pension plans probably shouldn't be allowed to own any company stock. So far neither Congress nor the administration seems to be interested.

Across the political spectrum, Americans believe that if you've spent a lifetime working, you shouldn't, simply by virtue of being too old to work, have to live the rest of your years in poverty. But the only way to fulfill that worthy goal is to reduce the amount of risk workers nearing retirement must face. Obviously we are not living in an era when there is a significant political appetite for doing much for average (non-campaign contributing) job holders. But maybe there's some promise in the approach taken by Rep. Bernie Sanders (I-Vt.) during debate of the proposal to reinstate cash-balance plans. Sanders said he would support the measure if the same rules applied to pensions for members of Congress. No wonder some of Sanders' colleagues see him as a dangerous revolutionary. Imagine aligning the interests of elected officials with those of working Americans!