[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
THE IMPACT OF THE FINANCIAL CRISIS
ON WORKERS' RETIREMENT SECURITY
=======================================================================
HEARING
before the
COMMITTEE ON
EDUCATION AND LABOR
U.S. House of Representatives
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
HEARING HELD IN WASHINGTON, DC, OCTOBER 7, 2008
__________
Serial No. 110-113
__________
Printed for the use of the Committee on Education and Labor
Available on the Internet:
http://www.gpoaccess.gov/congress/house/education/index.html
----------
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COMMITTEE ON EDUCATION AND LABOR
GEORGE MILLER, California, Chairman
Dale E. Kildee, Michigan, Vice Howard P. ``Buck'' McKeon,
Chairman California,
Donald M. Payne, New Jersey Senior Republican Member
Robert E. Andrews, New Jersey Thomas E. Petri, Wisconsin
Robert C. ``Bobby'' Scott, Virginia Peter Hoekstra, Michigan
Lynn C. Woolsey, California Michael N. Castle, Delaware
Ruben Hinojosa, Texas Mark E. Souder, Indiana
Carolyn McCarthy, New York Vernon J. Ehlers, Michigan
John F. Tierney, Massachusetts Judy Biggert, Illinois
Dennis J. Kucinich, Ohio Todd Russell Platts, Pennsylvania
David Wu, Oregon Ric Keller, Florida
Rush D. Holt, New Jersey Joe Wilson, South Carolina
Susan A. Davis, California John Kline, Minnesota
Danny K. Davis, Illinois Cathy McMorris Rodgers, Washington
Raul M. Grijalva, Arizona Kenny Marchant, Texas
Timothy H. Bishop, New York Tom Price, Georgia
Linda T. Sanchez, California Luis G. Fortuno, Puerto Rico
John P. Sarbanes, Maryland Charles W. Boustany, Jr.,
Joe Sestak, Pennsylvania Louisiana
David Loebsack, Iowa Virginia Foxx, North Carolina
Mazie Hirono, Hawaii John R. ``Randy'' Kuhl, Jr., New
Jason Altmire, Pennsylvania York
John A. Yarmuth, Kentucky Rob Bishop, Utah
Phil Hare, Illinois David Davis, Tennessee
Yvette D. Clarke, New York Timothy Walberg, Michigan
Joe Courtney, Connecticut [Vacancy]
Carol Shea-Porter, New Hampshire
Mark Zuckerman, Staff Director
Sally Stroup, Republican Staff Director
C O N T E N T S
----------
Page
Hearing held on October 7, 2008.................................. 1
Statement of Members:
Altmire, Hon. Jason, a Representative in Congress from the
State of Pennsylvania, prepared statement of............... 84
Kucinich, Hon. Dennis J., a Representative in Congress from
the State of Ohio, article submitted:
``Lehman Collapse Hits Oslo Oil Fund,'' dated September
24, 2008............................................... 56
McKeon, Hon. Howard P. ``Buck,'' Senior Republican Member,
Committee on Education and Labor:
Prepared statement of.................................... 71
Statement of the American Benefits Council............... 72
Miller, Hon. George, Chairman, Committee on Education and
Labor...................................................... 1
Prepared statement of.................................... 4
Statement of Investment Company Institute................ 75
Sestak, Hon. Joe, a Representative in Congress from the State
of Pennsylvania, letter submitted.......................... 85
Statement of R. Gregory Barton........................... 86
Statement of Witnesses:
Bramlett, Jerry, president/CEO, BenefitStreet, Inc........... 20
Prepared statement of.................................... 22
Ghilarducci, Teresa, Irene and Bernard L. Schwartz professor
of economic policy analysis, the New School for Social
Research, Department of Economics.......................... 36
Prepared statement of.................................... 37
Orszag, Peter R., Director, Congressional Budget Office...... 6
Prepared statement of.................................... 8
VanDerhei, Dr. Jack, research director, Employee Benefit
Research Institute (EBRI).................................. 15
Prepared statement of.................................... 17
Additional submission.................................... 18
Weller, Christian E., Ph.D., associate professor, department
of public policy and public affairs, University of
Massachusetts.............................................. 23
Prepared statement of.................................... 25
THE IMPACT OF THE FINANCIAL CRISIS ON WORKERS' RETIREMENT SECURITY
----------
Tuesday, October 7, 2008
U.S. House of Representatives
Committee on Education and Labor
Washington, DC
----------
The committee met, pursuant to call, at 1:05 p.m., in room
2175, Rayburn House Office Building, Hon. George Miller
[chairman of the committee] presiding.
Present: Representatives Miller, Andrews, Scott, Tierney,
Kucinich, Holt, Sarbanes, Sestak, Clarke, and Souder.
Staff Present: Aaron Albright, Press Secretary; Tylease
Alli, Hearing Clerk; Jody Calemine, Labor Policy Deputy
Director; Carlos Fenwick, Policy Advisor, Subcommittee on
Health, Employment, Labor and Pensions; Patrick Findlay,
Investigative Counsel; Denise Forte, Director of Education
Policy; Ryan Holden, Senior Investigator, Oversight; Jessica
Kahanek, Press Assistant; Therese Leung, Labor Policy Advisor;
Sara Lonardo, Junior Legislative Associate, Labor; Ricardo
Martinez; Policy Advisor, Subcommittee on Higher Education,
Lifelong Learning and Competitiveness; Alex Nock, Deputy Staff
Director; Joe Novotny, Chief Clerk; Rachel Racusen,
Communications Director; Meredith Regine, Junior Legislative
Associate, Labor; Melissa Salmanowitz, Press Secretary; James
Schroll, Staff Assistant; Michele Varnhagen, Labor Policy
Director; Mark Zuckerman, Staff Director; Robert Borden,
Minority General Counsel; Cameron Coursen, Minority Assistant
Communications Director; Ed Gilroy, Minority Director of
Workforce Policy; Rob Gregg, Minority Senior Legislative
Assistant; Alexa Marrero, Minority Communications Director; Ken
Serafin, Minority Professional Staff Member; and Linda Stevens,
Minority Chief Clerk/Assistant to the General Counsel.
Chairman Miller. The Committee on Education and Labor will
come to order for the purposes of conducting an oversight
hearing on the impact of the current fiscal and housing crises
on workers' retirement security. I want to thank all of the
witnesses who have agreed to testify this afternoon. And thank
you to the staff for putting this hearing together, and to the
members of the committee who were able to make it for the
hearing.
Last week, Congress approved an emergency rescue plan in
response to the worst financial crisis our country has seen
since the Great Depression. We know that this plan alone will
not magically turn the economy around, but we are confident
that, without it, we would not have a chance to move forward.
We insisted that the plan include strong protection for
taxpayers and tough accountability, neither of which was
included in the President's original request to Congress.
Immediately after the plan was approved, Speaker Pelosi
announced that the House would conduct a series of hearings to
investigate the causes of the current financial crises and what
steps should be taken next to protect homeowners, workers, and
families struggling today. As part of that commitment, the
Committee on Education and Labor is holding a hearing to
explore how this financial crisis is impacting the retirement
security of American families.
Yesterday, the House Oversight and Government Reform
Committee launched the first of many oversight hearings
examining the toxic mix of corporate greed, recklessness, and
deregulation that created this financial crisis.
During his testimony, Lehman Brothers' CEO, Mr. Fuld,
showed no remorse at his catastrophic mismanagement of the
company. In fact, he repeatedly denied responsibility for
running the storied Lehman Brothers Investment House into
financial oblivion. He refused to admit that his own reckless
management and his industry's success in keeping the regulators
at bay directly contributed to this historic financial crisis
that is costing taxpayers, shareholders, and the Nation's
current and future retirees billions of dollars from their nest
eggs. All the while he insisted on taking obscene multimillion-
dollar bonuses for his executive teammates. Unlike Wall Street
executives, America's families don't have a golden parachute to
fall back on.
It is clear that retirement security may be one of the
greatest casualties of this financial crisis. The current
financial and housing crisis are stripping wealth from American
families at a record rate. A new poll just found that 63
percent of Americans are worried that they will not have enough
savings for their retirement. Tragically, they may very well be
right.
Due to the collapse of the housing market, and the
financial crisis, trillions of dollars that Americans were
counting on has been lost. Americans were counting on much of
this wealth for their retirement. Now it is gone, as is their
ability to adequately fund their retirement.
Even before the current meltdown, middle-income families
were losing ground due to the decline in middle-class wages
over the last decade, making it harder for them to save for
their retirement and family emergencies. Retirement and
financial experts now predict that retirees and older workers
who rely on financial investments for their retirement income
may suffer more than any portion of the American population in
the coming years.
According to a survey released today by the AARP, one in
five middle-aged workers stopped contributing to their
retirement plans last year because they had trouble making ends
meet. One in three workers is considering delaying retirement.
Now, the number of investors taking loans on their 401(k)
accounts is increasing, and hardship withdrawals are also
increasing. T. Rowe Price estimates a 14 percent increase in
the hardship withdrawals just in the first 8 months of 2008,
and all of the signs point to an increased frequency of 401(k)
loans and hardship withdrawals in the coming year. It makes
sense that more Americans will be raiding their retirement
accounts as they deal with rising unemployment and the
increasing cost of basic necessities.
Unfortunately, these drastic measures that have been taken
by workers today will have a long-lasting impact by
significantly reducing their account balances once these
workers reach retirement age.
Over the past 12 months, more than half a trillion dollars
have evaporated from more 401(k) plans as a direct result of
the crisis in the markets. Some experts say it will take as
long as 3 years to recover market losses in 401(k)-style
accounts, but only if the market turns around soon.
Just like consumer-directed retirement plans, traditional
pension plans are not immune from the financial crisis.
Although pension plans hire professional money managers, and
are required to be diversified, these plans will likely lose
value as a result of the weak performance in the investment
markets.
Sophisticated pension plans lost 20 to 30 percent of their
value during the 2001 recession, and took several years to
overcome those losses. We must keep our eye on these plans and
I await further data on the health of our Nation's pensions.
While this crisis began on Wall Street, much of the
financial burden will ultimately be borne by Main Street. This
did not happen overnight. With the Republicans' help, armed
with their powerful lobbyists, Wall Street cunningly held off
fair regulations by Congress, arguing that Americans would be
better off if they were left to their own devices. As Congress
continues our investigations into the crisis, we cannot allow
those responsible to emerge unscathed. The American people are
paying a price for this ``Go, go, Wild West'' approach to
governing. One cost will be the concern that our Nation's
workers will not have sufficient savings to ensure a secure
retirement after a lifetime of hard work.
In the coming months, this committee will examine what
measures may be needed to ensure safe and secure retirement for
workers, retirees, and their families. For starters, we know
that 401(k) holders lack critical information about how their
money is being managed and what fees they pay. I am here to say
right now those days are over. We must have more transparency
and complete transparency in 401(k) investment practices. The
Wall Street veil of secrecy must end.
I would like to thank all of our witnesses for joining us
today, and I look forward to their testimony. I expect that we
will be back here repeatedly until we can ensure greater
security for the retirement of all hardworking Americans.
Our first witness will be Dr. Peter Orszag, who is the
Director of the Congressional Budget Office. CBO's mission is
to provide Congress and the public with objective, nonpartisan,
and timely analysis of economic and budgetary issues, as well
as analytic papers and cost estimates of the proposed
legislation.
Dr. Orszag received his BA from Princeton University and
his MA and PhD from the London School of Economics.
Next, we will hear from Dr. Jack VanDerhei, who is the
Research Director for the Employee Benefit Research Institute.
He is also the editor of the Benefits Quarterly, and a member
of the advisory board of the Pension Research Council at the
Wharton School and the National Academy for Social Insurance.
Dr. VanDerhei received a BA and MBA from the University of
Wisconsin, Madison, and an MA and PhD from the Wharton School
of the University of Pennsylvania.
Mr. Jerry Bramlett currently serves as President and CEO of
the BenefitStreet, an independent advisor for 401(k) and other
defined contribution plans. Mr. Bramlett founded the 401(k)
Company in 1983, and has 25 years of retirement industry
experience. He holds a BA from Southern Methodist University.
Dr. Christian E. Weller is Associate Professor of Public
Policy at the University of Massachusetts, Boston, and Senior
Fellow at the Center for American Progress Action Fund. His
work focuses on retirement income security, money and banking,
microeconomics, and international finance. Dr. Weller holds a
PhD in economics from the University of Massachusetts at
Amherst.
Dr. Teresa Ghilarducci is the Irene and Bernard Schwartz
Professor of Economic Policy Analysis at the New School for
Social Research. Dr. Ghilarducci specializes in pension
benefits, and is the author of several books, including, most
recently, ``When I Am 64: The Plot Against Pensions and the
Plan to Save Them.'' She received her BA and PhD from the
University of California at Berkeley.
Dr. Orszag, we will begin with you. As you know, you
obviously have testified so many times in front of Congress,
but a green light will go on when you begin to testify. We
allow you 5 minutes for your opening statements. And then an
orange light will go on when you have 1 minute remaining. We
suggest you might want to wrap it up, but we want to make sure
you complete your thoughts in a coherent fashion. And then a
red light when your time has run out. That will allow time for
the members of the committee.
Again, I want to thank all of the members for showing up.
Peter, please proceed as you are most comfortable.
[The statement of Mr. Miller follows:]
Prepared Statement of Hon. George Miller, Chairman, Committee on
Education and Labor
Good afternoon.
Last week, Congress approved an emergency rescue plan in response
to the worst financial crisis our country has seen since the Great
Depression. We know that this plan alone will not magically turn the
economy around. But we are confident that without it we will not have
the chance to move forward.
We insisted that the plan include strong protections for taxpayers
and tough accountability--neither of which was included in the
President's original request to Congress.
Immediately after the plan was approved, Speaker Pelosi announced
that the House would conduct a series of hearings to investigate the
causes of the current financial crisis and what steps we should take
next to protect homeowners, workers and families struggling today.
As part of that commitment, the Committee on Education and Labor
today is holding a hearing to explore how this financial crisis is
impacting the retirement security of American families.
Yesterday, the House Oversight and Government Reform Committee
launched the first of many oversight hearings examining the toxic mix
of corporate greed, recklessness, and deregulation that created this
financial crisis.
During his testimony, Lehman's CEO, Mr. Fuld, showed no remorse for
his catastrophic mismanagement of the company. In fact, he repeatedly
denied responsibility for running the storied Lehman Brothers
investment house into financial oblivion.
He refused to admit that his own reckless management--and his
industry's success of keeping regulators at bay--directly contributed
to this historic financial crisis that is costing taxpayers,
shareholders, and the nation's current and future retirees billions of
dollars from their nest eggs.
All the while, he insisted on taking obscene multi-million dollar
bonuses for his executive teammates.
Unlike Wall Street executives, American families don't have a
golden parachute to fall back on.
It's clear that their retirement security may be one of the
greatest casualties of this financial crisis.
The current financial and housing crises are stripping wealth from
American families at a record rate.
A new poll just found that 63 percent of Americans are worried that
they will not have enough savings for their retirement. Tragically,
they may very well be right. Due to the collapse of the housing market
and the financial crisis, trillions of dollars that Americans were
counting on has been lost.
Americans were counting on much of this wealth for their
retirement. Now it is gone--as is their ability to adequately fund
their retirement.
Even before the current meltdown, middle-income families were
losing ground due to the decline in middle-class wages over the last
decade--making it harder for them to save for their retirement and
family emergencies.
Retirement and financial experts now predict that retirees and
older workers who rely on financial investments for retirement income
may suffer more than any portion of the American population in the
coming years.
According a survey released today by the AARP, one in five middle-
aged workers stopped contributing to their retirement plans in the last
year because they had trouble making ends meet. One in three workers
has considered delaying retirement.
Now, the number of investors taking loans on their 401(k) accounts
is increasing. And hardship withdrawals are also increasing.
T. Rowe Price estimates a 14 percent increase in hardship
withdrawals just in the first eight months of 2008.
And, all the signs point to an increased frequency of 401(k) loans
and hardship withdrawals in the coming year.
It makes sense that more Americans will be raiding their retirement
accounts as they deal with rising unemployment and increasing costs of
basic necessities.
Unfortunately, these drastic measures taken by workers today will
have a long-lasting impact by significantly reducing account balances
once these workers reach retirement age.
Over the past 12 months, more than a half trillion dollars have
evaporated from 401(k) plans as a direct result of the crisis in the
markets.
Some experts say that it will take as long as 3 years to recover
market losses in 401(k)style accounts--but only if the market turns
around soon.
Just like consumer directed retirement plans, traditional pension
plans are not immune from the financial crisis.
Although pension plans hire professional money managers and are
required to be diversified, these plans will likely lose value as a
result of the weak performance of the investment markets.
Sophisticated pension funds lost 20 to 30 percent of their value
during the 2001 recession and took several years to overcome those
losses.
We must keep our eye on these plans and I await further data on the
health of our nation's pensions.
While this crisis began on Wall Street, much of the financial
burden will ultimately be borne by Main Street. And this did not happen
overnight.
With the Republicans' help and armed with their powerful lobbyists,
Wall Street cunningly held off fair regulations by Congress, arguing
that Americans would be better off if left to their own devices.
As Congress continues our investigations into this crisis, we
cannot allow those responsible to emerge unscathed. The American people
are paying the price of this go-go, Wild West approach to governing.
One cost will be the concern that our nation's workers will not
have sufficient savings to ensure a secure retirement after a lifetime
of hard work. In the coming months, this committee will examine what
measures may be needed to ensure a safe and secure retirement for
workers, retirees and their families.
For starters, we know that 401(k) holders lack critical information
about how their money is managed and what fees they pay.
I'm here to say right now, those days are over.
We must have more transparency in 401(k) investment practices. The
Wall Street veil of secrecy must end.
I would like to thank all of our witnesses for joining us today. I
look forward to their testimony.
And I expect that we will be back here repeatedly until we can
ensure greater security for the retirement of hard-working Americans.
______
STATEMENT OF PETER R. ORSZAG, DIRECTOR, CONGRESSIONAL BUDGET
OFFICE
Mr. Orszag. Thank you very much, Mr. Chairman, members of
the committee.
