By Anna Rappaport
This perspective focuses on information that has made me think over the last year. I find some of these issues troublesome. I hope that the readers will be interested in a dialogue with professional colleagues and might consider using the SOA Pension Section LinkedIn site as a vehicle for carrying forth this dialogue.
Retirement Security in America: Success or Failure?
During my adult life, I have seen a great deal of growth in the U.S. retirement system, and a lot of changes—some positive and some negative. Unfortunately, media reports focus more often on the negatives. (This is also true about press reports in general, what generally gets reported are large fires and other catastrophic events, murders, etc. and not the day to day success stories.)
When I have given talks about the pension system and its future, some of the points I have made include:
- Social Security is critically important and it has been a huge factor in retirement resources, particularly for the lower income and asset groups. At the same time, it is currently financially out of balance and periodic adjustments have been needed to improve its solvency. Success or failure? Huge success in terms of retirement income security, but periodic, politically difficult adjustments are needed, so we might put aspects of it in both columns. (Note that the adjustments currently being considered are generally modest, and I would consider the need for adjustments to be a challenge and a normal part of the system management, but not a failure).
- Poverty and near poverty rates for the elderly have declined over time, but they are still way too high among unmarried women. Poverty rates for the elderly are below the rates for some other groups. Success or failure? It depends on your expectations and viewpoint. I can argue either way.
- Defined benefit (DB) plans have made an important contribution to the security of retirees for many decades, and they continue to be a very effective way to provide retirement income security for longer-term employees. A National Institute on Retirement Security Study found that rates of poverty in 2010 among older households lacking DB pension income were approximately nine times greater than the rates among older households with DB pension income—up from six times greater in 2006. But DB plans, particularly in the private sector, are in a major state of decline. The combination of today’s funding and accounting rules, low interest rates, and severe market fluctuations in the 21st century have made funding these plans a challenge for plan sponsors. These plans remain a very important part of the compensation package for public employees, but are creating increasing challenges for the governments that sponsor them. Success or failure? It depends on your expectations and viewpoint. If you talk to enough different experts, you will get widely different views.
- Defined contribution (DC) plans and IRA rollovers are also making an important contribution to retirement security. People with a number of years of participation in these plans can accumulate significant balances. Critics of these plans point to average balances that are inadequate, to failure to save enough and invest appropriately, to leakage, and to lump sums. Others point to the much larger balances of people with longer service near retirement and to the dramatic growth of retirement system assets in general. Many people are much more likely to save within an employer sponsored plan than on their own. There are widely differing views on whether 401(k) plans have been a success. Some critics would prefer to see the 401(k) system replaced with a mandatory layer of retirement savings in addition to Social Security. I disagree. I would prefer to see the continuation of an employer system together with an income-based Social Security system.
The Society of Actuaries 2012 Research Project on Running Out of Money provides background research including information on which groups are likely to run out of money during their retirement years. That study found that 71 percent of older adults are adequately prepared for retirement according to their definition, but that outcomes vary substantially by marital status—80 percent of married adults are adequately prepared compared with only 55 percent of single adults. This assumes a 10 percent reduction in consumption following retirement. Without this 10 percent reduction in consumption, the researchers providing background information found that 77 percent of married couples and 49 percent of single adults would be adequately prepared. The background also showed that outcomes differ substantially by other demographic characteristics. For example, only 29 percent of single older women without high school degrees are adequately prepared for retirement, even after reducing consumption by 10 percent. This background analysis is based on the paper submitted as background for the project authored by Michael Hurd and Susan Rohwedder from Rand.
EBRI uses a projection model to estimate retirement security and their estimates show that more people are unprepared for retirement. Their 2012 updated calculations (May, 2012 EBRI notes) find that for Early Baby Boomers (individuals born between 1948 and 1954), Late Baby Boomers (born between 1955 and 1964) and Generation Xers (born between 1965 and 1974), about 44 percent of the people in these groups were projected to lack adequate retirement income for basic expenses and uninsured health care costs. They found some improvement since 2003: the “at risk” percentages were reduced largely due to increasing auto-enrollment in 401(k) plans. They estimate the drop in the “at risk” levels to be in the 5 percent to 8 percent range. While there are differences in opinion about the right way to estimate who is prepared and how many people are prepared, the various estimates show a significant of lack of preparation in a general sense. From my perspective, these levels of unpreparedness are unacceptable, i.e., they reflect failure.
