Most people have heard that our retirement income security system is built as if it were a three-legged stool, where income comes from Social Security, from employer-based pensions, and from personal wealth. That image implies that there are equal sources of income coming from each of those sources for all retired families, and that image is just plain wrong, for most people. Over 80% of retirees get most of their income for retirement from Social Security. Only about a half of workers are covered by employer plans at work. Only the top 10 percent have any kind of assets they can really draw down for retirement. So, for most people in this country, our retirement income security system really looks like a pyramid . . . : Social Security is on the bottom; supplementing that are pensions from work; and at the very top of that for a few people are the kinds of assets we manage to save for our retirement. When we talk about a retirement income security crisis, we’re really not talking about what’s happening with Social Security and Medicare even though there are problems in that system. It’s the top two layers that are really crumbling. . . .
Let me tell you a little bit about the 401(k) plan and where it came from. In 1978, Congress responded to lobbyists from some big firms who wanted a tax shelter for their executives. The executives wanted to save money in a tax-free account; in an account that would be set up at work, they wanted to put tax-free money in it. The Internal Revenue Service said: “That looks like a tax dodge to me, but, go ahead, if you allow all workers to be in that plan.” They said, “Fine,” knowing that most workers would not contribute an extra amount of money for their retirement — only their higher-income people do. The change became Subsection K of Section 401 in the tax code. Over time, companies have expanded participation in those plans at the expense of traditional defined benefit plans. So, for half of the workforce who have pension plans, most of them have this kind of plan, the 401(k) plan, that was really designed for executives. It was never meant to be the second tier of retirement support for most Americans.
Now, the average 401(k), as I’m speaking today, has fallen by 25% in just six months. Obama’s plan calls for employers without a pension plan to put 3% of their workers’ pay in a 401(k)-type account. These are commercial, individually directed accounts. And under Obama’s plan, they will be voluntary. . . . It does not actually fix the worst flaw of the 401(k) system, and the flaw is this: 3% of pay is not enough for people to supplement their Social Security; if people want to maintain their standard of living for the rest of their lives and they are in the middle class or above income brackets, they are going to have to save 7 to almost 20% of their income, depending upon family circumstances. . . . Also, these accounts are managed by for-profit, mutual-fund brokers. Charles Schwab, Vanguard, Fidelity — these are all commercial accounts that actually charge you hefty brokerage fees, hefty management fees, for your retirement accounts. So, people’s accounts are already small, because they have taken their money away from them, because they haven’t put enough in them, and they are also made small because these fees are quite large and they are also quite hidden. Many people don’t realize that the fees they pay to maintain a 401(k) account can over time erode that account by 20 to 30%. . . . The other problem that can’t be solved by good intensions or good education about finances is that people can’t time when they are old. They are born when they are bon, and they turn 65 when they turn 65, and if that happens to be at the time when financial markets are down, there’s absolutely nothing an individual can do about it. So, what Obama’s plan for a universal 401(k) system does, in a nutshell, is to expand the commercial, voluntary, individual account system. There’s nothing wrong with that system except that it’s voluntary, it’s commercial, and it’s directed by individuals. That’s a little bit of a joke, but it does point to the fact that the 401(k) system is an experiment that has failed, and when we look at pension reform, we have to go beyond the 401(k) promise and hope.
In early March of 2009, an organization called Retirement USA, which is a group of pension advocates, worker representatives, and academics who are really interested in a comprehensive pension reform, came out with a couple of principles that any reform should follow. They felt that we should no longer have a system where only 50% of the workforce has a supplement to Social Security. Pensions should be universal and they should be mandated; it’s the only way you can make everybody have a pension. The pension plans should be structured so the people have retirement income for the rest of their lives. A pension plan should have the employees and the employers contribute because we have to get beyond the 3% contribution rate. The government should also be helping people who need the help the most. We should not have tax breaks for the retirement savings that go to people in the very top bracket — it doesn’t make any sense. If the government is going to lay out money to help people accumulate their retirement funds, they should do it for lower-income and middle-income groups. The other principle they had is that retirement contributions should be pooled and professionally managed. . . . It minimizes costs and also smoothes out financial risks.
The Obama plan does not include any of these principles. In fact, the Obama plan really only helps one identifiable group, and that is the mutual fund industry. They have gotten most of their profits in the retail brokerage side in the last 10-15 years from the expansion of the 401(k) system. They make a lot of money from these very high fees of 401(k) accounts. They, the mutual fund part of Wall Street, are very worried about their future, as they should be, and Obama’s plan falls right into their laps: millions and millions of other people will have these retirement accounts. They really are encouraging the Obama administration to propose this.
Teresa Ghilarducci is Irene and Bernard L. Schwartz Professor of Economic Policy Analysis at the Department of Economics of the New School for Social Research. Her latest book is When I’m Sixty-Four: The Plot against Pensions and the Plan to Save Them (Princeton University Press, 2008). This video shows Ghilarducci’s address on retirement security at the IKD “Financial Institutions and Economic Securities” conference held at the Open University in London, England on 21 May 2009. The text above is an edited partial transcript of her address.