Election and Retirement Security

The election is now only days away and will occur within the context of a financial markets meltdown. The effect on retirement security has been significant. Public policy considerations must be addressed asap.

DB plan asset values have tanked and funding requirements for 2009 and thereafter will undoubtedly increase substantially. (Partial offsetting relief is experienced because of higher corporate bond rates.) Without some form of pension funding relief, more plan freezes can be expected. We could see some as early as 11/15/08 204(h) notices for 1/1/09 freezes. Several organizations have proposed various relief measures. An alternative simple proposal would be a measure that limited mandatory 2009 contributions to the amount of 2008 contributions with an accompanying rule that 2008 could be ignored for at risk plan status, etc. Hopefully, Congress could address this quickly during the upcoming lameduck session.

More long term, we need to evaluate how we can make 401(k) plans better vehicles for providing retirement security. Several suggestions (some of which have been conceptually addressed by others, e.g. Teresa Ghilarducci, in other conceptual frameworks) include:

1. Improve the market and regulatory rules regarding annuities- deferred annuities purchased throughout one's career, terminal annuities acquired at retirement, and longevity annuities that would commence in at some advanced age (e.g. 80). The first would allow for cost averaging of annuity purchases, the second (a market for which is slowly developing now) may need to be mandated for a portion of terminal account balance (if participant didn't acquire deferred annuities during active participation), and the third would guarantee a level of income for those that survive and allow the rest of one's account to be payable over a fixed period from date of retirement to longevity annuity starting date. Lump sum distributions would be limited to a specified percentage of account balance.
2. Require mandatory participation in some retirement vehicle. If an employee doesn't have a db plan, then they must participate in a 401(k) or similar vehicle. For those employers that don't want to sponsor, individuals should be able to participate in free-standing plans similar to 401(k) sponsored by current (and other) 401(k) vendors.
3. The investment responsibility should be moved from the participants to the sponsor or toher fiduciaries. Plans would only provide balanced, target date funds that employees participated in during their working lives and until distribution or annuitization. Protections for sponsors or vendors similar to 404(c) should apply as long as the manager of the target date funds was prudently selected and monitored.
4. A portion of 401(k) or other retirement plan distributions should be able to be used for retiree health costs on a pre-tax or other tax effective basis (e.g. very low tax rate).
5. For immediate assistance with current financial crisis and longer term thereafter, 10% excise tax on distributions for true financial hardships should be eliminated. It makes no sense to apply this tax to those suffering a financial emergency/hardship.

Comments

[Jane White]

First, Do No Harm to 401(k) Plans

Theresa Ghilarducci’s proposal to replace 401(k) matching contributions with a measly $600 government subsidy would make a flawed system more flawed.

First, replacing stock investments with government bonds guarantees investment poverty. The reason why bonds are nicknamed “certificates of confiscation is because they are a long-term investment that pays a premium that’s typically lower than inflation—so you usually lose money. My study of compound real returns for 20-year holding periods from 1926 to 2000 showed that long term government bonds produced negative returns for a whopping 51 of the 55 holding periods compared to a positive return for the S&P 500 in every holding period. Her proposal to have taxpayers subsidize an inflation-adjusted return on an investment that underperforms inflation makes no sense.

What’s more, if Ghilarducci’s recommendations had taken effect the day she presented testimony Oct. 7 401(k) investors would be hopping mad. After its initial slump, the Dow Jones Industrial average increased by more than 10% on Oct. 22nd. That 10% increase in the DJIA boosted these average returns to about 6.3% over 15 years and 5.9% over 40 years.

What makes even less financial sense is the one-size-fits all $600 government contribution that would replace the current contribution rate of about 3% of pay. This would lower nest eggs for 95% of Americans—and the other 5% are probably poor enough that Social Security replaces most of their income at retirement.

Americans aren’t pension-poor because of the stock market but because of the typical employer match of 3%. Of the eight countries in the advanced world using defined contribution plans the US rate is the second lowest—even Mexico’s employers have to contribute 6% of pay. My proposal for 401(k) reform would be to boost the employer contribution rate to 9%, which is the case in Australia. That is why most Australians are on track to accumulate at least “10 times final pay”—their salary right before retirement, a formula often used by pension actuaries in calculating defined benefit pensions.

I’m glad that 401(k) reform is finally on the table—since the first wave of Boomers are scheduled to retire in 2011 and can’t afford to. Let’s hope those who provide guidance on reform understand the financial concepts that will enable the plans to walk, talk and quack like real pensions.

[Dennis Ackley]

For millions of Americans (taxpayers), 401k retirement plans are not working. We cannot let 401ks or any other retirement arrangements fail. The price to our society would be unaffordable.

Before messing with 401ks or considering moving workers to any other never-proven approach – (401k plans were allowed with no proof they worked) – Congress should first adopt some thoughtful retirement standards.

Much like the auto industry is required to hit fuel economy standards, the government could require 401k standards linked to retirement income adequacy...not just participation and average contributions (antique measures leftover from the days 401ks supplemented DB plans.)

In business, what gets measured gets done. Today, no 401k retirement measures exist. So why are we surprised retirement isn’t getting done?
Dennis Ackley