The turmoil in financial markets that we have experienced
over the past year or so will and has affected many aspects of
our lives, including pensions, but perhaps for many households
the effects have not really manifested themselves dramatically
yet. That may start to change as households receive, for
example, their 401(k) balances that were mailed out at the end
of the last quarter, that are either in the mail or about to be
received today.
The most direct effect of the financial market turmoil on
pensions occurs through the prices of financial assets, such as
corporate equities and bonds. The Standard & Poor's 500 stock
market index, for example, has fallen by more than 25 percent
over the past year, as the outlook for the economy has worsened
and corporate profits have deteriorated and financial turmoil
has created stress in our financial markets. Because the
majority of pension assets are held in equities, these declines
in stock prices have had a significant adverse effect on
pension plans.
Data from the Federal Reserve suggests that the decline in
the value of financial assets held by pension funds, public and
private, defined benefit and defined contribution, amounted to
roughly $1 trillion, almost 10 percent, losses on their assets
from the second quarter of 2007 through the second quarter of
2008.
Since the end of the second quarter, asset prices have
continued to decline, and CBO analysis suggests that there may
well be another $1 trillion in losses on pension plan assets.
In other words, over the past 15 months or so, pension plans
have experienced a roughly $2 trillion decline in the value of
their assets.
As you know, the two principal types of pension plans are
defined benefit plans and defined contributions plans. If we
look at defined benefit plans, CBO's estimate suggests that the
value of the assets held by defined benefits plans has declined
by roughly 15 percent over the past year.
Offsetting that, to some degree, is that the way
obligations are calculated under defined pension plans involves
an interest rate. The interest rate that is used for those
calculations has increased, and that has partially offset the
decline in assets to the degree of change in the net asset
position, if you will, of defined benefit plans, has decreased
by perhaps only 5 to 10 percent over the past year. Still quite
substantial.
Defined contribution plans, if anything, are somewhat even
more heavily weighted towards equities than defined benefit
plans, so the declines in their asset values, again, if
anything, are more significant on a relative basis than defined
benefit assets.
State and local government pension plans have also suffered
losses. According to data from the Federal Reserve, for
example, the assets held by State and local government pension
plans declined by more than $300 billion between the second
quarter of 2007 and the second quarter of 2008.
Now, what does this all mean for real people and real
household? It will mean several things. One is that the decline
in the value of retirement assets may well lead households to
delay buying a new house or buying a refrigerator, or what have
you, consuming things, to the extent that they perceive the
assets in their retirement accounts to be part of their net
worth.
Another dimension of response may be that some people will
delay their retirement. In particular, those on the verge of
retirement may decide they can no longer afford to retire, and
will continue working longer.
If we look over a longer period of time, through the 1970s
and the 1980s, there was a trend towards earlier retirement,
which has somewhat reversed since then. The evidence is
somewhat ambiguous about the impact of financial market changes
on retirement behavior. For example, after the decline in the
stock market earlier in 2000, 2001, one paper suggested there
was not a significant response on retirement. However, during
the boom of the 1990s, other evidence suggests that people did
retire earlier in response to rising values in their retirement
accounts and other stock market wealth. One would think that
the reverse of that would then lead people to retire later. So
one dimension of response may well be in longer working lives
and later retirements.
I want to just wrap up by commenting on one lesson that we
can learn from the turmoil that we have been experiencing,
which is that in a defined contribution plan, like a 401(k)
plan, exposure to broad market risk is almost unavoidable. That
is to say, if all asset prices move in a particular direction,
workers bear the risk, almost by definition, under a 401(k)
plan, by design. But too many workers seem to be taking on
unnecessary risks even in the stocks that they hold. For
example, roughly 1 in 15, or about 7 percent of workers, hold
90 percent or more of their 401(k) balances in their own
company's stock. I think the experience that we are having with
corporate failures or potential corporate failures should
underscore the risk of not only risking your unemployment
status but also your retirement assets in making a big bet on
only one firm. Instead, a strategy of diversification is
generally sound. It is unavoidable. It doesn't get away from
the risk of an overall market decline, as we have been
experiencing, but too many workers are taking on unnecessary
risks over and above the risks they would otherwise face in
401(k) plans.
Thank you very much, Mr. Chairman.
[The statement of Mr. Orszag follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
------
Chairman Miller. Thank you.
STATEMENT OF DR. JACK VANDERHEI, RESEARCH DIRECTOR, EMPLOYEE
BENEFIT RESEARCH INSTITUTE (EBRI)
Mr. VanDerhei. Chairman Miller, members of the committee,
thank you for your invitation to testify today on the impact of
the financial crisis on retirement security. I am Jack
VanDerhei, Research Director of the Employee Benefit Research
Institute. EBRI is a nonpartisan research institute that has
been focusing on retirement and health benefits for the past 30
years. EBRI does not take policy positions and does not lobby.
With your permission, I have a longer written statement
that I would like to submit for the Record.
Chairman Miller. Without objection.
Mr. VanDerhei. Although the current financial crisis may
have an impact on defined benefit participants, the extent and
timing of the impact is difficult to assess, given the impact
of PPA on plan-sponsored contributions and/or benefit accruals
on amendments.
Considerably more is known though about the immediate
impact of the current financial crisis on defined contribution
plan participants. It should be emphasized that while older
employees have average equity allocations that are lower than
their younger counterparts, and hence are thought by some to be
less vulnerable to negative returns in the equity markets,
their average account balances tend to be larger, and therefore
they have more to lose in a significant downturn.
Research has shown that a worker's age is a major factor in
his or her ability to recover from an economic downturn. In
2002, Sarah Holden and I simulated the likely impact of a major
bear market on the overall replacement rates that could be
provided by 401(k) accumulations. Based on a baseline
replacement rate of 51 percent for a specific group of
employees, the decrease was estimated to be only 3.2 percentage
points if it took place at the beginning of the career, but
13.4 percentage points if it took place at the end of the
career.
However, building or modifying a simulation model that is
able to quantify the likely impact of a market downturn on
eventual retirement income is a very lengthy process.
Consequently, attention is typically focused on how a decline
in the financial markets has impacted the average defined
contribution balances.
For purposes of this testimony, EBRI has taken the most
recent information in the EBRI/ICI 401(k) database, year-end
2006, and used employee-specific information, as well as
financial market indices to estimate the percentage change in
average account balances among the 2.2 million 401(k)
participants that were present in the database from year end
1999 to year end 2006. This so-called consistent sample of
401(k) participants was created several years ago in the annual
analysis of EBRI/ICI 401(k) data to provide an estimate of
changes in average annual account balances that was not biased
downward by job-turnover 401(k) participants.
If you would like a look at the power point slides, figure
1, hopefully, it shows that for the first 9 months of 2008, the
percentage loss in average account balances among 401(k)
participants in this consistent sample varies from 7.2 percent
to 11.2 percent. As you would expect, groups with the lowest
average loss tend to have a reduced equity exposure, as well as
a larger ratio of contributions to account balance.
Figure 2 shows the cumulative experience for 2007, as well
as the first 9 months of 2008. In 2007, the S&P 500 index
return was positive, 5\1/2\ percent, but not nearly enough to
offset the losses in the first 9 months of 2008.
Figure 3 broadens the time span under the analysis and
shows that, even with the financial market setback suffered so
far in 2008, the percentage change in average account balances
from January 1, 2000, through October 1, 2008, was
significantly positive for all groups, and all age cohorts in
the two shortest tenure categories at least doubled their
account balances in nominal terms.
The largest increase, as you would expect, was experienced
by the group with the youngest workers and shortest tenure, in
large part due to the greater weight of contributions as
compared with investment returns. Those having the lowest
increase were the oldest workers with the longest tenure.
However, this number needs to be interpreted carefully in light
of the ability of many employees to start taking in-service
distributions from their plans at age 59\1/2\.
A research topic that is urgently needed to better
understand the vulnerability of 401(k) participants to
volatility in equity markets deals with the topic of target
date funds.
Figure 4 shows for that same consistent sample the
distribution of 401(k) participant account balances to equity
at year end 2006. In this case, equity is defined as a
percentage of the participants' 401(k) funds in equity funds,
company stock, and the equity portion of balance and/or target
date funds.
This figure shows that more than one in four, 27 percent of
the oldest 401(k) participants, those age 56 to 65 in 2006, had
90 percent or more of their 401(k) assets in equities. Another
11 percent had 80 to 90 percent in equities, and 10 percent had
70 to 80 percent in equities.
Target date funds with automatic rebalancing and a ``glide
path'' ensuring age-appropriate asset allocation are likely to
become much more common after full implementation of PPA, with
the expected increase in automatic enrollment for 401(k) plans
and the attendant interest in QDIAs. Based on unpublished EBRI
research, the average equity allocation for target date funds
designed for individuals in that 56 to 65 age range was 51.2 at
year-end 2006. That would imply that approximately one-half of
the consistent sample participants in that age category, those
on the verge of retirement, would have had at least a 20
percent reduction in equities if they were allocated 100
percent to target-date funds.
EBRI is currently conducting an extensive research project
on the provision and utilization of target-date funds, as well
as other defined contribution trends that are likely to impact
the retirement income adequacy of today's workers. We would
welcome the opportunity to share these results with you and the
committee at your convenience.
I thank you for the opportunity to appear before the
committee today.
[The statement of Mr. VanDerhei may be accessed at the
following Internet address:]
http://www.ebri.org
------
[Additional submission of Mr. VanDerhei follows:]
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Chairman Miller. Thank you.
Mr. Bramlett.
STATEMENT OF JERRY BRAMLETT, CHIEF EXECUTIVE OFFICER,
BENEFITSTREET, INC.
Mr. Bramlett. Thank you, Chairman Miller, and members of
the committee, for the opportunity to speak about this critical
issue facing billions of Americans.
My name is Jerry Bramlett, President and CEO of
BenefitStreet. Before that, I founded and ran the 401(k)
Company for 25 years, beginning in August of 1983. At the time
that it was sold to Charles Schwab and Company, we had 425,000
participants, and our average size plan was about $250 million
in assets. Pretty much built that business brick by brick over
a 25-year period.
401(k) plans have become the retirement foundation for most
Americans. Low-income individuals are 20 times more likely to
save when they are offered a 401(k) plan at work. However, the
current financial crisis has certainly made clear that ill-
prepared 401(k) participants bear the investment risk. 401(k)
participants are understandably concerned about their
retirement savings. The recent substantial decline in the
market impacts almost every one of them. The pain is
particularly acute for those participants closer to retirement
whose retirement income expectations have been significantly
impaired, possibly resulting in the need to postpone
retirement.
Given that most 401(k) participants are not investment
experts, there is a danger that many of them will overreact to
the market downturn. I want to caution against this. For
participants with many years of retirement, a drastic
abandonment of equity positions in the retirement account will
only serve to lock in as of yet unrealized losses. Markets do
go up and down, and 401(k) participants must try to think long
term.
As recently as September 1987, the market declined over 25
percent; or 3,000 points in today's terms. In the following
years, the market rebounded and reached even higher levels.
Let me emphasize, exchange in the equity investments in
your retirement account for Treasury bills is not a sound long-
term investment strategy and will subject retirees to
substantial inflation risks. This also applies to participants
who are entering retirement, who will likely be managing
retirement assets for some time.
To be clear, I am certainly not saying that those with
401(k) accounts should do nothing. Current participants should
take the time to evaluate where their new contributions are
being invested and perhaps consider less volatile investments
that will allow them to better diverse their entire account,
which brings me to another point.
I do not believe that the 401(k) system is doing an
adequate job of educating participants as to how they need to
invest their account as they get closer to retirement. If the
retirement income of a 64-year-old is heavily invested in
equities, the impact of a major market decline on retirement
income expectations can be devastating. However, if that same
account had been properly diversified with a greater emphasis
on fixed income securities, the impact of a major market
decline may very well be manageable.
Although target-date investment funds based on a
participant's age has greatly helped in this regard, we need to
do more. I would recommend that Congress instruct the
Department of Labor to develop education materials specifically
for 401(k) participants over age 50 to assist them in better
managing their account in preparation for retirement.
The current financial crisis also reveals some fundamental
flaws in the 401(k) system that I want to highlight. Given how
this turmoil is impacting large insurance companies and banks,
plan fiduciaries need to make sure that when offering a so-
called stable value fund, or fixed interest fund, such funds
are diversified across a number of financial institutions. What
we have learned over the last couple of years is that large
institutions can fail. In other words, just like plan
participants need to diversify the investments in their
account, plan fiduciaries need to diversify the initial
investment providers used by their plan.
You also may not be aware that if a financial institution
holding retirement plan assets becomes troubled, a plan
fiduciary may not be able to do anything about it. For example,
there are retirement assets invested in insurance contracts
that can be subject to back-end loads or may even have
contractual provisions on taking the money out, sometimes as
long as 5 years. Congress should consider whether such
restrictions should be permissible with respect to retirement
plan assets.
Finally, it is critically important that we not forget the
issue of transparency. While the market is going down, hidden
fees are still being assessed. As this committee has already
heard, hidden fees can have an enormous impact on participants'
retirement accounts. By some estimates, some participants are
experiencing as much as 40 to 60 percent loss of the retirement
income in the future due to the fact of excessive fees, most of
which are hidden.
Those opposed to a fee transparency say that only the
overall net return on investment should matter. So what is
their argument when the return is a substantial loss compounded
with hidden fees?
Mr. Chairman, I fully support the bill you introduced this
year, and very much hope you will continue your quest to shine
the light on hidden fees in the new Congress.
Thank you for this opportunity. I welcome any questions.
[The statement of Mr. Bramlett follows:]
Prepared Statement of Jerry Bramlett, President/CEO, BenefitStreet,
Inc.
Chairman Miller and Congressman Andrews, thank you for this
opportunity to speak before you today on this critical issue facing
tens of millions of Americans. My name is Jerry Bramlett, President and
CEO of BenefitStreet. BenefitStreet is the nation's premier,
independent recordkeeping and plan administration firm with more than
1,500 clients across the country. We are a pioneer in the creation and
delivery of innovative 401(k) solutions and leading-edge technology.
Throughout my 25 years of building the largest independent 401(k)
plan recordkeeping firms in the country, I have experienced every
aspect of the retirement industry up close and have developed a good
deal of insight as to how we got to this point and where we should go
from here. 401(k) plans have become the retirement foundation for most
Americans. In terms of promoting savings they have been immensely
successful. Low to moderate income individuals are twenty times more
likely to save when they are offered a 401(k) plan at work. However,
the current financial crisis has certainly highlighted the fact that
401(k) participants--whose 401(k) account represent their sole
retirement savings--bear all the investment risk. This contrasts to
defined benefit plans, where the burden of funding, asset allocation
and investment selection belong to an employer under the constraints of
fiduciary laws. With 401(k) plans, all the risk associated with asset
allocation and investment selection is shifted to the ill-prepared
worker. 401(k) participants are understandably concerned about their
retirement savings. The recent substantial decline in the market
impacts almost every one of them. The pain is particularly acute for
those participants closer to retirement whose retirement income
expectations have been significantly impaired possibly resulting in the
need to postpone retirement.
Given that most 401(k) participants are not investment experts,
there is a danger that many of them will over react to this market
downturn--I want to caution against this. For participants with still
many years to retirement, a drastic abandonment of equity positions in
their retirement account will only serve to lock-in as of yet
unrealized losses. Markets do go up and down and 401(k) participants
must try to remember to think long-term. It is important to remember,
that as recently as September 1987 the market declined over 25
percent--3,000 points in today's terms. In the following years the
market rebounded and reached even higher levels. In fact, according to
the economist Jeremy Seigel there has never been a 20-year period where
the stock market has yielded negative returns.
Let me emphasize, exchanging the equity investments in your
retirement account for Treasury bills is not a sound long-term
investment strategy and will subject retirees to substantial inflation
risk. This also applies to participants who are nearing or entering
retirement who will likely be managing retirement assets for some
time--on the average another 15 years or so. Even these close-to-
retirement employees can impair their long-term retirement assets by
acting precipitously.
To be clear, I am certainly not saying that those with 401(k)
accounts should do nothing. Current participants should take the time
to evaluate where their new contributions are being invested and
perhaps consider less volatile investments that will allow them to
better diversify their entire account. By changing where these new
contributions are being invested 401(k) participants should seek to
have an appropriately diversified allocation of assets with a good
balance of both equity and fixed income investments.
Which brings me to another point, I do not believe the 401(k)
system is doing an adequate job of educating participants as to how
they need to invest their account as they get closer to retirement. The
practical impact of a substantial market decline on a 64-year old
worker months away from retirement can be very different than the
impact on a 50-year old 15 years from retirement. If the retirement
account of the 64-year old is heavily invested in equities, the impact
of a major market decline on retirement income expectations can be
devastating. However, if that same account had been properly
diversified with a greater emphasis on fixed income securities, the
impact of a major market decline may very well be manageable. Although
the advent of target-date investment funds based on a participant's age
has greatly helped in this regard we need to do more. I would recommend
that Congress instruct the Department of Labor to develop educational
materials specifically for 401(k) participants that have reached age 50
to assist them in better managing their account in preparation for
retirement.
The current financial crisis has also revealed some fundamental
flaws in the 401(k) system that I want to highlight.
Given how this turmoil is impacting large insurance
companies and banks, plan fiduciaries need to make sure that, when
offering a so called stable value or fixed interest fund, such funds
are diversified across a large number of financial institutions. What
we have learned over the last couple of weeks is that very large
institutions can fail no matter how stable they may appear on the
surface. In other words, just like plan participants need to diversify
the investments in their account, plan fiduciaries need to diversify
the investment providers used by the plan. As far as I know, the
Department of Labor places no emphasis on this.
You may not be aware that since this recent financial
crisis began certain retirement funds--such as real estate investment
funds--have announced that they are frozen and not available for
distributions to participants due to the illiquid nature of the
underlying assets. This means that current participants cannot change
their investment and retirees cannot get distributions. Congress should
examine whether investments subject to this susceptibility are
appropriate.
You also may not be aware that if a financial institution
holding retirement plan assets becomes troubled, a plan fiduciary may
practically or even contractually not be able to do anything about it.