Finding a Balanced Perspective
One of my concerns for many years has been that much of what is reported about the retirement system related to the failures rather than a balanced view of successes and failures. I have tried to provide a balanced view in many of the presentations I’ve done over the years. In December 2012, I attended the Women’s Institute for a Secure Retirement (WISER) symposium, and was pleased to hear about successes as well as gaps. In this column I comment on some of what I encountered in the last year in both the successes and gaps columns.
Sarah Holden from the Investment Company Institute (ICI) was one of the WISER Symposium presenters (all of the presentations from the symposium are available online at the WISER website.) She focused specifically on The Success of the U.S. Retirement System. Her presentation is heavily linked to a new report from the ICI. I thought it was very good report and presents an important story. Here are some of the things that caught my eye from that report:
- Older Americans are better off than younger Americans when measured by poverty rates. In 2011, 9 percent of Americans age 65 or older were in poverty compared to 14 percent at ages 18 to 64 and 22 percent of the population under age 18. The report states that successive generations have been better off than those before them. (Of course, today, many people are asking whether future generations of seniors will be worse off.)
- The report provides an analysis indicating that the shift from DB to DC is unlikely to reduce retirement preparedness. This is a very different view from that provided by the National Institute on Retirement Security. I encourage actuaries to think about the ICI analysis and see whether they agree. I observe that neither system will do a good job for someone unless an individual has a number of years of work with coverage, that assets are invested wisely and that the funds saved for retirement are used for retirement. The employer based retirement system only works for people with longer-term employment and longer-term retirement savings. It was never intended to be any other way. Either type of plan can work well if benefits / amounts contributed are adequately generous. DC plans certainly offer the potential to do a better job for people who have several jobs during their careers.
The ICI analysis presents the idea of a retirement security pyramid (with five layers) rather than the traditional 20th century three legged stool. The five layers include financial assets both inside and outside of qualified plans, the value of Social Security, the value of DB benefits and DC accounts, both private sector and public employers, the value of IRAs, and the net value of housing. The analysis reflects people approaching retirement age today. Below is a summary of ICI calculations based on estimates of retirement wealth by Gustman, Steinmeier, and Tabatabai, presented by pyramid layer and wealth quintile. The analysis reflects the importance of housing wealth as a source of retirement income. 
Source: Figure 16, Investment Company Institute, The Success of the U.S. Retirement System, 2012
Note: Calculations exclude the top and bottom 1 percent of the population, quintiles established based on 2006. The value of DB and Social Security income streams is included. Health and Retirement Study data, analyzed by Gustman, Steinmeier, and Tabatai, underlies this analysis.
(Percentages may not add to 100 due to rounding)
The ICI report also provides an interesting analysis of coverage among near-retiree households. They estimate that of households with a working head aged 55 to 64, in 2010, 81 percent had accrued pension benefits. More specifically, 10 percent had DB only, 31 percent both DB and DC or IRA, and 40 percent DC or IRA assets only.
The ICI report catalogues areas of success today and points out areas of challenge for individuals, including retiring early due to poor health and having low levels of attachment to the labor force. I have a number of concerns with regard to future retirement security, and would encourage a debate about what is working well and what is not. Some of my concerns are as follows:
- Longer-term disability can easily derail retirement security, particularly for people who do not have long-term disability coverage and a DB plan.
- That part of the population who did not have longer-term employment in a reasonably paying job is also likely to face problems in retirement.
- Some people withdraw and use their retirement assets prematurely.
- In a voluntary savings system, some people will not save enough and they may not make good investment choices.
- Non-couples, and particularly women, are much less well off than couples.
- Many people do not do enough planning and do not have enough resources for retirement. This may increase in the future.
