LAGERS BLOGGERS

Jeff Kempker, CEBS, CRC

The September 30th Washington Post article, The New Reality of Old Age in America, by Mary Jordan and Kevin Sullivan is an eye-opening look at the state of senior citizens in the United States. The main takeaway from this piece: the days of retiring after a career of work with a gold watch and secure lifetime income are over for many Americans. The new reality is one where Social Security is the primary source of income with a full or part-time job as a supplement, forcing individuals to live out their remaining days near the poverty line.

This isn’t the way it’s supposed to work.

Everyone who works hard and plays by the rules should be able to retire and live out a life of dignity. But there are so many forces at play, as the article points out, that are making it harder and harder for the average American.

The major factor influencing the decline in the standard of living for many seniors is the shift in the U.S. retirement system away from defined benefit pensions over the past three decades.

From 1980 to 2017 the percentage of private industry workers covered by a defined benefit pension plan fell from 38% to just 8% (U.S. Bureau of Labor Statistics). A defined benefit pension is a plan where a retiree receives income for life. The amount of the income is based on a formula, normally driven by how long a person works. Income from a pension, Social Security, and the individual’s personal savings would create a “three-legged-stool” of security that would sustain that individual for the rest of their life.

Employers in the private industry have steadily been removing the pension leg of that stool over the last 30 years and have tried to replace it with investment-type retirement plans like 401(k)s. A 401(k) is a plan where the individual, and maybe the employer, puts money into an account that the individual invests in the markets. The amount of the retirement benefit is based upon how much the individual contributes, how much the employer contributes, how well the individual can invest, and how the market performs during the individual’s career.

Why the shift to 401(k)s? Employers began shying away from pension plans after the passage of the Employee Retirement Income Security Act by Congress in 1974. Though well intended, this legislation did more harm to employee retirement security than anyone at the time could have imagined. It placed burdensome regulations on employers that provided pension plans and made these plans very expensive to administer. Then, Congress enacted the Revenue Act of 1978 that created the 401(k) plan. The original intent of the 401(k) was not to create a better retirement plan for the masses, but rather to provide a mechanism for highly-paid executives to shelter some of their salary into a tax-deferred account that their employer could put funds into as well. Even the creator of the 401(k), Ted Benna, in an article in Workforce magazine, said, “I was certainly not anticipating that it would be the primary way people would be accumulating money for retirement 30 plus years later.”

Let’s be clear – there is nothing inherently wrong with a 401(k) plan, so long as it is structured properly and it is being implemented as it was originally intended. The problem is these plans work best for highly-paid individuals and not so well for the average worker. There are a few reasons for this:

1. The highly-compensated worker can afford to put more money into these plans, and since the benefit in retirement is solely based on the amount of money in the account at the end of their career, they will probably be just fine.
   
2. That individual earning a higher salary is more likely to be better educated than the average worker. This means they are more likely to have better financial knowledge, or have the resources to get help from someone who does. The financial landscape is difficult to navigate for the average worker, and a DIY approach will normally not produce the best results.
   
3. Those who are highly-compensated may actually prefer a 401(k) plan because it allows them to shelter some of their income from taxes while they are working.

The Center for Retirement Research at Boston College recently concluded that the shift to 401(k) plans has been more beneficial those who earn higher incomes and overall “providing less [retirement]  income today than in the past.”

The contrast to this is the state and local government workforce, where 75% of employees are covered by a pension plan (U.S. Bureau of Labor Statistics). Why are the coverage rates so different between the private a public sectors? Public pension plans are not subject to ERISA, rather they are governed by the states and localities in which they reside. Without the hefty administration requirements mandated by the federal government, these plans have continued to be the preferred retirement plan for government workers. That’s not to say that government employees don’t have to save money on their own in order to retire; they still need their own personal savings to complete the three-legged stool. And, 88% of state and local government employees are required to contribute to their pension plans (National Association of State Retirement Administrators).

Jeff Kempker is the Assistant Executive Director, Member Services at the Missouri Local Government Employees Retirement System.