For example, there are retirement assets invested in insurance
contracts that can be subject to significant back-end loads or may even
have contractual prohibitions on taking the money out. I have seen
contracts with such prohibitions lasting as long as five years.
Congress should consider whether such restrictions should be
permissible with respect to retirement plan assets.
You should also be concerned about funds that may be
advertized as ``low-risk'' (such as short term bond funds) but, in
reality, contain high-risk assets that cause the fund to perform more
like an equity fund in a down market. It is important not only to know
how a fund is labeled, but what is actually in a given fund regardless
of what it may be called.
Finally, it is critically important that we not forget the
issue of fee transparency. While the market is going down, hidden fees
are still being assessed. As this Committee has already heard, hidden
401(k) fees can have an enormous impact on a participant's retirement
account. Those opposed to fee transparency argue that only the overall
net return on an investment should matter. So what is their argument
when the return is a substantial loss compounded with hidden fees? Mr.
Chairman, I fully support the bill (H.R. 3185) that you introduced this
year enhancing 401(k) fee transparency and very much hope you will
continue your quest to shine the light on hidden fees in the new
Congress.
Thank you for this opportunity to testify on these important
issues. I will be happy to answer any questions you may have.
______
Chairman Miller. Thank you.
Dr. Weller.
STATEMENT OF DR. CHRISTIAN WELLER, ASSOCIATE PROFESSOR,
UNIVERSITY OF MASSACHUSETTS, BOSTON, AND SENIOR FELLOW, CENTER
FOR AMERICAN PROGRESS
Mr. Weller. Thank you very much, Chairman Weller, and I
thank the members of the committee for inviting me here today.
The current crisis highlights, in my view, the long-term
shortfalls in retirement savings. However, there is no single
silver bullet solution to the retirement crisis. Policymakers
instead should take a pragmatic approach and pursue policy
approaches that are efficient and effective. That means
strengthening defined benefit pensions, since they can deliver
benefits at lower costs than existing defined contribution
plans, as the National Institute on Retirement Security
recently showed. Also, it means improving 401(k) plans,
particularly by adapting defined benefit features to make them
more efficient. Let me talk a little bit about the long-term
benefit crisis.
In 2007, just 45 percent of all private sector workers
participated in employer-sponsored retirement plans, down from
50 percent in 2000. Minorities, low-income workers, and those
working for small employers are much less likely than their
counterparts to have a retirement saving plan at work, and all
of those ratios have declined since 2000.
But, the Investment Company Institute just last week
reported that when employers offer a retirement savings plan,
there is no distinction in take-out rates between small and
large businesses. That means it is efficient to focus on
expanding plan sponsorship, especially among small businesses.
Increasingly, however, many workers with retirement saving
plans have individual accounts that can leave them exposed to
market fluctuations, and those workers are currently hurt by
the sharp downturns in the numbers. The data shows several
important trends. Let me just highlight a few.
The total real wealth fell by $4.5 trillion from September
2007, the last peak in household wealth, to June, 2008, just 9
months. This is an annualized average loss of 10.2 percent for
the past three quarters compared, for instance, to an average
loss of 7 percent in the early 2000s.
Over the three quarters from September 2007 to June, 2008,
home equity, which is a large share of retirement savings for
older workers in particular shrank by $1 trillion, reflecting a
decrease in annualized average rate of 17.8 percent during
those quarters. This was the largest decline in home equity
since the first three quarters of 1974. Home equity relative to
income is now at the lowest level since the end of 1976.
These sharp wealth trends are mirroring peoples' worries
about their own retirement income security, which are at the
highest levels in most of the service that we know for the past
20 years. Importantly, however, increasing worries about future
financial and housing market uncertainty can result in under
saving asset misallocation as we go forward.
In my view, there are three policy goals: Improve
retirement savings coverage, more equity wealth creation, and
reduced risk exposures. The policy responses have to be
comprehensive, consistent, and progressive. Comprehensive
because the challenges are large. All well-designed options
need to be considered and implemented. Consistent, to introduce
DB plan features into 401(k) while also pursuing approaches
that are not harmful to DB plans. Progressive, to focus on
those who most need help, who currently receive a
disproportionately small share of saving incentives.
In particular, there are three general policy approaches
that I see for policymakers to take in considering to
strengthen DB plans. First, build up buffers for bad times.
That ultimately means encouraging DB plans to overfund during
the good times. Promote standalone entities. Take the pension
plans off the books of companies to avoid the inherent
conflicts of interest. The public sector already has standalone
entities. In the private sector we have plans. I think they are
good models.
Encourage regular employer contributions either by
requiring minimum employer consideration as is done or
considered at a number of State levels or through changes in
the calculations of employer contributions, although that will
require undoing some parts of the Pension Protection Act of
2006.
The other part to consider is to continue to build a better
401(k) plan. Make it easier for people to save. Continue
automating of savings. Equalize the saving incentives by
eliminating, for instance, some of the tax deductions and
replacing them with a straight-up refundable credit for
everybody.
Third, encourage or even require employer contributions,
although that would have to be done very carefully so employers
don't just simply unload their existing plans and start going
to the requirement as a minimum and go through that minimum.
Then, ultimately also lower the cost of saving. The
National Institute on Requirement Security recently showed DB
plans are inherently more efficient than DC plans. Among DB
advantages is professional management and lower fees, which can
reduce the cost of achieving a given level of benefits by 21
percent, relative to DC plans, streamlining investments and
helping new plans to build up to scale quickly. For instance,
through so-called State K plan efforts and default investment
options can help protect the nest egg; obviously, all of that
in addition to more transparency for the existing fees, as Mr.
Bramlett already highlighted.
Thank you very much for inviting me here today. I will be
happy to answer any questions.
[The statement of Mr. Weller follows:]
Prepared Statement of Christian E. Weller, Ph.D., Associate Professor,
Department of Public Policy and Public Affairs, University of
Massachusetts
Thank you Chairman Miller, Ranking Member McKeon, and members of
the House Committee on Education and Labor for this opportunity to
speak to you today.
My name is Christian Weller. I am an associate professor of public
policy in the McCormack Graduate School at the University of
Massachusetts Boston, a Senior Fellow at the Center for American
Progress Action Fund in Washington, D.C., and an Institute Fellow at
the Gerontology Institute at the University of Massachusetts Boston. As
my affiliations show, I have substantial expertise and experience
working on retirement security issues both in a research and policy
context.
I. Introduction and overview
In my testimony today, I would like to focus on the lessons that
can be learned from the current financial crisis for retirement income
security. In particular, the long-term trend in declining retirement
security has been exacerbated by the recent turmoil in the financial
markets, and thus ever more poignantly underscores the need for swift
and broad action to vastly improve the retirement income security for
the majority of American families. Too many Americans rely too heavily
on their homes as their primary source of household wealth. Declines in
house prices quickly decimate this wealth, especially when families are
heavily leveraged, as has been increasingly the case in the past few
years, when mortgages grew faster than home values. And, even those
families who have some retirement savings--about three quarters of
American families nearing retirement--increasingly rely on their own
luck and investment savvy to reach their retirement savings goals. Yet
economists have long known that the success of ``Do It Yourself''
savings plans is severely hampered by the underlying investor
psychology, which often leads individual investors to buy and sell low
in crises like these.
These data point toward three policy goals. First and foremost,
more Americans need retirement savings in addition to Social Security
and outside of their own home. Second, Americans need to save more for
retirement, encouraged by progressive saving incentives and supported
by their employers. Substantially raising Americans' retirement
security is a heavily lift, as the data further below show, and thus
can only be accomplished as a shared responsibility between
individuals, employers, and the public. Third, Americans need to be
reassured that the money that they will save for retirement will
actually be there when they need it. The exposure to large market
swings, as we have experienced twice in the past decade, can send
individual investors scrambling for an exit at the most inopportune
time. This prevents them from saving enough, and actually increases
their exposure to financial market risks.
The policy response to these challenges has to be comprehensive,
consistent, and progressive. It needs to be comprehensive because the
challenge is large. That is, all well-designed options need to be
considered and implemented. No one single silver bullet will accomplish
all that needs to get done.\1\ Moreover, the policy responses need to
be consistent with each other. It is an inconsistent policy approach to
try to introduce beneficial features from traditional defined benefit,
or DB plans, into 401(k)-style defined contribution, or DC plans, while
at the same time pursuing policy approaches that are harmful to the
same DB plans that are used as model for retirement savings. And
finally, the policy approach needs to be progressive in order to focus
especially on those families who are most in need of building
retirement wealth and who are currently receiving a disproportionately
small share of the existing retirement saving incentives that the
public allocates each year for this purpose.
With this in mind, there are several specific policy directions
that should be explored. Congress should consider both strengthening
existing DB plans and vastly improving existing 401(k)-style defined
contribution plans.
On improving DB plans, the financial market swings over the past 10
years have clearly shown that legislative and regulatory efforts should
increase the incentives for employers to make regular contributions to
their pension plans. A large part of the current crisis in retirement
security is that employers often either could not or did not want to
make additional contributions to their pension plans. Thus, they may
have been less well prepared for the financial market crisis that hit
after 2000 and again in 2008. New legislation, particularly the Pension
Protection Act of 2006, and proposed accounting rule changes--the same
ones that banks are now asking Congress to suspend--require smaller
contributions during good economic times and larger employer
contributions during bad economic times than past accounting rules did
or alternative rules would require.
As for DC plans, there are two separate directions that should be
pursued by policymakers to ``build a better 401(k).'' First, the
movement to making saving for retirement simpler needs to be elevated.
This would reduce the chance that individual investors will fall prey
to the well-known pitfalls of saving for retirement on one's own:
reducing contributions when prices drop, not regularly diversifying
even when prices change dramatically, buying high and selling low by
following fads, and hanging on to too much employer stock, among
others. Second, Congress should end the system of ``upside-down''
saving incentives, whereby those who are least in need of support to
save more receive the largest relative incentives, and those who need
the most help receive the least public support.
II. It was already bad before the crisis hit
While the events that have taken place over the past several weeks
have shone a spotlight on how affected Americans' retirement plans can
be by such volatility in the financial markets, it is important to keep
in mind that Americans' retirement security has been in distress for
much longer than the past few weeks. In fact, retirement security has
been a growing concern for Americans for many years due to limited
retirement plan coverage, little retirement wealth, and increasing risk
exposure of the individual.
Too few people are covered by a retirement savings plan at work. In
2007, the most recent year for which data are available, 52.0 percent
of full-time private-sector wage and salary workers participated in an
employer-sponsored retirement plan. That is more than five percentage
points lower than the 57.4 percent who participated in an employer-
sponsored plan in 2000. Twenty-three percent of part-time workers
participated in such a plan in 2007, down from 26.9 percent in 2000.
Thus, overall, just 45.1 percent of all private-sector wage and salary
workers participated in an employer-sponsored retirement plan in 2007,
down from slightly more than half of all workers--50.3 percent--in
2000. That is, even at its last peak, almost half of all workers did
not participate in an employer-sponsored retirement plan and this share
has substantially shrunk since then (Purcell, 2008a).\2\
A breakdown by demographics shows that there is little difference
in coverage trends by gender. Rates of participation in an employer-
sponsored retirement plan have fallen for both men and women since the
beginning of the century. In 2007, 51.1 percent of male private-sector
wage and salary workers participated in an employer-sponsored plan,
well below the 58.3 percent who participated in one in 2000. Women's
participation rates have not fallen as far as men's have, but they were
not as high as men's rates in 2000 to begin with. In 2000, 56.1 percent
of full-time female workers participated in an employer-sponsored
retirement plan, but that share shrank to 52.6 percent in 2007
(Purcell, 2008a).
There are, however, substantial differences in retirement saving
coverage by race and ethnicity. Minorities are less likely to
participate in an employee-sponsored retirement plan than whites, and
are also more likely to lack sufficient funds for a secure retirement
than their counterparts. In 2002, the first year for which consistent
retirement coverage data by race and ethnicity are available from the
Bureau of Labor Statistics' Current Population Survey, 58.8 percent of
white, non-Hispanic, private-sector wage and salary workers
participated in an employer-sponsored retirement plan. Less than half
of black, non-Hispanic workers--47.5 percent--and less than one-third--
31.1 percent--of Hispanic workers did. Participation rates were lower
for all three of these groups of workers in 2007, with 57.6 percent of
white workers, 47.1 percent of black, non-Hispanic workers, and only
30.6 percent of Hispanic workers participating in such a plan (Purcell,
2008a).
In addition, participation in retirement saving plans varies with
income, such that lower-income workers are markedly less likely than
higher-income workers to participate. Participation in employer-
sponsored retirement plans has declined for all quartiles of private-
sector workers from 2000 to 2007. Importantly, private-sector workers
in the bottom half of the wage distribution had especially low
participation rates to begin with. In 2000, 55.5 percent of private-
sector workers in the third-highest earnings quartile participated in
an employer-sponsored retirement plan, but in 2007, less than half--
49.7 percent--did. Workers with earnings in the lowest quartile, or
less than $27,000, have fared even worse. Less than one-third
participated in an employer-sponsored retirement plan in both 2000 and
2007, with rates of 32.1 percent and 27.7 percent, respectively. Even
workers in the highest two earnings quartiles have seen their
participation rates decline over this period. Slightly more than two-
thirds--67.1 percent--of workers in the second-highest income quartile
participated in an employer-sponsored plan in 2000, but that share had
dropped to 62.8 percent in 2007. Additionally, 69.2 percent of workers
in the highest earnings quartile participated in an employer-sponsored
retirement plan in 2007, down from roughly three-quarters--75.5
percent--in 2000 (Purcell, 2008b).
Much of the low coverage rate for lower-income earners is explained
by their personal characteristics. For instance, the Investment Company
Institute (Brady and Sigrist, 2008) recently concluded that ``most
workers who have the ability to save and to be focused primarily on
saving for retirement are covered by an employer-provided retirement
plan.'' Low participation is thus often a function of low earnings,
young age, and working for a small employer. The link between
retirement saving participation and income is also supported by the
fact that the gap between being offered a retirement plan at work and
participating in such a plan in the private sector is largest for low-
income earners (Purcell, 2008a).
Additionally, employer size matters. Brady and Sigrist (2008)
conclude that only 18 percent of employees at small businesses--those
with less than 10 employees--have access to an employer-sponsored
retirement plan, as compared to 71 percent of employees working for an
employer with more than 1,000 employees in 2004, based on data from the
Federal Reserve's Survey of Consumer Finances. Similarly, Purcell
(2008a) finds, based on the Bureau of Labor Statistics' Current
Population Survey, that only 29.3 percent of employees working for an
employer with fewer than 25 employees had access to an employer-
sponsored retirement plan. Additionally, only 25.5 percent of all
employees at such businesses participated in such a plan in 2007. In
comparison, 75.2 percent of employees at large firms, with more than
100 employees, had access to a plan and 65.4 percent participated in
2007.
The data thus lead to two important conclusions. First, there are
substantial differences by demographic characteristics. Second,
targeting lower-income workers and small businesses in terms of
retirement saving policies may generate the largest dividends in terms
of improving retirement wealth generation.
III. The crisis: wealth destruction in action
Aggregate data show that household wealth has declined sharply over
the past year and thus has taken a serious toll on the retirement
security of individuals. With respect to retirement security, it is
important to consider total wealth relative to disposable income. For
one, wealth is interchangeable. Families, for instance, borrow from
their 401(k) plans to pay for their home when they are tapped out on
other loans and do not have sufficient savings for the necessary down
payment or renovations (Weller and Wenger, 2008). Also, total wealth is
a store of future income that can be used to replace income, for
instance, in the case of an economic emergency, a disability, a death
of a breadwinner, and in retirement.
The trends in total household wealth show that families have lost
wealth at a breathtaking speed over the past year. Total real wealth
fell by $4.5 trillion dollars from September 2007--the last peak in
household wealth--to June 2008. This is an annualized average loss of
10.2 percent for the past three quarters. In comparison, during the
first three quarters of the downturn in the early 2000s, from March
2000 to December 2000, the rate of decline averaged to an annualized
6.8 percent. For the entire wealth loss streak from March 2000 to
September 2002, it averaged to 7.1 percent. That is, the current wealth
loss is more than 40 percent faster than during the last period of
wealth loss.\3\
Importantly, this sharp drop in household wealth came after
families had not recovered from their relative wealth losses incurred
during the last crisis. At its peak, total family wealth amounted to
619.4 percent of disposable income in December 1999. By September 2002,
this ratio had fallen to 483.8 percent, before climbing to 575.0
percent in June 2007. For the next four quarters, wealth did not keep
pace with disposable income and dropped to 517.4 percent. In other
words, if total household wealth had kept pace with disposable income
after September 1999, families in June 2008 would have had an
additional $11 trillion.\4\
Much of the drop in housing wealth is a consequence of the bursting
housing bubble, although an even larger share of total wealth losses is
concentrated in financial wealth. Over the three quarters from
September 2007 to June 2008, households lost a total of $1.1 trillion
in real housing wealth, $351 billion in the last quarter alone.
Additionally, their home equity shrank by $1.0 trillion, reflecting a
decrease at an annualized average rate of 17.8 percent during those
quarters. This was the second-highest drop in real home equity over a
three-quarter period and the largest since the first three quarters of
1974. As a result, home equity amounted to 81.2 percent of disposable
income in June 2008--its lowest level since the end of 1976.\5\
The figures clearly show a few noteworthy points. First, the loss
in household wealth goes well beyond the recent drop in house prices.
Second, the drop in household wealth, especially in real estate wealth,
is very sharp. Third, the loss of household wealth has put many
families in a precarious financial situation by adding to existing
economic woes, such as a weak labor market.
IV. Amid the crisis, the public is worried about retirement security
Given growing discomfort, to say the least, in today's economic
climate, it should not be surprising that public opinion polling data
also indicate that Americans have become increasingly worried about
their ability to afford a comfortable retirement. Gallup has polled
(non-retiree) Americans about whether they expect to have enough money
to live comfortably in retirement. The share of respondents who said
that they did expect to have enough money to live comfortably in
retirement held steady at 59 percent from 2002 though 2004, before
falling to 53 percent in 2005, and dropping to 46 percent in April
2008. The April 2008 Gallup poll also found that nearly two-thirds--63
percent--of Americans are worried that they will not have enough money
for their retirement. This share is higher than both the share of
Americans who were worried about their ability to pay medical costs
associated with an accident or serious illness (56 percent) and the
share who were afraid that they will not be able to maintain their
current standard of living amid 2008's economic troubles (55 percent)
(Jacobe, 2008b).
