Unequal Distribution of Retirement Wealth

The widespread replacement of defined benefit plans by defined contribution plans over the last few decades has transferred much of the retirement saving risk from the institution to the individual, particularly in the private sector. According to Colleen Flaherty Manchester, writing in the Southern Economic Journal, the prognostication is that this transition will increase overall retirement wealth but the expected gains are concentrated among high-income individuals with low-income individuals likely to experience reduced wealth.

Retirement Confidence Survey

A Retirement Confidence Survey of College and University Faculty examines the relative use of defined benefit (DB) plans and defined contribution (DC) retirement plans across institutions. A substantial portion of colleges and universities, in fact, offer faculty members a choice between the two plans. The Survey found that workers with a preference for a short career choose DB plans with early retirement ages of 62 or earlier. As a result, participants in DB plans tend to retire on average two years earlier than their colleagues who have opted for the DC arrangement.

401(k) Averages

At year-end 2008, the average account balance among the 24 million 401(k) participants in the United States was $45,519, according to the Economic Benefits Research Institute.  This average, of course, varies substantially with age and tenure. For example, for participants in their 60s, the average account balance for an individual who has been with the current employer at least 30 years was slightly more than $172,000.

Equity Assets

In 2007, almost a quarter of the oldest 401(k) participants (aged 56-65) had 90% or more of their 401 (k) assets in equities. Another 10% had 80-90% in equities, and 11% had 70-80% in equities.

Equity Allocations among Target-Date Funds

According to the Economic Benefits Research Institute, the average equity allocation for target-date funds designed for individuals in the 56-65 age range was 51.2% at year-end 2007.

Global Aging

The United Nations Department of Economic and Social Affairs has this to say about the world’s aging popuation:

• Population aging is unprecedented, without parallel in human history - and the 21st century will witness even more rapid aging than did the century just past.
• Population aging is pervasive, a global phenomenon affecting every man, woman and child - but countries are at very different stages of the process, and the pace of change differs greatly. Countries that started the process later will have less time to adjust.
• Population aging is enduring: we will not return to the young populations that our ancestors knew.
• Population aging has profound implications for many facets of human life.

The American Retirement System

Anna Rappaport, writing in Benefits Quarterly, sums up the American “retirement system” as follows, quoted verbatim:

• The system is voluntary and an add-on to Social Security.
• Over the long term, the system worked very well for long-term employees in large employers, but poorly for employees of very small employers and those without stable long-term employment.
• In recent years, there have been problems with the system in the areas where it had historically worked well, and it is important to address those.
• It is equally important to focus on the areas where it historically did not meet population needs and fill in the gaps.
• Individuals' capability to understand risk and deal with it effectively is variable and, for some, very limited.
• Social Security represents virtually all of the resources that people at the lower end of the economic spectrum have and virtually all of the income for four out of ten older women living alone. The system needs to work in partnership with Social Security, and Social Security needs to be strong.
• There are a lot of benefits and efficiencies to be obtained from risk pooling, and pools need to be at least a minimum size to be effective.
• While health care and long-term care are not part of the discussion today, providing for both of them is an important part of retirement security.

Life Expectancy

Postretirement life expectancy has increased more than 25% in the past 35 years.

Phased Retirement

According to a 2005 AARP survey of individuals over the age of 50 concerning their reactions to the idea of phased retirement:

• Almost 90% of the respondents thought it is important to be able to continue to accrue pension benefits while participating in phased retirement.
• About two-thirds indicated that a phased retirement program would be less attractive to them if it could lead to lower final pension benefits than what they would receive if they continued to work full-time.

Retirement Policy Improvement

Anna Rappaport, writing in Benefits Quarterly, makes these recommendations for retirement policy improvement, quoted verbatim:

• National retirement policy - Develop a national retirement policy and keep it updated. Recognize that an integrated retirement system is important to the fabric of the nation, and that it needs an underlying rationale with stability and that makes sense. Include in the policy a minimum age for receipt of benefits from tax-qualified plans (except for disability), as retirement should focus on old age security.
• Role of the employer - Support a strong employer role in the retirement security system while at the same time recognizing that employers should have a choice of what role they wish to play. Recognize that employees are much more likely to save through employer-affiliated plans.
• Small employers - Understand special issues of small employers and work to develop plan structures that will be more attractive to them.
• Standalone multiple employer entities - Study the range of multiple employer approaches in use in the United States and other industrial countries to look for new and better approaches.
• Unbanked and underbanked - Work with appropriate entities to get as many of these people as possible into the mainstream financial system. R bonds are a possible vehicle to help this group.
• Family benefits and spousal rights - Recognize that there are still many families where there is one spouse who accounts for the greatest part of the family lifetime earnings and that the other spouse counts on retirement resources based on that one's work history.
• Unify and rationalize employee benefit regulations - At present there are a number of federal agencies regulating pensions and a number of different agencies regulating financial institutions. Insurance is primarily regulated at the state level. Where annuities are involved with DC plans, benefit and insurance regulation intersect. Steps are already being taken to unify financial institution regulation.
• Integrate housing wealth into thinking about retirement security - Housing wealth is a very important part of the assets for middle Americans. There is a need to develop approaches to help Americans focus on whether it is better to invest more in housing or save more directly for retirement. From a policy perspective, public policy encourages putting much of one's assets into housing, and this should be reevaluated as well. The U.S. Department of Labor (DOL) should encourage the appropriate groups to look at this issue.

