The Enron implosion briefly focused public attention on the vulnerability of ordinary Americans' pension coverage. But the remedial legislation passed by the Republican House actually makes workers even more vulnerable. The bigger scandal is not the occasional loss of entire retirement savings in cases such as Enron's but the inadequate coverage and systematic erosion of worker retirement benefits generally.
Real reform would not just safeguard retirement savings from Enron-style thefts but would broaden retirement savings, especially for those less affluent workers who typically have little or no coverage at all. While the Democratic leadership is pushing for better legislation to protect against Enron-style abuses, neither party is currently promoting broader reform.
A basic flaw in the current system is that retirement is tied to one's job, and that a given employer is free to have -- or not have -- some kind of pension plan. A second flaw is the shift to so-called defined-contribution plans, such as 401(k)s, which shift the risks to workers and have no guarantee of a set pension benefit, either from the employer or from the government.
In the era after World War II, large national employers typically offered companywide pension systems run by management, so-called defined-benefit plans. Workers were guaranteed a set pension for life, the amount of which was based on their pre-retirement earnings and their years of service. The company managed the pension investments and bore the related risk. By the mid-1970s, almost one worker in two had such pension plans. Since 1974, federal law has guaranteed the safety of these benefits via the Pension Benefit Guarantee Corporation.
But in the past two decades, employers have shifted the responsibility and risk for retirement plans to employees. Under the new wave of defined-contribution plans, employees may put money into the plan; the employer must then match part or all of the worker's contribution. But worker payment is optional, there is no guarantee of benefits and payout is entirely a function of how much money accumulates over time in the individual's account -- and how well the investments do.
With the growing reliance on defined-contribution plans, individuals assume a variety of risks. One is the chance of misjudging the market and investing in losing assets. A second is unlucky timing. Markets sometimes stay depressed for decades, generating low rates of return for even the savviest investor. Further, there is the risk that the employer will induce or require a worker to concentrate savings in company stock, which violates the first rule -- diversification -- of prudent investing. Bad experiences in the market may also lead people to put aside too little, leaving inadequate assets for retirement.
A Collapsing System
As the system has shifted more toward defined contributions, retirement coverage has become more tenuous. In general, retirement savings are considered adequate if they allow the household to replace at least 75 percent of its pre-retirement income. However, most people retire on significantly less income than that. Whereas 44 percent of households could replace three-fourths of their pre-retirement income in 1989, only 39 percent could by 1998. And in 1998, almost 40 percent of households faced retirements with less than half their pre-retirement income.
The proliferation of new retirement-savings instruments such as 401(k) plans did not lead to an increase in pension coverage, even though the plans shifted the risk to workers. For a quarter-century, the share of private-sector workers covered by a pension plan remained constant at about 46 percent but dropped steadily in traditional guaranteed-defined-benefit plans. In 1998, more than one-fourth of households with workers between the ages of 47 and 64 had no pension assets whatsoever.
Why the inadequate coverage? First, many employers have no pension plan at all. Even if an employer offers a 401(k) plan, many employees, especially lower-income workers, do not contribute because they lack the income or the financial education. Lower-income workers also don't have large tax incentives to contribute. Further, many pension plans require a minimum job tenure before a worker qualifies, and in high-turnover companies, few workers stay long enough to receive benefits even where an employer offers a plan.
Retirement wealth is very distributed. Single households are less likely to be covered than married couples, minorities have less adequate retirement assets than whites and households with higher incomes tend to have disproportionately more pension wealth than others. Even at companies that don't offer traditional pension benefits to ordinary workers, senior executives often have special pension plans that guarantee them a set benefit.
Many of the recent proposals to address the pension crisis are woefully inadequate; some would even worsen the current system. For example, the Republicans' proposed Pension Security Act of 2002, their response to the Enron scandal, would actually weaken existing nondiscrimination rules. Under current law, "non-highly compensated" employees -- those earning less than $90,000 -- must receive at least 70 percent of the average benefits of higher-paid employees. The proposed Pension Security Act would eliminate this provision and leave it to the discretion of the U.S. Treasury to decide whether a plan is fair. The Republican bill has no provision to hold corporate executives accountable for misleading income statements. Enron workers were undone by lock-in requirements: They couldn't sell their plummeting Enron stock. But the House bill would allow firms to bar workers from trading company stock matches for up to three years. The bill even invites new conflicts of interest by allowing investment companies that manage a retirement plan for the company to market investment advice to workers.
A much better approach would be to require that private-pension plans, including 401(k)s, have diversified assets, with no more than 10 percent of holdings in any one asset. This provision is included in legislation proposed by Sens. Barbara Boxer (D-Calif.) and Jon Corzine (D-N.J.). But the Senate leadership has already backed weaker legislation with no quantitative limits. The Senate bill will have to be reconciled with the even more pro-industry bill already passed by the House.
Rebuilding Secure Retirement
A successful pension reform needs to accomplish three things: It should significantly increase pension coverage, raise retirement assets for moderate-income households and guarantee the security of pensions. The existing proposals before Congress all fall short on one or more of these fronts.
As a national policy goal, retired workers should receive at least 80 percent of their pre-retirement income via a combination of Social Security benefits and private pensions. Social Security already offers almost universal coverage, disproportionately higher benefits for low-income workers and safe retirement. Its coverage is close to 100 percent of all households. Thanks to its benefit formula, workers with low lifetime earnings will receive higher relative benefits than average or high lifetime earners, and Social Security's benefits are inflation-proof and guaranteed. However, since its inception, Social Security was always meant to be only a basic benefit. A worker with average lifetime earnings can expect benefits equal to about 42 percent of his or her earnings.