According to a January 2006 Pew Research Center poll, 71 percent of
Americans were either very or somewhat concerned about not having
enough money for retirement, up from 60 percent in 2005. This was
slightly higher than the 68 percent concerned about their ability to
afford necessary health care for their family, and considerably higher
than the 44 percent who were concerned about receiving a pay cut or
losing their job. An April 2007 Gallup poll found that 56 percent of
those surveyed were either very or moderately worried about not having
enough money for their retirement. This was a higher percentage than
any other economic worry Gallup asked about, including covering
unexpected medical costs, maintaining their current standard of living,
and paying for housing costs. Especially telling is the fact that even
a majority of those in households earning $75,000 or more per year--who
would be considered upper-middle income to wealth--indicated that they
were worried about their retirement income (Teixeira, 2008).
Other surveys found similar trends. The 2008 Retirement Confidence
Survey, which is conducted annually by the Employee Benefit Research
Institute, found that both workers' and retirees' retirement security
confidence has dropped in recent years. In 2008, just under one-third--
61 percent--of workers polled indicated that they were either very
confident or somewhat confident in their ability to afford a
comfortable retirement, down from 65 percent in 2005. Additionally,
current retirees' confidence has declined, with 64 percent indicating
that they were very or somewhat confident in their ability to afford a
comfortable retirement, down from 80 percent in 2005 (Employee Benefit
Research Institute, 2008).
A recent poll conducted by Bankrate Inc. found that only about 3 in
10 workers expected to have enough money to retire comfortably. Nearly
7 in 10 Americans have set low expectations about their retirement
prospects. One in five Americans said they were afraid they would never
be able to retire (Austin Business Journal, 2008).
Another way to see this increased worry about personal retirement
security is to examine the change in how workers expect to fund their
retirement. For example, in April 2001, only 10 percent of respondents
to a Gallup poll expected to use part-time work as a major source of
their retirement funding. By April 2005 that share had risen to 18
percent. By April 2008, it had increased even more, to 20 percent
(Jacobe, 2008a).
Additionally, many Americans of retirement age are already
struggling to make ends meet. In 2007, the median income of Americans
ages 65 and older was $17,382. However, their actual incomes varied
widely. Importantly, in 2007, one-fourth of people ages 65 and older
had incomes of less than $10,722. When one considers just the quickly
rising costs of necessities, it is easy to see why Americans, both of
retirement age and younger, are concerned about their retirement
security. While 57 percent of households with a head of the house or
spouse aged 65 or older earned income on assets in 2007, half of them
received less than $1,585. The overall mean income from assets among
these households was just $2,254 (Purcell, 2008a).
Because of these worries, retirement has remained an important
issue on Americans' minds throughout the election year of 2008. A
March-April 2008 CBS News/New York Times poll showed that while paying
everyday bills was the public's top personal economic concern, saving
for retirement was the second biggest concern (American Enterprise
Institute Public Opinion Studies, 2008). Additionally, an August 2008
poll for George Washington University found that the public viewed
retirement as a more important issue for Congress than the mortgage
crisis, taxes, or education (Lake Research Partners and The Tarrance
Group, 2008).
Clearly there is both public desire for and a defined need to
improve the retirement security of America's workers. Policymakers must
catch up to fill these voids and design a more fulfilling retirement
plan for America's workers. To improve retirement security, we must
build a better DC plan and strengthen existing DB plans.
V. Building better retirement plans
If one were to design an ideal retirement plan, it would likely
encompass the following features:
Broad-based coverage, which covers all workers
automatically
Secure money for retirement, with limited opportunities
for leakage of retirement assets
Portability of benefits, which will allow workers to
retain benefits if they switch jobs
Shared financing, with contributions from both employees
and employers
Lifetime benefits, so that retirement income cannot be
outlived
Spousal and disability benefits to provide protections
against death or the inability to work
Professional management of assets
Low costs and fees
It is important to realize that there are already retirement plans
in the United States that meet almost all of these criteria. In
particular, the DB plans that provide retirement benefits to employees
of state and local governments typically meet all of these criteria for
a model retirement system. Also, multiemployer or Taft-Hartley plans in
the private sector tend to fit this description.
The implication of this is twofold. First, public policy should
strengthen the existing DB plans that already do a good job of offering
retirement security to American families. Second, policymakers should
adopt policies that will allow plans that do not yet meet these
criteria to incorporate features that will bring them closer to this
ideal.
The following discussion thus highlights these important plan
features, shows how they work in multiemployer and public-sector DB
plans, and draws policy lessons for the design of policy approaches to
improving existing DB and DC plans.
Broad-based coverage: Employees must simply meet the eligibility
requirements of the DB plan to earn benefits in a DB plan. They are
then automatically enrolled without having to make any active
decisions. This truly ``automatic'' enrollment is a typical
characteristic of all DB plans.
DC plans, on the other hand, often require employees to enroll
themselves, and then make difficult decisions about how much to save
and where to direct their investments.
Another DB feature that is reflected in proposals to restructure DC
is universal coverage, which would make saving for retirement easier.
However, there is generally a qualitative difference to DB plans.
Universal coverage under DB plans automatically includes benefit
accruals for vested employees, while proposals for universal DC
coverage generally only include universal access to a savings account,
i.e. the possibility of wealth creation without any assurance of
contributions.
In passing the Pension Protection Act of 2006, Congress
acknowledged this inherent flaw in DC plans and attempted to make
automatic enrollment and efficient asset allocation easier. It is too
soon to reach any conclusions about the law's effectiveness in
increasing automatic enrollment in DC plans. Early indications show,
however, that automatic enrollment is a feature of a growing share of
existing DC plans. For instance, a survey by Hewitt Associates LLC
(2008) showed that 44 percent of responding firms already offer
automatic enrollment and 30 percent of those who do not are considering
implementing it in 2008. Also, Deloitte (2008) reported that 42 percent
of their survey respondents offered automatic enrollment in 2008, up
from 23 percent just a year ago.
The evidence on the impact of automatic enrollment in the existing
DC universe is too thin to evaluate how much faster employees,
especially lower-income ones, are accruing retirement savings than in
the past. Time will eventually tell how effective this policy move has
been toward achieving greater retirement security for lower-income
workers, for minorities, and for employees in small businesses.
Policymakers, though, should not be content with waiting for new
evidence to emerge with respect to the impact of past policy changes.
After all, the automatic enrollment features that were passed with the
Pension Protection Act of 2006 only affect employers, who either
already offer a qualified retirement savings plan or plan on offering
one.
Instead, policymakers should consider added incentives for
employers to offer access to qualified plans. The ``automatic IRA''
proposal does this by requiring that employers above a certain size
offer access to direct deposits into an IRA, or by changing public
saving incentives. In particular, two examples of proposals that move
toward universal coverage in DC plans are ``automatic IRAs'' (Iwry and
John, 2006), and ``universal 401(k)s'' (Sperling, 2005). Under the
first plan, ``automatic IRAs'' would require that every employer with
10 or more employees would have to offer employees the opportunity of
automatic payroll deductions into designated IRAs. To increase
participation, Iwry and John (2006) suggest that this program could be
coupled with automatic enrollment. To minimize costs, government
administered accounts could be offered as the default investment (Iwry
and John, 2006).
The second proposal goes a step further and pays attention to the
particular vulnerability that low- and middle-class workers face
because of low levels of savings. A universal 401(k), as proposed by my
Center for American Progress Action Fund colleague Gene Sperling, adds
progressive saving incentives, since all of these plans allow an
employee to opt out of their coverage even if they were ``automatically
enrolled' (Sperling, 2005). Although this would again not automatically
guarantee contributions, it would have the advantage of skewing savings
incentives more toward low-income earners, where savings shortfalls are
largest. The combination of universal access and progressive savings
incentives could go a long way toward creating wealth for many middle-
class families who currently do not save enough.
These proposals are directly targeted at increasing retirement
savings coverage among employees who work for smaller businesses. As
discussed before, the chance of being offered a plan when working for a
smaller business is substantially lower than when working for a larger
employer. Both the ``automatic IRA'' and the ``universal 401(k)''
proposals are intended to increase retirement savings coverage
especially in this market segment. Coupled with automatic enrollment
features, the hope is that increased coverage will also result in
faster wealth accumulation.
Secure money for retirement: DB plans provide a secure source of
income in retirement for a number of reasons. First, one's funds cannot
be borrowed from and typically are not distributed as a lump-sum
payment. That is, money under a DB plan will be there to provide a
lifetime stream of retirement income.
Second, multiemployer DB plans and DB plans for state and local
government employees reduce the impact that bankruptcy of an employer
may have. In the case of multiemployer DB plans this is simply a
function of many employers banding together to provide benefits. And,
in the public sector, this is a result of the fact that state and local
governments typically do not go bankrupt. This is sadly not always the
case for single-employer, private-sector DB plans.
A third point is that pension plans tend to follow prudent
investment principles and thus secure assets as much as possible. The
security of assets in DC plans for future retirement income is, by
comparison, compromised. Importantly, the vast majority of individuals
in DC plans can borrow from their retirement accounts or withdraw funds
before retirement age. Economists use the term ``leakage'' to describe
assets that are drawn out of retirement savings plans for purposes
other than providing retirement income (Weller and Wenger, 2008).
According to one conservative estimate, a full 10 percent of all
retirement wealth is lost due to leakage from DC plans (Englehart,
1999). Loans from DC plans have risen, especially to allow families to
smooth over economic hard times, which will likely reduce their
retirement income security (Weller and Wenger, 2008).
While employer default risk is generally not an issue for DC plans,
individuals saving with those plans can be exposed to a number of well-
known risks. These include longevity risk, idiosyncratic risk, and
market risk among others. Moreover, these risks can be exacerbated by
typical psychological responses of individual investors as the
literature has demonstrated (Benartzi and Thaler, 2007). Policy can
mitigate some of these risks by encouraging automated plan designs. I
will return to this point further below.
This leaves the issue of potential leakages from DC plans due to
loans. The policy response, however, should not be to eliminate loans
from DC plans. It is important to recognize that employees typically
take out a loan because they are financially strapped or because of an
economic emergency, especially a sick family member (Weller and Wenger,
2008a). Consequently, the complete elimination of loans from DC plans
may be simply impractical. If loans are prohibited, employees, who want
to take out a loan because of an emergency, may request a hardship
withdrawal instead.\6\
Policymakers, however, should encourage employers to limit the
incidences for which employees can take out a loan, e.g. by mandating
stricter limits on loans. Employers could discourage loans from DC
savings plans by limiting the number of loans that can be taken out
during a given time period--for example, only two loans in a five-year
period. Employees could be required to wait for a minimum amount of
time after a previous loan has been paid off before taking out a new
loan. Employers could also further restrict the reasons for which a
loan can be taken out and require that employees provide proof of those
instances.
Portability of benefits: Portability of benefits can be limited
within some DB pension plans. It is important to realize, however, that
this is a limited issue in the DB world. Single-employer DB plans may
not offer lump sum withdrawal options, but more and more single-
employer plans follow a cash balance plan design where a lump sum
option is typically offered (Weller, 2005).
Further, public pension plans are responding to changing workforce
needs in public service by offering much greater portability than in
the past. Often, if employees move to another government position
within the state, they are able to carry pension benefits with them.
Should they move to other jurisdictions, they can usually purchase
service credits (Brainard, 2008).
This portability also exists for most DC plans and in multiemployer
plans. Little additional policy room exists, except that policymakers
may want to consider reducing the maximum vesting period, as was done
for cash balance plans in the Pension Protection Act of 2006. Shorter
vesting periods will allow more mobile workers to accrue benefits where
they may not accrue any right now, and thus enhance benefit
portability.
Shared financing: This is a typical characteristic of public-sector
pension plans. The funding of state and local DB plans is a shared
responsibility between employee and employer. Private-sector defined
plans, by contrast, have employers typically finance the entire
benefit. In 2004, for workers covered by Social Security, the median
employer contribution rate was 7 percent of salary, while the employee
contributed an additional 5 percent of salary (Munnell and Soto, 2007).
More could be done, however, to encourage employer contributions to
DB plans. Two alternative approaches are available to accomplish this.
First, policymakers could require a minimum employer contribution as is
already the case or considered in some states for the employer
contribution to existing DB plans (Weller et al., 2006). Second,
funding rules for DB plans could allow for more smoothing of asset and
liability values. This would reduce the pro-cyclicality of existing
rules. Currently, the funding rules require larger contributions during
bad economic times, when plan sponsors can often ill afford such
additional requests on their cash flow. Inversely, current rules tend
to lower the required contributions during good economic times, when
employers can best afford contributing to their plans. An alternative
set of funding rules would thus shift the funding burden from the bad
to the good economic times without lowering benefit security. Weller et
al. (2006) discuss two different valuation approaches to accomplish
greater regularity of employer contributions. One of these approaches
would allow for the smoothing of pension plan asset and liabilities
over 20 years and require that employers contribute up to a specific
level of assets above liabilities, e.g. 120 percent (Weller and Baker,
2005).
Further, the Pension Protection Act of 2006 has opened the door to
more shared financing among DC plans. If employers offer the safe
harbor option of automatic enrollment, they will have to also offer an
employer matching contribution in addition to establishing
automatically escalating employee contributions (Groom Law Group,
2006). More could be and should be done to encourage employer
contributions, either as match or as non-matching contributions.
In addition, several proposals have included mandatory employer
contributions in an effort to increase DC plan coverage. For instance,
Weller (2007) develops a proposal called ``Personal Universal
Retirement'' accounts. The costs and risks of these accounts would be
kept low by managing the funds through a government entity, for
example, the Federal Retirement Thrift Investment Board. Professional
fund managers invest the funds of PURE accounts according to a worker's
instructions. The investment options are the same as those for the
Thrift Savings Plan to keep administrative costs to a minimum.
Furthermore, universal employer contributions of at least 3 percent of
earnings to a qualified pension plan or to a PURE account are required.
These contributions would be pre-income tax, but subject to FICA. In
addition, low-income workers would qualify for direct, non-elective
contributions, while higher-income earners could qualify, up to a
limit, for government matching contributions.
Also, Ghilarducci (2007) proposes ``Guaranteed Retirement
Accounts'' which incorporate the low cost and effective risk management
advantages of pooling assets, require coverage, and assure assets are
paid-out in annuities. The GRAs are funded by a mandated 5 percent
contribution on earnings up to the Social Security maximum, split
evenly between the employer and employee. The contribution goes into a
national fund comprised of individual accounts. Contributions are
recorded in individual accounts and the account values represent an
individual's claims on future benefits. Unlike conventional DC plans,
the rates of return are guaranteed; the U.S. government will guarantee
a rate of return of 3 percent with excess returns added, depending on
the fund's earnings. Workers and retirees can add to the accounts at
any time with pre- and post-tax dollars. By reconfiguring the current
tax subsidies for retirement plans--that give people earning over
$100,000 per year over $7,400 in tax subsidies while middle- and
working-class workers receive practically nothing--each employee will
receive a tax credit of $600. This tax rebate will go directly into
workers' individual accounts and will add to national savings. The
rebate will also soften the impact of a 5 percent mandated contribution
for lower-income workers--most workers will pay much less than 5
percent. The efficient and well-managed Social Security Administration
will administer the account. Qualified DB plans will be able to opt out
of the mandate. At retirement, the accounts will be annuitized, and
``opt to'' withdraw a lump sum worth a maximum of 10 percent of the
account value. The GRAs, combined with Social Security, are designed to
guarantee the average worker 70 percent of pre-retirement earnings at
retirement, approaching the level of 75 to 80 percent of pre-retirement
income that is typically considered adequate by financial experts.
Lifetime benefits: State and local DB plans are designed so that
retirement income can never be outlived--retirees are guaranteed a
paycheck for life. This is also the case with private-sector DB plans
that have to offer an annuity benefit, even if it is as an alternative
to a lump-sum distribution.
This is in stark contrast with DC plans. Here, the burden of
managing one's retirement income, so that retirees do not run out of
savings in retirement, falls mostly on the individual. In many cases,
however, employees do not understand how much money they will need in
retirement. The result is that many workers do not save sufficiently
and face inadequate income in retirement. In order for a private-sector
worker to purchase a modest annual annuity of $20,000, she must
accumulate an estimated $260,000 in a 401(k). Yet, the median 401(k)
balance for heads of households approaching retirement in 2004 was just
$60,000 (Munnell and Soto, 2007). Further, Boston College researchers
have found that, in part due to the shift from DB to DC plans in recent
years, between 44 percent and 61 percent of households are at risk of
being unable to maintain their living standards in retirement (Munnell
et al., 2007).
A study by the National Institute on Retirement Security (Almeida
and Fornia, 2008) recently quantified the additional cost that DC plans
incur to provide the same retirement benefit to employees, who do not
annuitize. Their calculations show that if employees self-annuitize,
they will have to plan for the maximum life expectancy, instead of the
average life expectancy. This increases the required contributions
during the build-up phase of a retirement savings account by 15
percent. Consequently, policymakers could lower the implicit costs of
DCs and thus deliver a better ``bang for the buck'' to beneficiaries if
they could increase the share of savers, who annuitize their savings
upon retirement.
Spousal and disability benefits: DB plans typically provide special
protections for spouses of married beneficiaries, as well as disability
benefits for active employees who are stricken by illness or injury
that prematurely ends a career. Adding these types of benefits to DC
plans, however, would require purchasing life insurance and disability
insurance policies for beneficiaries. Addressing these ancillary
benefits is beyond the scope of this testimony.
Professional management of assets: Public-sector plans and private-
sector DB plans are managed by professionals with ``considerable
financial education, experience, discipline, and access to
sophisticated investment tools'' (Watson Wyatt, 2008). This is
reflected, for instance, in the aggregate asset allocation data of
public-sector DB pension plans. These plans tend to regularly rebalance
their portfolio in response to price changes, show no signs of employer
or trustee conflicts of interest, and appear to follow a best practices
model by pursuing strategies similar to those employed by industry
leaders (Weller and Wenger, 2008b).