- There is not enough focus on developing and implementing an organized post-retirement financial plan. There is a specific need for better planning for “shocks” including catastrophic health care, the need for long-term care, and the possibility of poor investment results, particularly early in retirement.
- There is considerable uncertainty about future changes in taxation, Social Security and other government programs.
I hope that this discussion will encourage a dialogue about successes and failures.
Thinking about Disability
Moving in a different direction, I have been concerned about the interaction of DC plans and disability coverage. In a separate article in this issue, David Kaleda and I talk about the specific issues related to disability derailing retirement security.
The 2012 ERISA Advisory Council looked into the issue of Disability Coverage in a World of Individual Responsibility. I encouraged that topic and was delighted that the council decided to focus on this as one of their three study topics. I learned several new things that go beyond the issue of the connection between disability and DC retirement plans:
- The public is poorly informed about disability and underestimates how big a problem this can be for those affected (the disabled person and his/her family).
- Only 31 percent of the labor force has employer sponsored long-term disability (LTD) insurance. While Social Security disability benefits are available to almost everyone, the benefits are too low (and, arguably, too restrictive) to provide an adequate income for much of the population.
- Among those who have LTD coverage, misunderstandings are not uncommon. Offsets are a potential area for misunderstanding. The most common plan design for employer sponsored benefits is to offer a total benefit that replaces 60 percent to 65 percent of pay. This design provides for an offset of Social Security disability benefits if they should be payable. However, while reviewing the testimony presented to the 2012 ERISA Advisory Council, I also learned that there are a variety of other offsets that can be applied to disability benefits, including family Social Security disability benefits, retirement benefits, Worker’s Compensation, Veteran’s benefits and others. I did not learn how common some of these other offsets are. Plaintiff’s attorneys who submitted testimony about them were very concerned about them. This is an area to learn more about.
During recent discussions, I was also reminded that homemakers and family caregivers have no access to disability coverage, but their families may have a serious problem if they are disabled. The SOA Committee on Post- Retirement Risk is working with Rick Miller and other representatives of NAPFA “University”—a continuing education program for NAPFA members—on education for financial planners about disability benefits.
Dilemmas about Advice
Many comments are made about how important advice is for the middle market, but at the same time there is a lot of focus on the fact that this group is underserved. The 2012 Wharton Pension Research Council symposium was focused on the market for retirement financial advice, and there are several working papers available from that conference. To complicate this further, I have heard concerns expressed about potential conflicts of interest when advice is provided, and questions about whether advice addresses the right issues. The Society of Actuaries Committee on Post-Retirement Risk sponsored a project in 2011-2012 focused on Running Out of Money. Some of the background information is cited above. That project focused on thinking about some of the challenges in the retirement system today. Look at that report and the Pension Research Council papers to see some discussion about the middle market and concerns relative to advice.
Too Many Trade-offs
Risk protection is a vital issue when it comes to retirement security. Yet when we think about important risk protection products, we find that there are trade-offs when considering whether to buy these products. For most people there are too many immediate needs competing for the limited amounts of money available to them. People need to make choices and focus on trade-offs. They are often complex.
Uncertainty about Public Policy
Taxation is very important in structuring retirement savings and how retirement funds are used. In spite of the claimed “permanence” of the recent tax changes, there is still considerable uncertainty about future tax policy in both the income tax and estate tax arenas. Tax deferral rules may also change. There are also fiscal imbalances in Social Security, Medicare and Medicaid, and substantial concerns with regard to how these programs may evolve. These public policy uncertainties create challenges for people as they plan for retirement.
Closing Comments
I hope this perspective will encourage you to share and discuss your ideas with your professional colleagues. I believe that the story of the retirement system is indeed a mixed story of successes and failures and that it would be helpful if each us wrote down and shared what we view as the successes and which areas need further work. Then we can focus on how we can help to make the system better.
Anna Rappaport, FSA, MAAA, is an internationally known researcher, speaker, and author. She chairs the Society of Actuaries Committee on Post Retirement Needs and Risks and is a Past President of the SOA. She founded Anna Rappaport Consulting in 2005 after retiring from Mercer. She will complete 50 years as a Fellow in 2013.