Social Security is the basic tier in a three-tiered retirement pyramid that also includes private pensions and personal savings. For a retired worker to afford a decent standard of living, additional sources of income are necessary. This does not mean that private pensions could serve as a substitute for Social Security, only that work-related pension coverage must be broadened.
A reformed pension system would depart from the current pension system in one important aspect: by making pension coverage mandatory. In its weakest form, this mandate would merely require that every employer has to offer access to a pension plan but not to put money into it. Rep. Richard Gephardt (D-Mo.) has proposed such legislation. His Universal and Portable Pension Act of 2002 would create a new type of account, Universal Retirement Savings Accounts, which would be managed by private financial institutions.
However, administration of these new accounts in the private market would likely be very expensive; many of them will hold only small balances, as they are targeted toward currently uncovered workers, who are predominantly low income. To reduce the costs of these accounts, they could piggyback on the existing Federal Thrift Savings Plan, the pension plan for U.S. government employees. Professional fund managers run this plan, and federal employees have a choice of (currently five) investments. Thus, private employees could take advantage of a well-diversified investment option without costly fees.
But many low-income workers don't earn enough to put aside adequate retirement contributions. A stronger reform would have government use direct and matching contributions to shore up the retirement savings of low- and moderate-income households. President Clinton proposed a version of this in his Universal Savings Accounts. The idea was that government would contribute retirement savings for people with incomes below $20,000. (Households with incomes exceeding $80,000 were ineligible.)
Even $300 per year in direct contributions would help low-wage workers build up substantial savings by the time they retire. If government contributed that sum for 40 years for a low-wage worker, it would replace 7 percent of his or her pre-retirement income. A two-for-one match of worker contributions would double the sum to 14 percent. Together with Social Security, this would give low-income workers an inflation-adjusted 70 percent of their pre-retirement income.
The Clinton proposal would have cost about $38 billion in its first year. This cost has to be seen in context, though. The government currently subsidizes private pensions with substantially larger amounts by making contributions to the pensions tax-exempt. Defined-benefit plans are estimated to cost $48 billion in foregone tax revenues, and 401(k) plans to cost $53 billion. In other words, the government is currently spending $101 billion -- or more than twice as much as required for the USA Accounts -- with little effect for the retirement security of low- and moderate-income families.
The additional revenues to pay for government contributions could come from two sources. First, already scheduled tax cuts could be eliminated. According to Citizens for Tax Justice, 80 percent of benefits to the richest 1 percent of households from President Bush's tax cut will come into effect due to changes in the tax code after 2005. If future tax cuts for the richest 1 percent are repealed, the federal government would have an additional $380 billion in revenue at its disposal between 2005 and 2011, or enough to pay for any proposed government contribution.
The direct-contribution levels of the proposed USA Account plan, however, are not enough to provide a low-income worker with adequate retirement savings over the course of a full working life. To do that, the contribution amounts would have to be doubled. An alternative is to require employers to contribute a minimum percentage of their payroll to their employees' pension, in addition to government contributions. President Jimmy Carter proposed a Mandatory Universal Pension System with a minimum employer contribution of 3 percent of payroll for most workers. This would give a typical low-wage worker about 14 percent of pre-retirement earnings. Together with Social Security, this would produce a retirement income of 70 percent of earnings. With direct or matching contributions by government, it could be raised to 80 percent.
Will mandatory minimums cause employers with more generous plans to reduce them to the lowest possible level? Probably not. Employers with generous plans use them as a recruitment or retention tool. Critics of universal pensions also contend that mandatory pension contributions would reduce wages, because the employer presumably has only so much money to spend on payroll. However, the same argument was made about minimum-wage laws. The evidence suggests that more generous compensation for low-wage workers often pays off in the form of higher productivity and reduced turnover.
A third issue is that a mandatory contribution might affect the competitiveness of U.S. businesses. Because all employers in the United States would be affected by this change, such a mandate would have little to do with the competitiveness of domestic employers. Domestic producers already compete with producers from such low-wage locales as China, Vietnam and Mexico, who enjoy a huge wage advantage. But marginal changes in the compensation of U.S. workers will not offer a meaningful incentive for production to move overseas.
Is Reform Possible?
In sum, we need a universally mandatory private system. Government should also contribute money on behalf of low-wage workers and toughen its regulation of plans, so that the Enron case can never be repeated. Without a serious reorientation of our retirement policy, we are likely to continue spending more than $100 billion in foregone tax revenue to subsidize a system that fails the majority of households.
Life expectancy is likely to continue rising. However, many older people are in fragile health, so continuing to work beyond the ages of 65 or 70 is not an option for all. Unless we are willing to accept a growing old-age poverty for the foreseeable future, we need to address the inadequate retirement savings of a growing share of households sooner rather than later.
The retirement situation today is comparable to health care, where the problem is extreme and the legislative responses feeble. Many Americans are at risk of retirement coverage that is inadequate, insecure or both. With a universal pension, low-income workers could for the first time build up wealth in pension accounts. Middle-class workers would also gain new security, and all Americans would enjoy a decent standard of living in retirement. A new approach to pensions, which combines mandates on employers with direct government expenditures, is likely off the political radar screen in the current political environment. With political leadership, however, broad support would be forthcoming.