The individualized nature of DC plans, however, means that these
rely on self-management. As the Investment Company Institute found
using 2006 year-end data, the bulk of 401(k) plan assets are invested
in stocks (Investment Company Institute, 2007). When faced with the
wide array of complicated and confusing choices that most DC plans
have, workers may find themselves more vulnerable to the negative
impacts of disturbances in the financial market. These can include a
lack of diversification or an improper assessment of risk associated
with their choices.
One response to this may be well-managed, balanced default
investment options that allow participants in DC plans to take
advantage of professional management of assets and thus help to avoid
the commonly known pitfalls of individual investing (Benartzi and
Thaler, 2007). The Investment Company Institute (2008) reported that
lifecycle funds continued to experience growth from the end of 2007
through the first quarter of 2008, despite adverse overall market
conditions. Most importantly, more widespread use of default investment
options would encourage participants to diversify their assets and
regularly rebalance them, thus avoiding the underperformance that often
arises in DC plans due to an unintended ``buy high, sell low''
investment strategy. If the past is any indication, automatic
investment options, such as lifecycle funds and model portfolios, will
become increasingly prevalent. The Investment Company Institute (2007)
reported that recent hires are more likely to choose these funds as
their investment option.
Low costs and fees: Evidence shows that administrative costs are
substantially higher for DC plans as compared to DB plans. An
international study of plan costs finds that while, on average, fees
can range between 0.8 percent and 1.5 percent of assets, larger
institutional plans can reduce such fees to between 0.6 percent and 0.2
percent of assets (James et al., 2001). The UK Institute of Actuaries
finds very high administrative costs for DC plans--of 2.5 percent of
contributions and up to 1.5 percent of assets--leading to the
equivalent of a 10 to 20 percent reduction in annual contributions. DB
administrative costs, however, amount to just 5 to 7 percent of annual
contributions (Blake, 2000). Similar differences exist in the United
States, with DB plans incurring substantially lower fees than DC plans
(Council of International Investors, 2006; Weller and Jenkins, 2007).
Almeida and Fornia (2008) estimate that the combination of
professional management and lower fees reduces the costs of a DB plan
relative to a DC plan by 21 percent annually. This is by far the
largest area of economic inefficiencies in the existing DC structure.
Policymakers could help to substantially improve retirement income
security by lowering fees and increasing the performance of DC plans,
e.g. through more professional management and the avoidance of well-
known pitfalls, such as lack of diversification, no regular
contributions, and emotionally charged investment decisions (``buy
high, sell low'') among others.
A number of proposals have focused on the cost savings from pooling
a large number of small accounts. Originally, Baker (1999) suggested
that the government should establish a default investment option
modeled on the Thrift Savings Plan for federal workers. Investment
options would be limited to a small number of index funds. Because such
a plan could take advantage of economies of scale and simplicity in
investment options, management fees would be substantially lower than
rates prevailing in private-sector plans (Congressional Budget Office,
2004).
This proposal is currently being studied at the state level as
Washington state is studying the feasibility of the Economic
Opportunity Institute's proposal for their Washington Voluntary
Accounts proposal (Idemoto, 2002). This proposal has also been brought
forth in other states, such as the Pennsylvania Voluntary Account
proposal of the Keystone Research Center (Weller et al., 2006) or the
Michigan Retirement Program Act of 2006 ( Michigan Legislature,
2006).\7\
VI. Conclusion
The decline in workers' retirement security is not a new
occurrence, but rather a troubling trend, which is especially evident
over the course of the current business cycle. We may have very well
dodged a bullet last week with the actions taken by Congress and the
administration. However, the long-term problems that were highlighted
by the recent turmoil in the financial markets, including the overall
weak retirement security of Americans overall, will not simply go away.
The strength of America's workers' retirement security has been
declining for many years and will likely continue to worsen, regardless
of what happens as a result of last week's activities. It is because of
this, and because of what America owes its workers, that we cannot
stand idly by as this happens. We must instead improve retirement
security by building a better DC plan and strengthening DB plans so
that all Americans can look forward to a comfortable retirement and
actually have the means to finance it. Importantly, there is no single
``silver bullet'' policy response. Instead, policymakers should take a
pragmatic approach. They should consider all efficient policy options
to increase the number of workers with a retirement savings plan, to
raise retirement saving--especially among lower-income workers, those
who work for smaller employers, and minorities--and to reduce the risk
exposure of retirement savings.
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Weller, C. 2005. ``Ensuring Retirement Income Security With Cash
Balance Plans.'' Washington, D.C.: Center for American
Progress.
Weller, C. 2007. ``PURE: A Proposal for More Retirement Income
Security.'' Journal of Aging and Social Policy. Winter.
Weller, C., and Baker, D., 2005, ``Smoothing the Waves of Pension
Funding: Could Changes in Funding Rules Help Avoid Cyclical
Under-funding?'', Journal of Policy Reform 8, No. 2:131-151.
Weller, C., and Jenkins, S. 2007. ``Building 401(k) Wealth One Percent
at a Time: Fees Chip Away at People's Retirement Nest Eggs.''
Washington, DC: Center for American Progress.
Weller, C., Price, M., and Margolis, D. 2006. ``Rewarding Hard Work:
Give Pennsylvanians a Shot a Middle Class Retirement
Benefits.'' Washington, D.C.: Center for American Progress and
Harrisburg, PA: Keystone Research Center.
Weller, C., and Wenger, J. 2008a. ``Robbing Tomorrow to Pay for
Today.'' Washington, DC: Center for American Progress.
Weller, C., and Wenger, J., 2008b, Prudent Investors: The Asset
Allocation of Public Pension Plans, PERI Working Paper No. 175,
Amherst, MA: Political Economy Research Institute.
endnotes
\1\ It is also important to note that voters are not consistent,
even when they profess support for a particular policy proposal
(Madland, 2008). In other words, policymakers need to be mindful that
promises of a single policy approach could quickly encounter opposition
due to ideological predispositions. Instead, policymakers will need to
take a pragmatic approach and promote all efficient policy options to
increase retirement savings.
\2\ The trends look very similar when the share of workers who have
access to an employer-sponsored retirement plan is considered (Purcell,
2008a).
\3\ Calculations based on Board of Governors (2008).
\4\ Calculations based on BOG (2008).
\5\ Calculations based on BOG (2008).
\6\ In addition, the evidence suggests that the existence of a loan
option may result in higher contribution rates (GAO, 1997). This link
should weaken, if it hasn't already done so, if default employer
contribution rates and automatic enrollment become more widespread,
since an ever smaller share of employees will likely make a
contribution decision that will differ from the employers' default
option. This follows logically from the fact that automatic savings
options are successful because they are taking advantage of people's
inertia. Consequently, more people, who otherwise would not have
contributed anything to their DC plan, will participate because it is
the default option and will contribute the default contribution rate.
The incentive provided by a loan option will thus be no longer
necessary and policymakers limiting loan options will not inadvertently
reduce savings incentives.
\7\ This proposal was introduced as House Bill 6250 and Senate Bill
1329 in 2006, which both propose the Michigan Retirement Program Act.
The act transfers Michigan's retirement plan to a private or non-profit
entity no later than five years after this act is passed. Michigan's
Department of Management and Budget would administer the retirement
plan and would be the sole fiduciary of any plan. Administrative
expenses would be paid by the participants and beneficiaries who have
not closed their accounts.
______
Chairman Miller. Dr. Ghilarducci.
STATEMENT OF DR. TERESA GHILARDUCCI, IRENE AND BERNARD L.
SCHWARTZ PROFESSOR OF ECONOMIC POLICY ANALYSIS, THE NEW SCHOOL
FOR SOCIAL RESEARCH
Ms. Ghilarducci. Thank you, Chairman Miller, for inviting
me to talk about guaranteed retirement accounts. As you
mentioned----
Chairman Miller. We just heard from four people about the
unguaranteed plans. So we thought we would have you come.
Ms. Ghilarducci. Yes, I like the placement. It does make
sense, because my proposal actually meets the principles of Dr.
Weller.
As we sit here, the number that you cited that most
Americans don't feel they can live comfortably in retirement
has only gotten worse. I mean, as we sit here, hour by hour, as
the market fails, and Peter Orszag's numbers get worse. The
panic now actually tops off chronic anxiety that we have been
seeing for the last 10 years, and that anxiety is caused by the
corrosive effects of 401(k) plans and other defined
contribution plans.
Despite a 30-year history with 401(k) plans and DC plans,
we have seen that we have not expanded pension coverage, we
have not increased the national savings rates. Though, we have
added to the profits of the financial sector and to the
expansion of the financial sector, and we have extracted ever
increasing tax subsidies from the Treasury.
Now every English major knows that if you show a gun in the
first act, it will be used by the last one. I am going to show
you $80 billion of tax subsidies. By the end of my
presentation, I am going to spend it, to help everybody.
Short term, I propose--and last week I did an op ed to the
New York Times--that the Congress allow workers to swap out
their 401(k) assets, perhaps at August levels, for a guaranteed
retirement account. Just a one-time swap, trade in your 401(k)
for a guaranteed retirement account that will be composed of
the equivalent of government bonds that pay 3 percent real
return, and the promise will be that when you collect Social
Security you can draw from that account balance for an annuity
that would top off your Social Security plan. That plan is
detailed in a longer paper that I have submitted.
How would this work? You go back to your districts and you
meet up with a 55-year old who had had $50,000 in his account
last month, and now has $40,000 in the account. He can swap out
that $50,000, valued in August, for that guarantee of what
would become, if he retires at 62, a $500 a month addition to
Social Security.
The economy is probably in recession. We economists don't
call it until after it is over. But a guaranteed income from
his 401(k) account could actually take off some anxiety that
that recession is going to cause him.
A long run solution is for you all to recognize that we
have a long-term retirement crisis. It is not in Social
Security, but it is in this heavily subsidized voluntary
commercial tier of retirement security. Half the workers have
not been covered at any one point in time by any kind of
retirement account. Most Americans, especially the folks in
your districts who are now under 60, are going to be at a real
risk of not even replacing 70 percent of their retirement
income.
I propose that every worker get a guaranteed retirement
account, that we mandate that they save 5 percent on top of
Social Security. That will, with a government credit of $600,
that will actually give every worker at least 1 percent
replacement rate, which will, on top of Social Security, give
you 70 percent replacement rate.
Where do I get that $600 credit for everybody? I mean
everybody, people who aren't covered. I get it from the $80
billion we now spend on DC accounts.
The way the government now encourages 401(k) plans is to
spend $80 billion in tax breaks, which, with Peter Orszag's
research, we know goes to the very highest income earners.
Fifty percent of these subsidies go to 6 percent of the
population. All that happens is that we transfer money from
taxed accounts to untaxed accounts.
Worse, this inefficiency is growing. If you look at your
Treasury numbers, the value of these tax expenditures to these
wasted tax breaks are projected to grow 49 percent, while those
for traditional plans are only going to fall by 8 percent. If
we implement automatic IRAs or we expand the 401(k) system, all
we are doing is adding to this inefficiency.
So I propose that Congress establish a universal pension
plan on top of Social Security, funded by workers' own
contributions but subsidized by a rejiggering of those tax
breaks so that everyone has $600 going forward every year into
their retirement account.
Thanks.
[The statement of Ms. Ghilarducci follows:]
Prepared Statement of Teresa Ghilarducci, Irene and Bernard L. Schwartz
Professor of Economic Policy Analysis, the New School for Social
Research, Department of Economics
As Congress reacts to the modern financial order changing forever,
we should also realize that individual retirement plans based on that
financial order, have also changed forever. In the last few weeks,
we've been confronted with older worker and retirees' lives being
turned upside down; their panic tops-off an already existing state of
chronic anxiety about retirement futures. Much of both--the panic and
anxiety--is caused by the corrosive effects of 401(k) and 401(k)--like
plans,\1\ including IRA plans. 410(k) plans have not expanded pension
coverage, increase the savings national rates; though they did add to
the profits and growth of the financial sector and extracted ever
increasing tax breaks from the Treasury.
Short Term Solution to the Retirement Crises
Short term, I propose that since 401(k) accounts and the like are
financial institutions--the bank about where 38% of the workforce\2\
can intend to save for their retirement--Congress let workers trade
their 401(k) and 401(k)--type plan assets (perhaps valued at mid-August
prices) for a Guaranteed Retirement Account composed of government
bonds (earning a 3% return, adjusted for inflation). When the worker
collects Social Security, the Guaranteed Retirement Account will pay an
inflation adjusted annuity, based on the accumulated funds.
How would this work? Take a 55 year old who had $50,000 in his
401(k) account in August and faces job loss and eroded assets because
of the erosion of his retirement accounts.\3\ Let him swap out the
$50,000 for a guarantee of $500 per month.\4\ The economy is probably
in a recession, but a guaranteed income from his former 401(k) removes
a source of financial anxiety, and--this is not trivial--it end
fruitless discussions with brokers and financial sales agents, who are
also desperate for more fees and are often wrong about markets.
Long Term Solution to Eroding Retirement Income Security
Because there is a long run retirement crises, not in Social
Security, but in the heavily tax-subsidized, private, voluntary, and
commercial tier of our nation's retirement income security system,
about half of workers will not have enough income after age 65 to
replace, the bare necessity, 70% of their pre-retirement income
according to Boston College's Retirement Risk Index. The erosion is
primarily caused by Congressional bias towards 401(k) plans, their
fundamentally flawed design and little regulation.
Going forward, I propose Congress establish universal Guaranteed
Retirement Accounts and the federal government deposit $600 (inflation
indexed) in those Guaranteed Retirement Accounts every year for every
worker.
Every worker (not in an equivalent defined benefit plan) would save
5% of their pay into their Guaranteed Retirement Account to which the
government pays a 3% inflation-indexed guaranteed return. Workers would
earn pension credits based on these accumulations.
The 5% target comes from the basic math that an average earner
saving 5% of pay over a life time with a guaranteed 3% rate of return
plus inflation would supplement their Social Security benefits to
achieve a 70% replacement rate at retirement. In other words had GRA
been in effect instead of 401(k) plans an average earner reaching 65
today would have accumulated enough to pay about 1% for every year of
service. (This rate is equivalent to the average defined benefit
pension plan payout because it its inflation indexed.)
This basic math, though, comes up against the basic reality that
many Americans can not afford to save that much. That is why workers'
contributions would be mitigated by a $600 a year contribution from the
federal government indexed for inflation which will be paid for by
scaling back substantially the tax breaks for 401(k) type accounts. The
$600 defrays the expense for most low and middle class workers (it pays
for all the contribution for a minimum wage worker). Employers could
top it off, pay a portion, and workers could add to it.
Advantages of a GRA?
First, this is a fiscally responsible plan. Rearranging tax breaks
is revenue neutral, efficient and fair because the current tax
breaks.\5\ High-income earners get a much higher subsidy than anyone
else because they are more likely to have a 401(k) and contribute
more.\6\ This design has shocking results: 6% of taxpayers with incomes
over $100,000 per year get 50% of the tax subsidies.\7\ And, for all
this effort, the nation gets no extra savings and workers no extra
retirement security (see Appendix). At most, this complicated system
creates economic activity when accountants happily transfer money
between taxed accounts to tax-sheltered accounts and tax payers foot
the bill.
Worse, the inefficiency is growing: the value of tax expenditures
for DC plans is projected to grow 49 percent while those for
traditional plans are projected to fall by 8.9 percent between 2009 and
2013. The sooner we admit that our 30 year experiment with 401(k)
accounts has failed the sooner we can use these precious government
subsidies efficiently and equitably.
Second, GRAs are responsible because they are prefunded. A
government agency connected to the Thrift Savings Plan and Social
Security (for administration efficiency) governed by trustees
representing workers, business, and the public, invests the GRA
contributions in a range of assets, like the sovereign wealth funds of
Alaska, Alabama, New Mexico Wyoming, and many other nations do to
ensure the federal government can pay a 3% inflation-indexed rate of
return to the Guaranteed Retirement Account lifetime annuities.
Third, GRAs are universal;
Fourth, GRAs provide adequate retirement income and encourages
people to save more;
Fifth, the money is locked away until retirement;
Sixth, the payout is for a person's life;
Seven, every America has the opportunity to save in a low cost,
professionally managed account with guaranteed returns.
GRAs are better than automatic IRAs. Automatic IRAs add complicated
requirements on small and medium sized employers. Automatic IRAs expand
the risks workers already face in individual retirement account plans:
the risks they won't save enough because of high fees and wrong in
investments choices; the risk financial markets tank, the risk of
inflation eroding income and that you will out-live your money.
Automatic IRAs cause deadweight losses to the economy because, net of
fees, 401(k) and other individual retirement accounts are among the
lowest earning among all financial vehicles. Add the risks of
preretirement--withdrawals, moral hazard, and adverse selection
Automatic IRAs would entrench inefficiency and risk and a dollar of
retirement income becomes more expensive to fund. Automatic IRAs are
worse than nothing.
Disadvantages of GRAs
Scaling back 401(k) deductions going forward may put pressure on
vendors to lower fees and boost returns. Also people like the option of
saving at work for hardships. Fine, Congress may to subsidize
precautionary savings but don't call them retirement accounts. Put them
in a separate category.
Should we mandate savings in a recession? Yes, as long as fiscal
policy provides for short term stimulus. No one is proposing we suspend
Social Security taxes in recessions. Households need a source of
disciplined savings over the business cycles; it is not the job of
households to go in debt and spend wildly to get us the nation out of
recessions. This ethos--debt-led consumer spending--got us in the
trouble we are in.
Predicted Popularity of Guaranteed Retirement Accounts
Even before the financial crises of September 2008, workers are
catching on that Congress needed to provide more secure sources of
retirement income security.
Surveys show less than 50% of people think they will live
comfortably in retirement and, crucially, that they bear personally
responsibility for their supplements to Social Security benefits.
Though they accept the responsibility--they want the government to
help.\8\ Over 77% of people support mandated pensions.