Recommendations Regarding DB Plans

• Short term - Enact legislation necessary to resolve short-term Pension Protection Act (PPA) issues.
• Hybrid plan designs - Explicitly authorize new hybrid plan designs. The statute needs to be structured to preclude potential problems with age discrimination and allow latitude in transitions. Hybrid authorization should include account-designed plans with pooled investments and payouts in either lump sums or income. Plan sponsors should have a choice about offering a guaranteed investment income. Hybrids should also include designs that build to a lump sum.
• Self-adjusting systems - DB designs should be allowed to include self-adjusting features, such as the right to gradually move up retirement ages. Ideally, they would also include some type of "safety valve" to provide for the potential to reduce benefits somewhat in case of very adverse experience. A range of self-adjustments should be allowed.
• Alignment and modernization of employee contribution requirements - Employee pretax and posttax contributions should be allowed on a comparable basis in both DB and DC plans. In contributory DB plans, the plan sponsor should be allowed to pass along some part of cost increases through adjustments to employee contributions in times of adverse experience. Some public plans include such a feature.
• Recommendations to Respond to New Patterns of Retirement
• Recognize emerging patterns of retirement - Discuss retirement as a time when wages and earnings are replaced or supplemented by Social Security, pensions (if any) and/or the use of retirement assets. Focus thought about retirement in terms of sources of financial support.
• Regularly update retirement ages - Index Social Security and private plan retirement ages or at least increase them. Retirement ages that change gradually with changes in life spans would create very different expectations. Note that the American Academy of Actuaries issued a statement on August 4, 2008 calling for an increase in Social Security retirement ages.
• Remove and reduce barriers to phased retirement - In the United States, there are a range of barriers to phased retirement. They include complexities in pension laws and uncertainties about and barriers to the rehire of retirees. These barriers should be addressed so that phased retirement can become an accepted option.
• Effective Messaging and "Nudges"
• Effective messaging and signals - Use "nudges" to promote retirement security. Show information about Social Security benefits by starting with the age where the monthly benefit is the largest rather than the earliest age at retirement.
• Change the terminology about retirement ages - While it does not seem practical to get an entirely new term, it is suggested that the terms normal and early retirement are not helpful in working toward a different world.
• Financial and health literacy - Try to build a culture of analysis and improve financial and health literacy. Encourage individuals to do more analytical work in retirement planning. Create situations where peers talk about this and where peer groups encourage it. Many tools are already available, and more are coming on the market regularly.
• Encourage long-term and balanced planning - Balance messages about leisure, working in retirement and new retirement with messages about risk, long life and the need for retirement income. Focus on longer term thinking.
• Respond to gaps in individual knowledge - Recognize the limitations surrounding financial literacy and include appropriate defaults in programs.
• Trade-offs - Identify trade-offs and the pros and cons of various positions and alternatives. For example, there are major pros and cons when an individual considers selecting a guaranteed income stream for payment of benefits.
• Housing and retirement wealth - Provide tools to help people understand the options with regard to housing and evaluate strategies.
• Build on and leverage success communications - For example, use the DOL's "Taking the Mystery Out of Retirement Planning" as a platform to build on and expand.
• Recommendations Regarding the Payout Period
• Rethink default distribution options in DB and DC plans - While DB plans pay income, today lump sums are the common default in DC plans and life income options are often not available. While there has been a great deal of innovation in plan design over past decades, there has not been much innovation in payout management. Open up new possibilities for options and defaults. Public discussion is needed to reach consensus on what should be allowed, what should be required and what should be protected in a safe harbor.
• Enable use of DC funds for risk protection - Change DC regulatory structure so that 401(k) funds could be a retirement risk-protection account and, after retirement, balances could be used to purchase a variety of risk-protection options, either through the plan or through employer offerings on an advantageous basis. Some of the choices should include lifetime income with survivor protection, with or without inflation protection, supplemental health insurance and long-term care benefits.
• Restructure or eliminate required minimum distribution (RMD) requirements - As they exist today, RMD requirements often become the DC distribution default, and they can be a barrier to guaranteed life income and other desirable distribution options.