Pensions and Retirement Savings: Facts, Figures & Recommendations (Issues 2006)

Pensions and Retirement Savings

By David C. John

Over half of all American workers face a bleak retirement future because they have not saved enough to provide for an adequate income. Fewer than one in five workers are covered by a traditional defined benefit pension that pays retirees a monthly amount based on their incomes and length of service. Many of the plans that still exist are so underfunded that the federal agency that insures traditional pensions, the Pension Benefit Guaranty Corporation (PBGC), faces huge deficits that are expected to get worse.

Traditional pensions are being replaced by 401(k)-type retirement savings plans, but over half of the work force is not in such a plan. Of 153 million American workers in 2004, 71 million worked for an employer who did not offer a pension plan, and 17 million more did not participate in their employer’s plan. Most workers who do not participate are young, have lower incomes, or work for a small business. Workers can build an adequate retirement income through such plans, but they must have access to them and participate from an early age.

Recommendations

Improve the funding of traditional defined benefit pension plans. Funding rules for defined benefit pension plans are extremely complex and assume that the employer will always remain in business and contribute to the plan. Plans can legally avoid putting much or even any money in their plans and still be considered fully funded. Funding rules need to reflect the real financial status of the plan and require that companies fully fund the promises they have made to workers. In addition, both workers and stockholders need improved information about underfunded plans’ actual status. Otherwise, taxpayers will be required to bail out PBGC and pay off failed companies’ pension promises.
Add automatic features that increase participation and savings in 401(k)-type plans. Under auto-enrollment, a worker is automatically part of an employer’s pension plan unless he or she chooses not to join. Studies show that this raises participation into the high 80 percent–90 percent level, with the biggest improvement being among women, Hispanics, and lower-income workers. Without auto-enrollment, a worker must decide to participate, how much to save, and which investment to choose. Many workers find these decisions daunting and do not join their plans. Auto-enrollment can also include both automatic increases in a worker’s contribution as his or her income improves and automatic investment in an appropriate option that is keyed to the worker’s age. Workers always retain the ability to choose not to participate or to change their contribution or investment choices.
Expand pension plans’ coverage by requiring small businesses with over 10 employees to offer their workers the opportunity to save in an automatic payroll deduction IRA. Almost half of all U.S. workers work for employers who do not offer any form of pension plan. This would improve if businesses with over 10 employees that have been in business for over two years were required to offer their employees an automatic IRA. Automatic IRAs would include direct payroll deposits to a low-cost, diversified individual retirement account. The firm would inform employees of the opportunity to begin an automatic IRA plan and receive from each employee a decision either to participate or to opt out. Employers using auto-enrollment to promote participation in direct deposit IRAs would not be required to obtain responses from employees who fail to respond to the request. Employers making direct deposit or payroll deduction available would be protected from potential fiduciary liability. In addition, employers would receive a tax credit to cover their initial costs that is very similar to the existing credit for employers that begin a 401(k)-type plan.