In 2006, HSBC bank asked 21,000 workers in 20 nations what the
government should do about the expense of aging societies- on average,
workers preferred compulsory savings to any other policy. A third of
Americans wanted the government to force them to save more for
retirement; far fewer; 16% would support a tax increase; and, only 9%
wanted the government to reduce benefits.\9\
In October 2007, a whopping 91% of Americans told a Wall Street
Journal poll that the government should do something to secure
retirement and 41% said they were not hearing enough from the
Presidential candidates about retirement income issues.\10\
Conclusion
American workers know we have a short term and long term pension
crises but it is not with Social Security but with the voluntary, self-
directed, commercial-account-based pension system. The loss of
retirement security is a reversal of fortune and the result of very
specific flawed governmental policies that have been biased toward
401(k) plans, rather than the result of technological change or the
logical consequences of global economic trends. That is the good news.
Government policies eroded pensions government can help secure workers'
retirement futures. If you implement the short term 401(k0 asset swap
and Guaranteed Retirement Accounts, we can look back at the financial
crises and bailout and know Congress did permanent good for workers'
retirement income security.
TABLE 1
------------------------------------------------------------------------
2009 growth to
Tax Subsidies for Retirement Plans 2009 ($ Billion) 2013 estimated
------------------------------------------------------------------------
DB plans............................ $45.67 Billion -8.9%
401(k) (325 B) Individual retirement $75. 70 Billion 49.5%
plans and Plans covering partners
and sole proprietors (``Keogh
Plans'')...........................
------------------------------------------------------------------------
EBRI calculations Original data from Executive Office of the President,
Office of Management and Budget, Analytical Perspectives, Budget of
the United States Government, Fiscal Year 2009 www.whitehouse.gov/omb/
budget/fy2009/
appendix: the savings paradox
Savings rates should be higher now than at any time in the history
of the United States. The American workforce has never been more
educated and people with more education save more. Middle-aged workers
save more than any other age group and there are an estimated 73
million baby boomers in the U.S. who are between age 48 and 63 in 2008.
High income people have higher savings rates the richest Americans have
gained the most income since the 1990s. Further, as national income
grows the demand for normal goods grow because when people have money
they buy more of what they want Ipods, better health, and retirement
``leisure:'' witness the 1960s and 1970s, when, as the economy grew,
older people lived longer AND retired earlier.\11\ And, in an attempt
to further increase retirement savings Congress has relentlessly
expanded tax breaks for retirement savings since the 1980s.
The value of the favorable tax treatment for retirement savings is
at an all-time high 110 B, while its effectiveness is at an all time
low.
To be clear, saving is hard. Humans often lack the foresight,
discipline, and investing skills required to sustain a savings plan.
But human characteristics haven't changed as much as retirement savings
as eroded.
The deep decline in national savings rates showed up in the 1990s
when employers started to reduce their contributions into defined
benefit pension plans,\12\ these plans were a main driver of national
savings. The expansion of 401(k)-type plans did not boost savings for
three reasons: they supplanted already existing defined benefit plans,
were cheaper for the employer, and did not expand pension coverage to
people who had no pension plan. This is surprising: although 401(k)--
type plans are growing,\13\ they don't expand pension coverage.
Instead, they replace existing traditional pension plans. When groups
of workers who ordinarily don't have pensions get them--poultry
workers, janitors, home-health care workers, etc.--it is most likely
because they are included in a newly negotiated collectively-bargained
defined benefit plan.\14\
Defined benefit plans are institutionalized, contractual forms of
saving that happen automatically at work. Workers have little
discretion about whether to save or spend. Workers can't opt out,
decide how much to invest, or take out lump-sum payments without
difficulty. Even though 401(k) plans do not increase pension coverage
nor secure retirement income, people like their portability and like to
watch their individuals accounts grow. People do not like the financial
and investment risks, or the risks of outliving their money, inherent
in 401(k) accounts.
Therefore we understate the true spending on pensions because the
U.S. Government maker uses ``tax expenditures''--the value of the tax
code's exemption of income generated for certain activities--to
encourage workers and the nation's business owners to spend their
income in socially approved ways.
In 2007, Social Security and Medicare cost $800 billion. Tax
expenditures for retirement plans--traditional employer pensions
(defined benefit plans), 401(k) plans, Individual Retirement Accounts,
other savings vehicles dedicated for disbursement at older ages, and
exemptions of Social Security and other federal pensions from tax--
totaled over $156 billion in 2007.\15\
In 2004, taxes not collected on pension contributions and earnings
equal a fourth of annual Social Security contributions and, at over
$114 billion, are perversely larger than household saving of over $102
billion.\16\ The tax breaks were supposed to expand pension coverage
and increasing retirement security.
Pension tax breaks are deductions from income; high-income earners
get more breaks than low-income workers. If a lawyer earning $200,000
makes a $1000 contribution to his 401(k) plan, he reduces his income
tax by $350. If his receptionist, earning $20,000, makes the same $1000
contribution (which is much less likely), she will save only $150 in
taxes. The Brookings Institution and Urban Institute calculate that the
3% of taxpayers with incomes over $200,000 per year get 20% of the tax
subsidies.\17\ And, for all this effort, the nation gets no extra
savings. At most, this complicated system creates economic activity
when accountants happily transfer money between taxed accounts to tax-
sheltered accounts and tax payers foot the bill. The value of tax
expenditures for 401(k) plans is projected to grow 49 percent while
those for traditional plans are projected to fall by 2.1 percent
between 2009 and 20013.\18\ (The estimated tax expenditures for 401(k)
plans, Individual Retirement Accounts, and Keogh plans in 2009 is
estimated to be $75.1 billion and for defined benefit plans $45.7
billion.)
In sum, the shift towards 401(k) plans increases tax expenditures,
does little to expand retirement savings, and favors workers who need
the help least. All told, the tax subsidies are not meeting a public
purpose. The top heavy benefits for 401(k) plans create a sad paradox:
since 1999, tax expenditures for retirement plans grew by 20%, while
retirement plan coverage fell.
401(k) plans Exist Because They are Cheaper for Employers; but they
Earn Subpar Returns
If 401(k) plans are so bad why are there so many of them? Though
workers don't gain much from 401(k) plans, some employers and Wall
Street firms do. I followed 700 firms over 17 years and found that
firms that adopted a 401(k) lowered pension expenses by 3.5--5% without
sparking worker complaints.\19\ Since 401(k) plans are voluntary, many
(about 20%) workers who can don't bother to contribute ``leave money on
the table'' by not accepting the employer match. Employers'
contributions are 26% lower than they would be if everyone
participated.\20\ Employers could pay the match to every worker, as
they do under defined benefit plans. Because workers have to trigger
the match, and some don't, 401(k) plans boosts profits at the expense
of retirement income security. Firms find sponsoring 401(k) plans is
more profitable than sponsoring defined benefit plans. For firms,
defined contribution plans are less costly, less risky, and can be
funded with their own stock, not with hard cash.
Wall Street firms collect over $40.5 billion annually in 401(k)
fees.\21\ Yet, brokers and human resources often tell workers the fees
on their accounts are zero. A good way to see what workers lose when
they invest in a 401(k) plan rather than a group--based pension fund is
to compare what each earns after fees are subtracted. A comprehensive
study by Dutch and Canadian researchers Ron Bauer and Keith
Ambachtsheer\22\ found that U.S defined benefit plans--where
individuals do not direct their own accounts--earned a 2.66% higher
return NET of fees on equities than did retail mutual funds. In Canada,
the skim was even higher; the retail mutual funds earned 3.16% less.
(These shortfalls are the averages for the 25 year period between 1980
and 2004.) The gap makes sense--investing in retail funds means
investors pay for advertising, shareholder profits, and glossy
brochures. Add the fact that workers buy high and sell low--because
people follow the leaders and buy stock as its rising in value and sell
when its falling--and you have self-directed accounts earning much
less. This isn't just a leakage, it's a levee break. Hidden from view,
workers are unwittingly transferring huge sums of money to financial
firms.
The unpublished report confirmed that the GRA 3% real rate of
return was a conservative long-run estimate under a range of plausible
investment strategies that a government agency could undertake and not
take any substantial risk of underperforming.\23\
endnotes
\1\ 401(k)--type plans are defined contribution plans include and
include the following: 401(k) plans [about 80% of participants in
defined contribution plans are in 401(k) plans]; profit sharing plans;
money purchase plans; individual retirement accounts; and 403(b) plans
which are 401(k) plans for employees in the public sector.
\2\ Center for Retirement Research Boston College. 2004.
``Eligibility and Participation in 401(k) Plans by Age, 2001 and 2004''
http://crr.bc.edu/frequently--requested--data/frequently--requested--
data.html accessed October 4, 2009.
\3\ Note the macroeconomic destabilizing effects of 401(k) plans--
and all defined contribution plans--when asset values go down; people
increase their job search just when jobs become scarce. This makes the
recession worse.
\4\ This is what the annuity would pay at a 3% inflation rate and a
3% real return.
\5\ The GRA plan as written is budget neutral. If we allow tax
breaks for the first $5000 in voluntary 401(k) contributions the plan
will cost $25 billion. But know that accounts that allow hardship
withdrawals are savings for hardship which is different from retirement
income security.
\6\ Because the tax subsidies come in the form of tax deductions
and not credits they are regressive. For example, if a lawyer earning
$200,000 makes a $1000 contribution to his 401(k) plan, he reduces his
income tax by $350. If his receptionist, earning $20,000, makes the
same $1000 contribution (which is much less likely), she will save only
$150 in taxes.
\7\ A good paper on the distributional effects of the tax
expenditures for DC plans is Burman, Leonard E.,William G. Gale,
Matthew Hall, and Peter R. Orszag. 2004a. Distributional Effects of
Defined Contribution Plans and Individual Retirement Accounts.
Washington, D.C.: Urban-Brookings Tax Policy Center.
\8\ Madland, David. 2008. ``Reforming Retirement: What the Public
Thinks.'' For the Georgetown University conference on ``The Future of
Retirement Security.'' Held October 3, 2008. department of History
\9\ HSBC Bank. ``How should governments finance ageing
populations'' http://www.hsbc.com/1/PA--1--1--S5/content/assets/
retirement/2006--for--news--release--final.pdf.) HSBC. 2007. ``The
Future of Retirement: What People Want.'' http://a248.e.akamai.net/7/
248/3622/7d1c0ed7aa1283/www.img.ghq.hsbc.com/public/groupsite/assets/
retirement--future/2006--for--what--people--want.pdf (accessed online
February 2, 2007).
\10\ Bright, WSJ.com November 2007 online Harris personal finance
poll
\11\ Ghilarducci, Teresa. 2008. When I am Sixty Four: The Plot
Against Pensions and the Plan to Save Them. Princeton University Press,
Princeton, NJ. Chapter 1.
\12\ Bosworth, Barry, and Lisa Bell. 2005. The Decline in Saving:
What Can We Learn from Survey Data?'' Unpublished draft written for the
7th Annual Joint Conference of the Retirement Research Consortium,
``Creating a Secure Retirement'' (Washington, DC, August 11-12, 2005).
http://www.bc.edu/centers/crr/dummy/seventh--annual.shtml.
\13\ 401(k)--type plans are defined contribution plans include and
include the following: 401(k) plans [about 80% of participants in
defined contribution plans are in 401(k) plans]; profit sharing plans;
money purchase plans; individual retirement accounts; and 403(b) plans
which are 401(k) plans for employees in the public sector.
\14\ From 1999-2005, the correlation between defined benefit
coverage growth rates and pension coverage growth rates was 79%, while
the correlation between defined contribution and pension coverage
growth rates was a negative 10%. Ghilarducci. Teresa. 2006. ``Future
Retirement Income Security Needs Defined Benefit Pensions.'' Center for
American Progress. www.americanprogress.org/kf/defined--benefit--
layout.pdf
Back in 1981, Congress rejected President Carter's Pension
Commission's call to reconsider the social value of these tax breaks
and create a mandatory universal pension system (MUPS). Because they
are designed to meet a social goal there were always conditions on
these tax breaks. When the federal income tax was implemented in 1913,
employer pension contributions were given special tax treatment only if
the managerial plans included most of the rank and file. This is in
direct acknowledgement that the tax breaks were targeted to the
wealthy. The wrangling--over how many tax breaks that higher income
employees get in exchange for how many lower paid workers are in
employer pension plans--continues to this day and is part of a healthy
process of assessing if the federal government tax breaks have the
intended effects. Instead, in that same year, Congress satisfied the
lobbyists for executives and made way for 401(k) plans by creating a
section of the tax code which allowed workers to save, pre tax, in
plans at work. After Wall Street firms and consultants successfully
marketed 401(k) plans, the rest--to use a shop-worn phrase--is a
history we all know: 401(k)-type plans replaced traditional defined
benefit (DBs) pensions.--over 63% of pensions are DC plans; whereas, in
1975, most pensions were DBs.
\15\ Employee Benefit Research Institute. 2008. ``Facts From EBRI:
Tax Expenditures and Employee Benefits: Estimates from the FY 2009
Budget.'' EBRI, 1100 13th St. NW #878, Washington, DC 20005. February
\16\ See Bell, Elizabeth Adam Carasso and C. Eugene Steuerle,
``Retirement Savings Incentives and Personal Savings,''Tax Notes,
December 20, 2004.for this provocative insight.
\17\ A good paper on the distributional effects of the tax
expenditures for DC plans: Burman, Leonard E.,William G. Gale,Matthew
Hall, and Peter R. Orszag. 2004. ``Distributional Effects of Defined
Contribution Plans and Individual Retirement Accounts.''Washington,
D.C.: Urban-Brookings Tax Policy Center.
\18\ Employee Benefit Research Institute. 2008. ``Facts From EBRI:
Tax Expenditures and Employee Benefits: Estimates from the FY 2009
Budget.'' EBRI, 1100 13th St. NW #878, Washington, DC 20005. February
\19\ Ghilarducci and Sun 2006. How Defined Contribution Plans and
401(k)s Affect Employer Pension Costs: 1981-1998.'' With Wei Sun.
Journal of Pension Economics and Finance, 5(2): 175-196
\20\ I used information from Munnell and Sunden. 2004. Munnell,
Alicia, and Annika Sunden. 2004. Coming Up Short: The Challenge of
401(k) Plans. Washington, DC: Brookings Institution Press to get
participation rates, average contribution levels by earnings, the
distribution of employees by earnings (Calculated from the CPS (2003)
to make the three billion dollar estimate. The average savings per
worker is $156, calculated for their sample of over 800 employees in
one firm that the employer saved over $250 per older worker who did not
participate in the 40(k) even when they were eligible. Choi, James J.,
Laibson, David I. and Madrian, Brigitte C.,$100 Bills on the Sidewalk:
Suboptimal Investment in 401(K) Plans(August 2005). NBER Working Paper
No. W11554. Fidelity's (2004) annual report documents employers' match
behavior.
\21\ There are $2.7 trillion in 401(k) assets Employee Benefit
Research Institute. 2007. ``401(k) Plan Asset Allocation, Account
Balances, and Loan Activity'' An Information Sheet from the Employee
Benefit Research Institute (EBRI). www.ebri.org/pdf/
InfSheet.QDIA.23Oct07.Final.pdf. The average fee is over $700 per year
and average fees are 1.5% of assets which equals $40.5 billion.
\22\ Ambachtsheer, Keith, Bauer, Rob. 2007. ``Losing Ground.''
Canadian Investment Review; Spring, Vol. 20 Issue 1, p8-14.
\23\ My report for the Economic Policy Institute explains the GRA
plan in depth Ghilarducci, Teresa 2007. ``Guaranteed Retirement
Accounts Toward Retirement Income Security'' Economic Policy Institute,
1333 H Street, NW Suite 300, East Tower Washington, DC 20005-4707 (202)
775-8810, Economic Policy Briefing Paper #204, November 20.
______
Chairman Miller. Thanks very much. Well, if I may
characterize what I heard, we are talking about a system--a
number of you touched on broader pension issues, but with
respect to the 401(k), it appears to be a plan that is not
really well devised for the changes in the market, that we load
an awful lot onto the back of the individual. I have been to
more seminars and conferences where they ask for more and more
education about savings and investing.
But we keep asking this person to get smarter and smarter
about their savings, and that is sort of it, and they are on
their own. Then the market takes an abrupt turn, or they are
not tuned in, they don't see it, and all of a sudden their
future has changed to some extent.
I think the key point raised by Dr. Ghilarducci and, Mr.
Orszag, I direct this to you, is that we have invested $80
billion a year into subsidizing this activity which originally
I thought was sort of a savings plan and now it has become a
retirement plan. I don't know when it changed, but now
everybody is told that is their retirement supplement.
Again, it appears that while we lament it all the time, the
savings rate isn't going up with the investment of this $80
billion. In fact, it is probably going down. It has been on a
downward trend a number of years.
What is the policy? What do we have to start to think about
in Congress about whether we want to continue to invest that
$80 billion for a policy that is not generating what we now say
it should?
Mr. Orszag. Let me say three things. Let me start with your
comment about 401(k) plans because they involve shifting two
things onto workers. The first is risk and the second is
decision-making responsibility. That first shifting of some
risk is unavoidable to the design of a 401(k) plan as opposed
to a defined benefit plan. It is who bears the risk.
The second part though, in terms of decision-making
burdens, we could do a lot more to help workers, and we are
starting through the Pension Protection Act and what have you
to help workers. I would raise a big caution flag about the
benefits that we should expect from financial education. I
think as we look back over the history of financial education
efforts, I am starting to become increasingly skeptical that
they work. And we can talk more about that.
The second part of this is now what about the tax
preferences for 401(k) plans. We have designed them relatively
inefficient. They are tilted towards higher income households
because they are linked to your marginal tax rate. So you put
$1 into a 401(k), and you are in the 15 percent tax bracket,
you are saving 15 cents. If you are in the 35 percent tax
bracket, you are saving 35 cents. That would make sense if
higher income workers are more responsive to the tax incentive
or were more deserving of financial assistance. I think it is
hard to make the argument in either case that this is an
efficient approach.
The idea has already been mentioned that instead of that
you could on a revenue neutral basis take that same amount of
money and when you put $1 in, you get 35 cents if you are high-
income worker and 15 cents if you are a middle-income worker,
everyone gets 20 or 25 cents matched into their account on a
revenue neutral basis. That would arguably not only be more
fair, but do more to promote retirement saving. Here is the
reason.
