Fixing Retirement Part 2

by Phil Anderson

“When tens of millions of people all have the same problem, it’s not a failure of individual initiative.” Ganesh Sitaraman and Anne L. Alstott, law professors and authors   

Last week we looked at why many people are not going to have enough to retire. Wisconsin  treasurer Sarah Godlewski is establishing a task force to study and make recommendations on these issues. This effort will likely not address all possible solutions in order to make its recommendations more politically palatable to the Republican controlled legislature. But the people of Wisconsin need, and deserve, a full examination of the issues and comprehensive consideration of all possible solutions. 

Some states are making efforts to address the retirement crisis. Their proposals focus on improving defined contribution programs (IRAs and 401ks). Defined contribution retirement plans are voluntary, individual, retirement savings programs. They can be sponsored by employers, banks, or other financial services organizations. They provide tax advantages to encourage people to participate. There are usually a variety of investment options. For many people these are useful tools to save for retirement. 

But they are not traditional pensions with guaranteed retirement income. With defined contribution programs what a person gets at retirement (and how long it lasts) depends entirely on how much they saved and the accumulated investment returns. ALL the responsibility and risk rests with the individual. The employer may or may not provide a matching contribution but they have no responsibility for the final retirement income, its stability, or its adequacy. 

Traditional pensions are defined benefit programs. Employers and employees contribute to the program. All contributions and investment returns are pooled in a trust fund. The program is usually run by a retirement or investment management organization. Retirement benefits are based on the amount contributed to each individual’s account, years of service, highest pay, and other program criteria, thus the term “defined benefit.” In defined benefit programs the employer is responsible for making contributions on behalf of the employee AND for managing the retirement program to ensure sufficient funds to pay promised benefits. These plans are not perfect and sometimes fail, but for many people they provide stable, guaranteed, lifetime income. Defined benefit company pensions are backed by the federal Pension Benefit Guaranty Corporation. 

Oregon passed legislation in 2017 to deal with the retirement crisis by encouraging more retirement savings. Called Oregon Saves, it is a state sponsored Roth IRA program. It makes investing for retirement easier and a little less risky for employees. The program encourages individual savings by requiring automatic enrollment for employees and mandating payroll deductions at work. The program is voluntary for employees but a person must opt out of the automatic enrollment. People are 15 times more likely to participate in voluntary retirement programs if they are automatically enrolled and if they can do it through their employer. The state oversees investment options and contracts for a program manager to operate the program. This provides some consumer protection for participants and reduces some investment costs. When fully implemented, all Oregon employers will be required to either offer a standard retirement plan, 401k plan, or participate in the state program. California and Illinois have similar programs. 

A t the national level the House of Representatives (but not the Senate) has passed legislation attempting to improve 401k programs. Called the SECURE Act it does some minor changes to federal laws governing these employer sponsored retirement programs. This legislation doesn’t seriously address most of the problems with 401k programs or the overall retirement crisis.  

In their book “The Public Option: How to Expand Freedom, Increase Opportunity, and Promote Equality,” Professors Ganesh Sitaraman and Anne L. Alstott propose a “public option” 401k as a solution to the retirement crisis. Modeled on the federal employee program, every worker would automatically be enrolled. About 3-5% of their wages would be deposited in a retirement savings account managed by the federal government (they suggest the Social Security Administration known for its very low overhead). Individuals choose investment options from an approved list. At retirement, their balance would be converted to an annuity providing a guaranteed income for life (a big improvement over current 401ks). No one would be required to participate but individuals must proactively opt out. Other “market” based retirement programs would still be an option and would compete with the public program. 

All this sounds good and could help some people save more for retirement. But none of these proposals are a retirement pension program nor do they address the major deficiencies of existing individual defined contribution retirement programs. Individuals still must have enough income to contribute! Too little income still results in too little retirement savings. ALL RISKS are still borne by the individual participant.  If the markets tank so does your “savings.” There are no mechanisms for sharing investment risks across all the program participants. Individual savings programs do not leverage economies of scale, or provide the retirement income security available from traditional defined contribution programs. As I said last week, IRAs, 401ks and similar programs make a good ADDITIONAL, third leg for the retirement stool. But they are no substitute for a well managed defined benefit pension.  For more on this Google “CNBC A brief history of the 401(k), which changed how Americans retire.”

Defined benefit programs are more efficient, share risk, and provide the ability to guarantee retirement incomes. The stability of the individual monthly retirement check is the result of the overall financial strength of the trust fund and not just your individual investment performance. Research has shown that a well run defined benefit retirement program provides a more secure, stable, retirement with lower costs and higher monthly income. 

The news organization Politico recently sponsored a study by a diverse group of retirement experts and business leaders. One of the conclusions was that “the retirement crisis can’t be fixed by tweaks and ‘nudges’ designed to subtly spur workers to save more...[minor changes] won’t mean much for the vast swath of workers with temporary jobs, stagnant wages, and no savings...” (read the full report by Googling “How to Solve the Retirement Crisis Politico”). As the opening quote says, accusing people of lacking individual responsibility will not fix our retirement problems. The  Wisconsin task force needs to look at serious retirement reforms.  

In part 3 of this series we will look at several defined benefit options that could actually fix the retirement crisis.