High income households are much more likely to have other
assets that they can just shift into the 401(k) plan. So that
dollar showing up into the 401(k) plan is much less likely to
be new saving as opposed to just shifting from a nontax
preferred account if it comes from a high-income worker than if
it comes from a middle-income or low-income worker.
So the more you tilt the tax benefits towards low-income
workers and middle-income workers, the more likely it is that
you are on net raising total savings as opposed to just
sloshing funds around, in addition to any distributional
concerns you would have.
The final point is I think the entire history of trying to
promote retirement saving through the tax preference reflects
an over emphasis on what I call Econ 101 thinking. I think we
need to dial way down Econ 101 thinking and dial way up
Psychology 101 thinking in not only retirement saving but in
health care and lots of other areas, and thinking that we are
all hyper rational super computers that are just optimizing our
lifetime income and behaving perfectly rationally is not likely
to correspond to actual behavior.
Chairman Miller. With the indulgence of my colleagues, I
would like to ask one more question because of the title of the
hearing. Given that this is what is going on out there, and we
had a housing crisis in the eighties and sort of in the
nineties, and we had a tech bust, and now we have a combination
of all of those, and we are talking about people who appear at
the outset that they may not have the ability to recover those
assets for the purpose for which they were going to use them.
We know that people not only are losing money in the
market, but huge numbers of people have tapped the equity in
their homes, and as a result of the housing crunch and the
market's failure, they are also getting credit card bills with
new higher interest rates or cutting off their lines of credit,
and wages haven't kept up terribly well. That is a very bleak
picture, from where I sit.
But we have these studies on whether people will be able to
recover or not. Mr. VanDerhei, you have talked about this long-
term study that you have done. I just want to ask, and if you
can touch on it because I would like to come back to it in the
next round, but what do you anticipate and, Peter, this has a
lot of other policy considerations for the Congress because
these people could end up using a lot more public services
later in life, but what do you really think about the ability
of these families or individuals to recover sufficiently to
provide for the retirement that they were considering in
January 1 of this year?
Mr. Orszag. Well, other than dramatic asset recovery, I
mean financial market booms which may or may not happen that
can offset the losses, there are basically three things: You
can spend less now and save more to offset it; you can spend
less when you retire; or you can retire later. You have to
respond in one of those three ways, other than just hoping for
a financial market recovery, which may or may not happen, and
is not a wise or prudent course to adjust to a financial market
downturn like we are experiencing.
Chairman Miller. But in one of those three options you are
suggesting that people would be able to continue to provide
something for savings.
Mr. Orszag. Well, this is just simple accounting, in some
sense. One way you can adjust is by saving more and spending
less today. By the way, in the very short run that will
adversely affect the overall economy. In addition to the
financial market downturn that we are experiencing, I think it
is implausible that, given the employment numbers that we are
seeing and the strength of the credit crisis that we are
experiencing, that this period will ultimately not be termed a
recession. In that environment, having households spend even
less is exactly the opposite of what you want in the short run.
Chairman Miller. Thank you.
Mr. VanDerhei.
Mr. VanDerhei. I certainly agree with everything Peter just
stated. One thing that might be instructive to take a look at
is in 2003 EBRI actually did a series of simulation models for
the various States to show what this type of impact would be on
their Medicaid system. One very important point of that is as
these individuals hit retirement age, if they have insufficient
assets what is going to happen with respect to the potentially
catastrophic health care costs they have, which are not being
picked up obviously by Medicare, more and more of this is being
shifted in our modeling to the State governments through their
programs as far as picking up the overall things like nursing
home costs.
Chairman Miller. Mr. Bramlett.
Mr. Bramlett. Just in terms of more of a long-term issue
and then talk about the short-term issue. This issue of fees I
think is--we just don't talk about it enough. We have gone----
Chairman Miller. I try. God knows, I try.
Mr. Bramlett. We have gone from an economy that 2 percent
of the GDP's earnings were from financial institutions to over
20 percent. That is a tenfold increase in 20 years. We have
gone from the estimated cost of securities intermediation from
$2.8 billion in the last 28 years to $528 billion.
To quote John Bogle here, ``Does this explosion
intermediation cost create an opportunity for money managers?
You better believe it does. Does it create a problem for
investors? You better recognize that too. For as long as
financial service systems delivers to our investors in the
aggregate, whatever returns our stock and bond markets are
generous enough to deliver, but only after the cost of
financial intermediation are deducted. These enormous costs
seriously undermine the odds in favor of success for our
systems who are accumulating savings for retirement. A loss, as
we all know, investor fees are at the bottom of the costly food
chain.''
Then he goes on to say, ``In any event, we are moving, so
it seems, towards becoming a country where we no longer are
making anything. We are merely trading pieces of paper,
swapping stocks and bonds back and forth to one another and
paying our financial properers,'' I think that is somebody who
works a roulette wheel, right--``a veritable fortune. We are
also adding even more costs by creating even more complex
financial derivatives in which huge and unfathomable risks have
been built into our financial system.'' And it is this
implosion that we are seeing right now.
Chairman Miller. Quickly. Did you want to finish?
Mr. Bramlett. The only other thing I would say is that
where we are today, it is not inconceivable--I don't think a
huge program that rescues a system is something that would
necessarily be good for the system. But I think that there will
have to be adjustments made, and I think those adjustments need
to be made in that area.
Chairman Miller. Dr. Weller.
Mr. Weller. I think we have to realize we have had massive
losses, and they came very quickly in the last year. A lot of
them in terms of absolute amounts are concentrated especially
among those nearing retirement. I was recently asked what I see
as the biggest challenges to retirement savings, and the answer
is, quite frankly, the labor market. We have had the weakest
labor market performance since the Great Depression in terms of
jobs, wages, and benefits. I think we need to focus on getting
people good jobs that will allow them to save rather than
crossing our fingers that somehow asset values will rebound
from the current downtime.
Chairman Miller. Thank you.
Dr. Ghilarducci. Sure. Do what you can. You added on a
stimulus package to help out the job loss and the recession.
But to refer back to retirement income security, I propose that
you treat 401(k) asset accounts like the banks and take some of
those toxic assets away from workers and give them a vehicle so
they know they can get a guaranteed retirement on top of Social
Security. That won't solve the recession, but it will certainly
help this problem we are talking about today.
Also, I am just very curious about Mr. Bramlett's testimony
because on one hand he gives a most powerful indictment of our
experiment with 401(k) plans. He says that the 401(k) plans is
actually a part of the problem of the meltdown in the financial
industry and the misstructuring of our economy, and yet he
wants to expand it with education programs from the DOL.
I really have one point here and that is to end the
experiment with tax subsidized 401(k) accounts as a retirement
vehicle. They are fatally flawed in a way that Mr. Orszag
pointed out. They are too risky, and it is not good policy to
have workers run their own retirement plan. They want
government help and they also want to be responsible.
So savings. And all sorts of studies shows that this is a
way that people actually become engaged in their own futures,
and they need Congress' help to do it in a secure way.
Chairman Miller. Thank you.
Mr. Andrews.
Mr. Andrews. Thank you, Mr. Chairman. Thank you for
convening us today at a time when these questions really need
to be asked and answered. I thank the witnesses for very
provocative, thought-provoking testimony.
Dr. Ghilarducci, I want to go back to the 55-year old
constituent that you hypothesized about and think about what
her situation looks like today. Let me first confess my bias. I
wish she were in a defined benefit plan. Because if she were,
the value of the fiduciary duty would have protected her. I am
not saying that defined benefit plans are immune from the virus
that is sickening the American economy, but I think my
constituents who are in them are a heck of a lot better off
than those who aren't today. That is something I think we
better think about.
But, second, I want to think about how she is faring if she
is in a defined contribution 401(k) type account. Dr. VanDerhei
tells us in his research that going into 2007, at the end of
calendar 2006, of people over the age of 55, about half of
them, 48 percent, had at least 70 percent of their assets in
equities. Now we don't know what those numbers are today, but
we do know that across the economy a lot of American investors
are rushing to the protection and security of Treasury bills to
protect themselves.
I want to explore what this 55-year old constituent's
options are today under the 401(k) regime; what she has going
for her, what her risks are. First of all, I don't know that
there are any data about how many plans do not have the option
of switching to an account that is largely government secure.
Does anybody know that? I think most plans have such an option.
But does anybody know how many plans or what percentage of them
do not offer that as an option to a participant?
Mr. Bramlett, Dr. VanDerhei.
Mr. Bramlett. You have government bonds, but they can go up
and down in the market. There is no government guarantee that I
am aware of.
Mr. Andrews. I didn't say guarantee, I said a plan that is
largely government securities. T bills.
Ms. Ghilarducci. You can go into cash or you can go into
government bonds. But that would not be a good thing to do now.
Mr. Andrews. It may or may not. The question I am asking is
I have this image of this 55-year old standing aboard the deck
of the Titanic as it is sinking and seeing other people getting
on lifeboats in the form of Treasury bills, escaping the risk
market to do that. How many of our 401(k) plan participants
don't have an option like that in their plan right now? Does
anybody know?
Mr. Orszag. I can't quote a specific number, but I think
the vast majority of 401(k) plans offer the option to go into a
fixed income kind of thing.
Mr. Andrews. Do you think we should require that all of
them offer such an option? What do you think?
Mr. Bramlett. I mean the risk in the U.S. Treasury is
essentially mainly inflation risk.
Mr. Andrews. Of course there are tips.
Mr. Bramlett. That as well. That is possible.
Mr. Orszag. You are asking a different question.
Mr. Andrews. I am asking whether we should require DC plans
to offer a government-fixed income type option as an option.
Should it be required?
Mr. Orszag. I think it is hard to make an argument
necessarily against that, although again I am not sure how
binding it will be because I think that option exists in most
cases.
Mr. Andrews. I think it does, too. Let me ask a second
question, which I think is more vexing. In 2006 we had a long
and tortuous debate over conflicted versus independent
investment advice. Looking at that debate in this context
becomes even more interesting.
The chairman and I were pretty steadfastly on the side that
any conflicted investment advice ran great risk, and I think
this is the day that we were talking about that coming.
It is my understanding that the Department of Labor is
considering two loopholes in a regulatory sense to the statute
that we passed in 2006; one dealing with the use of
subsidiaries and the other dealing with--I frankly forget the
substance of it, but two potential loopholes.
Does anybody on the panel think this is a good time to be
considering loopholes to the prohibition against conflicted
investment advice?
Mr. Bramlett. Absolutely not.
Mr. Andrews. Anybody else care to offer a thought on that?
I don't mean that to be a rhetorical question. There were good
solid arguments made in 2005 and 2006 that deregulation, to
coin a phrase, the deregulation of this ERISA provision was a
good idea because it would open up investment advice for people
who don't have it. In retrospect, that doesn't seem like such a
good idea to me.
Mr. Bramlett. In many ways, it is salt into the wound
because investment advice is a very simple, straightforward
thing that can be given at a very low cost across a broad
number of employees. We showed that at the 401(k) Company for
many, many years. It can be provided for literally pennies per
participant. To add that fee on top of all the other fees is
just another, to me, more salt in the wound.
Mr. Andrews. I see my time has expired. The comment I would
simply make is that one can only imagine the potential for
abuse in this kind of context where firms are starving for
cash, and a likely person to give bad advice to is someone who
has a modest 401(k) plan. This is an issue I think we have to
revisit. I, frankly, think the compromise we struck in 2006 is
not terribly workable or wise. I hope we are here to revisit it
in January, 2009.
Mr. Weller. I think it goes back to the question of is it
efficient; is it a good use of, in this case, investor dollars;
and in this case it probably isn't. And I am with Peter, I
think the value of financial education and financial advice is
often overstated. I think in terms of the regulation side, you
are better off just simply automating, for instance, default
investment options possibly giving some sort of guaranteed
income options in a 401(k). There is a bigger bang for the buck
for the investor.
Mr. Andrews. I think we also have to reexamine the
department's QDIA thoughts that happened before this crisis
came along, too. Thank you.
Mr. Scott. Mr. Chairman, thank you for holding the hearing.
Just following up, we have always had problems--some of us
have had problems with the idea that the investment adviser
would have a direct financial interest in your decisions, which
suggests that you may not get the best advice, you might get
the advice that would steer you to that particular product. And
in terms of what your investment ought to be, we have talked
about the safest investments. But isn't it true that long term,
if you are a young person, the safest investments through a
lifetime will offer you the worst returns?
Mr. Orszag. Yes. In general, when you reduce your risk
exposure, you are also reducing your expected return over long
periods of time.
Mr. Scott. We have talked about these defined
contributions. That is where you put in a defined amount of
money, and at the end what you see is what you get based on
whatever the market did.
Dr. Orszag, you mentioned how worse off people were after a
few months from this year. What were those totals again, 10
percent in last quarter and----
Mr. Orszag. So from the second quarter of 2007 through the
second quarter of 2008, the end of the second quarter, pension
plan assets combined, public-private defined benefit, defined
contribution, declined by about $1 trillion. Our estimates
suggest that since the end of the second quarter----
Mr. Scott. What does that mean to somebody's individual
account? What kind of percentage drop are we talking about?
Mr. Orszag. That is roughly a 10 percent decline in overall
pension assets. Again that includes defined benefit plans.
Defined contributions plans, actually, since they are weighted
slightly more heavily towards equities, the percentage may be
slightly higher.
Mr. Scott. What has it done since the end of the quarter?
Mr. Orszag. Roughly same decline since then.
Mr. Scott. So it is about a 20 percent drop----
Mr. Orszag. Yes.
Mr. Scott [continuing]. On average, in a defined
contribution plan. What does that mean to somebody's check upon
retirement? If they had retired back at the beginning of this
drop they would have made something. If they retired now, they
would be getting 20 percent less. Is that a fair estimate?
Mr. Orszag. From the retirement slice--and we need to
remember that for a significant share of the population, Social
Security is the bulk of their retirement income, and of course
that is not directly----
Mr. Scott. Just from the pension you are going to get 20
percent less by waiting----
Mr. Orszag. If they experience a 20 percent decline in that
account balance then a feature of the 401(k) system is in
general you have 20 percent less to consume in retirement.
Mr. Scott. You alluded to the Social Security part, which
you kind of inferred that that is a secure payment. If a few
years ago we had gone to this privatization thing and people
could be betting on the stock market, is it fair to say their
whole retirement would have dropped 20 percent if we had
privatized Social Security?
Mr. Orszag. That depends on the structure. Those plans have
different structures. It depends on the structure of the plan.
Mr. Scott. If you had gotten into a you can invest in your
own kind of thing, your retirement would have gone down with
the market.
Mr. Orszag. What is clear is that a lot of those plans do
have the feature of more financial market risk in the upside,
but more financial market risk is shifted to individual
workers. And in the current environment that would mean that in
general there would be a larger deterioration in retirement
prospects.
Mr. Scott. Mr. Weller, you mentioned something about a
stand-alone pension. If you have a defined contribution plan
where you have your own account, is that not stand-alone?
Mr. Weller. Those are stand-alone, but my remarks were
specifically toward targeting. If you think about what works in
the DB world, in the the defined benefit world, it is the
stand-alone entities, the Taft-Hartley plans in the private
sector, or the government pension plans. And I think it can
serve as a good model for the defined contribution world.
Mr. Scott. Now, on a defined defined benefit when you
suggested it is separate, is the defined benefit plan now part
of the corporate balance sheet?
Mr. Weller. The single employer plans are, and that does
create enormous conflicts of interests and created some of the
problems we have seen since 2001.
Mr. Scott. For example, underfunded funds.
Mr. Weller. Largely there are good strong incentives to
take advantage of the good times and basically take advantage
of contribution holidays in the public sector where we are
struggling with some of that, but the States are tackling that
aggressively by putting a floor, for instance, under employer
contributions. In the multi-employer plan and the Taft-Hartley
plan, the collective bargaining agreement actually sets a rate
of contribution into the plan and their contribution holidays
are less likely to happen.
Mr. Scott. A couple of years ago when this committee looked
into it, a lot of the major corporations in America were at
about two-thirds solvency. We considered legislation to try to
make them more solvent. If we separated it and required the
funds to be solvent, what effect would that have?
Mr. Weller. Well, it is hard to say. I think if you
generally, however, look at what employers wanted--and we had
substantial discussions during the negotiations of the Pension
Protection Act--what employers were were looking for in
particular was regular contributions. So I think if Congress
required or set up rules that regularized contributions to DB
plans, we would ultimately have better-funded plans and we
would have more of them.
I think the Pension Protection Act of 2006 went exactly the
opposite direction and made, for instance, the contribution to
pension plans much less predictable and ultimately led a lot of
employers to abandon their plans.
Ms. Clarke. Mr. Chairman, thank you so much for calling
this very timely hearing, and to each of the panelists thank
you for sharing your expertise today. I have to tell you that I
just got back from my district, and what we are talking about
here is flying above the heads of everybody. They are just
reeling from what is happening to them and are really in a
state of shock.
And so my question to you is really coming from the people
of the district. What they do understand is that we are in the
midst of a reorganization of our financial system. They do
understand that. Some people paint it as demise. But at the end
of the day, we are going to have a system. And they recollect
that there were tax cuts for the wealthy. That is a piece they
really, really, really remember. And in the midst of this
current financial crisis, they are trying to figure out, how do
I just hold on? How do I hold on and land safely and work
things through?
As a result of the current financial crisis, many of my
constituents are either borrowing or contemplating borrowing
from their 401(k) plans either in the form of a loan for
themselves, to themselves, or as a hardship withdrawal. These
actions either carry a penalty, hidden fees for early
withdrawal and/or possible exposure to additional taxation if
they are unable to pay back the loan.
In your opinion would it be appropriate for Congress, in
light of our current economic downturn, to repeal the penalties
and/or the imposition of taxes for withdrawals from 401(k)
plans?
Mr. Weller. A colleague of mine, Professor Wenger from the
University of Georgia, and I wrote a paper this summer on
401(k) loans. I think it is a fairly tough issue because a lot
of families need to take those loans. In our research we find
that they often serve for supplemental unemployment insurance
or supplemental medical insurance. I think there you could help
them out.
But on the other hand our research also showed that even a
small amount of loans can have severe impacts on retirement
security. For a typical average earner, $40,000 a year, if that
person took a $5,000 loan early in their career, and even paid
that off it can reduce their retirement savings ultimately by
15 to 20 percent.
So I think where we are at this point, my recommendation
would be to restrict access to loans to really just the
emergencies and maybe help out there. But we have,
unfortunately over time, moved towards making it easier for
people to rob their future retirement income security to pay
for their current financial security.
Ms. Clarke. I want to go back and, I am trying to recall
who it was who said we are actually dealing with a
psychological issue here. So when you talk about robbing your
retirement, people feel robbed right now. Right now. We want to
be very honest with the American people. We want to really deal
with this in a constructive way. People are trying to make ends
meet. And they feel like their life is in crisis right now,
whether they are ready to retire or not. And so the options to
them are few and far between.
Think about the psychology of that and looking at what is
happening with their 401(k) and trying to figure out mortgage
payment, or do I watch this 401(k) continue to diminish? Maybe
this is the time to do what I can, is reorganizing our
financial system to at least save myself for now.
Can anyone respond to that type of psychological pressure
that is hitting the American people right now?
Mr. Bramlett. Keep in mind the difference between financial
hardship and a loan. Financial hardship, you are taking money
out that can't go back in. There is a penalty. On a loan you
are actually borrowing the money from yourself. You are paying
yourself back, the money goes back into the plan. Ultimately
there are limits set on that, and basically whatever the
interest rate return is on the loan is the earnings that you
are getting on the loan. So to me it is fairly easy to
rationalize loans as a way of distribution.
Financial hardship is another thing, and that is a more
difficult thing. So it is a real challenge because they need it
now, but they are going to need it in the future. And with life
being extended, and it will continue to be extended, people are
going to be challenged in their older age. And so we have got
to find ways to help people keep money in these accounts when
it is very difficult and it is very challenging.
I don't want to sound harsh but there is a study recently
that said people's happiness maximizes at $17,000 a year, and
that is hard to believe. But the reality is that your basics,
once they are taken care of, you know, and in the future,
people in retirement may not be able to take care of their
basics. And so there may not be anybody there to help them. It
would be great to have across-the-board plans, but chances are
that is going to be challenging. But loans I think are a good
positive thing.
Ms. Ghilarducci. I just want to say that if you do that, if
you need to do that, then you just know that Congress should
just abandon the subsidies for 401(k)s going forward, because
those penalties were put in by Congress to preserve it for
retirement. If in a recession you now reduce those penalties,
then you have actually erased all the reasons to have those tax
subsidies. So if you do it, you can only do it once and, going
forward, don't have tax subsidies for the way that 401(k)s are
structured now.
Ms. Clarke. Just in closing, Mr. Chairman, the whole issue
of the loan, if you don't pay back the loan, the money is added
as income and taxed. Isn't that correct?
Ms. Ghilarducci. Yes. Right.
Ms. Clarke. So I think it is just important as we go
through this process for the layperson out there who is really
just trying to figure out what life needs to be like for them
right now, these are the types of bread-and-butter issues that
they are drawing upon right now. And they are looking to us to
come up with the best way to navigate and to hold onto the life
preserver. And they are looking at their 401(k)s, they are
seeing them shrink, and they are thinking my life preserver is
melting away before my eyes.
Thank you very much, Mr. Chairman.
Chairman Miller. Thank you. Mr. Sarbanes.
Mr. Sarbanes. Thank you, Mr. Chairman.
What is the credit access of retirees? In other words I
know that you can get a fair number of credit cards with pretty
high limits on them if you are a working adult. But what does
that world look like for your typical retiree? Anybody. Quick.
Mr. Weller. Well, the data does show that more retirees or
more older households have loans these days than in the past.
These data are before the current crisis, so we know for
instance increased access in particular for mortgages, that is
typically where we see the expansion of credit for older
households. Less so among credit cards.
Mr. Sarbanes. So reverse equity loans and so forth. They
are pulling the equity out of their homes essentially.
Mr. Weller. Yeah, or prolonging----
Mr. Sarbanes. So they don't have as much access to the
typical credit card, the value of their home is dropping, and
their retirement is sinking. So all the directions they could
turn to try to come up with dollars to get through the day
basically are on the downslope. So everything that is happening
right now is hitting them.
Mr. Weller. There are fewer job opportunities for them in
the current market.
Mr. Sarbanes. That is a fourth one.
Let me ask you this. I represent a district that has a very
high number of retirees and an increasingly high number of
retirees, so I am very sensitive to these issues. Do we have a
pension system in this country?
Ms. Ghilarducci. Yes, we have a tiered pension system. On
the bottom is Social Security. It is in pretty good shape. In
the middle tier are employer pensions subsidized very
generously by Congress. They are increasingly individual-
directed, they are defined contribution, and they are heavily
tax subsidized, and that system is eroding.
On top of that is personal savings which you just alluded
to is also eroding. There is in that top also home equity which
is an important part of our pension system. We don't usually
talk about that. But we have a pension system, but it is
increasingly only secure in the Social Security base.
Mr. Sarbanes. I guess what I am getting at is that doesn't
strike me as a system. If it is eroding, if two of the tiers
are eroding, how is that a system? And compare it if you could,
anybody who knows enough about it, to systems other places. Is
there any country out there that has a pretty decent system
that is not sort of eroding every time you turn around?
Mr. Bramlett. Well, there are the European systems which
are the strongest, but they are largely underfunded and they
also exclude a lot of people who are immigrants and so----
Mr. Sarbanes. Why are they the strongest quote-unquote?
What makes them strong?
Mr. Bramlett. They are the most comprehensive in terms of
coverage, from in terms of----
Mr. Sarbanes. Is there more of a public-private
partnership?
Mr. Bramlett. For instance in 2012, the U.K. Will have a
program that will require every single employer to contribute
to a plan which will be matched and employees will
automatically be defaulted into that, and it is called the
personal account. And so there are systems that are emerging
that are broad based, that are government mandated, that
require employer contributions and require employee
contributions and are not optional. And so those exist out
there.
And the issue I think, really, is how competitive can we be
on a worldwide basis with our own labor, in our own economic
system, if we have a hugely expensive pension system and people
are living very long and there is just no money there to pay
for it?
Mr. Sarbanes. If they don't have money then they can't buy
things, as Mr. Orszag was saying too, which is going to
undermine the economy.
Mr. Orszag. I think the defining characteristic of many of
those other systems is that they involve a mandate somewhere.
It is really hard to get to basically universal coverage on a
pension system solely through voluntary means. And so if you
are looking at, you had said, an eroding system which is
partially because we don't have anywhere near full coverage,
one of the reasons is that we do rely on incentives for both
planned sponsorship and then for participation. And you don't
get full kick to that, you don't get universal take-up in part
because it is optional.
Mr. Sarbanes. What I see here is that we really have like a
pension evaporation system in our country. And the problem is
we never told the retirees that that is what it was. We
actually represented to them, employers represented to them,
people that entered into collective bargaining agreements
represented to workers, et cetera, that we actually had a
pension system. And it turns out we don't really have a pension
system. And so a lot of these people who thought they were
going to be looked after in their retirement years are figuring
out where they are going to go get a job.
Mr. Souder. Thank you, Mr. Chairman. I am sorry, I was over
with AIG asking questions over there.
Chairman Miller. How are things going over there?
Mr. Souder. Pretty rowdy.
I have a general question first, and that is that in the
retirement funds, wasn't the higher--in other words if you
received higher benefits you were taking higher risks--maybe
you have covered some of this ground, but was that risk fully
disclosed?
Now what has happened here is that it was very hard to
predict the very high risk we have. But anybody who was trying
to maximize and got more return presumably had more risk. Could
you comment on that? Because part of the question here is that
while certainly some people scammed the system and should go to
jail and others manipulated the weaknesses in the regulation,
some of this was everybody was trying to maximize their return,
which encouraged people to take riskier and riskier subprimes
and all that type of thing. Would you kind of discuss that from
a retirement----
Mr. Weller. I would say we could definitely do more in
terms of disclosing and showing risks. By and large, especially
with the mutual fund industry, what you do is, what is your
attitude toward risk, and you check a few boxes and they put
you in the green bucket, the yellow bucket, and the red bucket,
red being the riskiest one, and you go on your merry way. There
is more you can do. There is a chance if you go in this red
bucket in your investments, your chance of losing 20 percent in
the next 5 years is much higher than if you stayed in the green
bucket. So there is definitely more to be done in terms of
disclosure.
But let me also say the one thing that Peter Orszag already
alluded to, we have to get back to psychology 101. We know that
people do make what seems irrational choices for economists. In
particular, about 20 percent of all 401(k) assets are in
employer stock. Peter had some numbers that 15 percent of
people have more than 90 percent of their money in employer
stocks. So that is one thing; the lack of diversification; the
phenomenon of buying high and selling low.
People started opening up subprime loan funds in 2006. That
doesn't seem like such a wise decision today. But clearly a lot
of people did. So clearly--there is not much that you can do in
terms of disclosure, you can't tell the participant at the
bottom of your fund prospectus ``Warning, your psychology may
lead you to make irrational choices.'' So I think we have to
think about how we can structure better 401(k) plans.
Mr. Souder. But one of the questions is, when people--my
fundamental question is: Is there anything that pays higher
return that doesn't have higher risk?
Ms. Ghilarducci. No, there isn't. But if the stock market
is going up, surveys show that more and more people will say
their stock market can never go down. Or more people will say,
yes, I can expect 8 percent return. All the retirement
calculators on the Web, all the financial education you get,
start with assuming you get 6 and then you get to choose
whether or not you want to assume 8 or 10 percent.
So we have an industry that actually wasn't up against
irrational humans, but actually knew these irrational humans
and made enormous profits. So the financial sector went from 2
percent of the economy to 20 percent on the backs of these
401(k) plans and on the backs of congressional subsidy. This
means, what Representatives Clarke and Andrews said, that all
the disclosure in the world would not fix the problem we have
now; that people who have these 401(k) assets have no flight to
safety. It is just practically not an option for them. They
didn't know they needed the safety. And if they do do it, they
are stuck with selling at the very bottom of the market. They
are instructed to not save anymore because Congress is not
helping them restructure their other debt.
Why don't you pass laws that make every credit card
company, every home mortgage, restructure the debt before you
have them go into the only asset they have? I would suggest
that.
So we have set up a system, and there is really no way of
fixing it on the margin, that requires people what they can't
have, and setting up a whole vendor, a commercial vending class
that will take advantage of what humans do when they try to do
something that they are not trained to do. It is fundamentally
flawed.
Mr. Bramlett. We need a paternalistic system. Except the
parents we have put in charge turned out to be--the furthest
paternalistic system has been the financial institutions. And
that is like the fox guarding the chicken house, as they say.
So, you know, there is what Teresa is saying is that what
the average person experiences in a stock plan in terms of
return is about half of what that actual fund actually
produces. And that is because they get in too late, and they
follow the returns in, that kind of thing. And there are all
kinds of reasons for this. The average turnover in a mutual
fund has gone from 20 percent in 1970 to 113 percent today.
What in the world has happened between 1970 and today that we
have had to have turnover go up from 20 percent to 113 percent?
So that the average stock being held in a mutual fund is like 8
months. Is that long-term investing? And why is it churning so
much? And how much expenses are being generated as a result of
that?
So yes, risky assets do. But people don't take advantage of
that return.
Mr. Bramlett. If I could just add and summarize briefly,
Congressman, you have identified exactly the right point, which
is that in general when you assume more risk you get a higher
expected return. However, there are two parts of the 401(k)
system where we need to modify that conclusion. First, people
assume too much risk that they don't get compensated for by
investing in a single stock, their employers', and way
overinvesting in that single stock and not diversifying. And
you don't get compensated for that so the normal trade-off
doesn't work. And secondly, as has already been mentioned,
administrative costs, especially on actively managed funds, are
higher than on passively managed index funds, and the academic
research suggests you don't get anything in return for those
additional fees. So many investors are overinvested in a single
stock instead of being diversified, and therefore they don't
get the extra return in return for extra risk. And then they
are overinvested in a high-cost fund which the research
suggests doesn't get you any extra return; you just pay higher
fees.
Chairman Miller. Mr. Kucinich.
Mr. Kucinich. Thank you, Mr. Chairman. I also just came
over from the AIG hearings, so if I ask any questions that have
already been answered, forgive me. But these are areas that I
think bear scrutiny.
A few years ago, there was a lot of talk in Congress about
privatizing Social Security, which meant that Social Security
would have bought into, quote, invested, unquote, in the
market. We know now that would have been an absolute disaster
for the American workers. As a matter of fact, I think it was
the Lehman Brothers, had holdings which included the country of
Norway's pension funds, invested in the U.S. market. And that
has gone down. What is going to happen to those people? We
don't hear much discussion about it. But it is in Norway.
I have for the record here, Mr. Chairman, without
objection, an article that says Norway's Finance Minister was
being summoned to the Parliament this week to answer questions
tied to investments made by the country's oil fund in a
bankrupt U.S. investment bank, Lehman Brothers. Without
objection.
[The information follows:]
[From Upstream, Wednesday, September 24, 2008]
Lehman Collapse Hits Oslo Oil Fund
By Upstream Staff
Norway's Finance Minister Kristin Halvorsen will address parliament
later this week after it emerged that the country's oil fund
substantially boosted its holdings in now-bankrupt US investment bank
Lehman Brothers in the final stages of the bank's collapse.
The move follows a report published in the Financial Times which
revealed that as the investment bank's share price fell to catastrophic
levels, some schemes invested heavily in Lehman shares, effectively
placing speculative bets that private or government groups would bail
it out.
Halvorsen initially refused to answer questions about the fund's
potential losses on the investment, but will now address parliament,
daily newspaper Aftenposten said.
According to the FT, the $346 billion Norwegian Government Pension
Fund--Global, the country's oil fund, looks set to be one of the
largest Lehman victims.
Norges Bank Investment Management (NBIM), the fund's investment
manager, added 15 million Lehman shares to its holding in the latter
phase of the collapse. This took the total number of shares held in the
bank to 17.5 million.
The FT said that, according to the shareholder database of Mutual
Fund Facts About Individual Stocks (MFFAIS), the scheme could face up
to $238 million in equity losses.
NBIM would not comment about any losses or the most recent value of
its holdings in Lehman Brothers.
An NBIM spokeswoman told the FT: ``We are very concerned and are
following the situation closely. But we only disclose our holdings once
a year in our annual report and will not comment on any single
investment.''
However, equity losses could be the least of the fund's worries. It
is believed that the fund has exposure to debt securities in Lehman, as
well as more holdings in Lehman subsidiaries and existing mandates and
contracts with the collapsed bank.
The losses will be difficult to calculate, the FT reported, at
least until the bank's remaining assets are sold off.
The report added that the oil fund has $779 million in Lehman debt
securities that are now trading at distressed levels. It also has both
bond and equity holdings in various Lehman subsidiaries.
______
Mr. Kucinich. I am looking at this report that Mr. Orszag
has done, and thank you for your excellent work, and you talk
about mitigating financial market risks by sensibly designing
pension plans. But here it is: If you had any degree of money
in the market one way or another you were putting aside for
your pensions, there are many people who have put themselves--
who are in a situation right now, where they are going to have
to continue working, right? Is that true?
Mr. Orszag. That is likely to be one response, yes. People
will live longer.
Mr. Kucinich. So somebody who may have been saving to
retire at age 64 or 65 is quite likely, as a result of these
circumstances with the market, could be working until they are
70 or more; is that not true?
Mr. Orszag. It is possible. One caveat is, and one would
expect that to be part of the response. One caveat is that in
response to the decline in the stock market in 2001 and 2002,
when you would have expected the same thing, the research that
has been done there doesn't suggest any significant effect on
delaying retirement post the 2001 decline.
But I would say that one would expect, again, at least
directionally, that one response would be to delay retirement.
Mr. Kucinich. And if people are delaying their retirement,
they are also wearing out at a faster rate physically. It is
just axiomatic. My concern is that with the Pension Benefit
Guaranty Corporation seeing even more stress as a result of
these circumstances, what do we say to all these Americans who
are on the threshold of retirement about what can the
government do? Maybe you have covered this already. But what
should we be doing to try to find a way to salvage the
retirement position of American workers?
You know, it seems that Congress--excuse me, with no
disrespect to anybody on this panel--rushed to protect Wall
Street in hopes that some benefits would trickle down to
workers, right? And the question is what should we be doing
apart from the bailout--which I voted against because I thought
it was a fraud--what should we be doing to help America's
workers right now? What kind of legislative action should we be
taking now?
Mr. Orszag. I would say three things. First, it is not
legislative but just a reminder, as you know, that for the
majority of American households in retirement, Social Security
does provide a majority of their income, and that is a base; it
is not a full solution, and it is not anything that anyone
would want to live on exclusively, but it is a base. Secondly,
that the best outcome for 401(k) balances will be a general
recovery of the economy and a general recovery of financial
markets so we can talk more about the steps that would bolster
the economy in the short run.
Mr. Kucinich. If we prime the pump of the economy, for
example?
Mr. Orszag. As I said earlier, I think at this point it is
very undoubtedly the case that when the official NBR committee
that looks back on these things looks back at this period,
given the strength of the credit crisis that we are
experiencing and therefore the further diminution in economic
activity that will come and the job losses that have already
occurred, it seems implausible to me that this period will not
be labeled a recession. In that kind of setting, there are
additional aggregate demand steps that could be beneficial.
Mr. Kucinich. Mr. Chairman, I just want to say--my time has
concluded for questioning--that I think Congress has a chance
here to really do something that will help pensions as well as
other areas by taking steps to have the government assume a
controlling interest in these mortgage-backed securities, so
that we can create a fix for people who are worried about
losing their homes, through changing the terms of their
repayments of their mortgage and also create jobs. This is
something the Chairman certainly knows about because this is
the religion that a lot of Democrats were raised on, priming
the pump of the economy, getting people back to work, help
people save their homes. And that has a percolating effect on
banks and on markets.
So I want to mention that, because apparently the market
isn't responding too well to the bailout and maybe we will get
a chance to do something else.
Thank you, Mr. Chairman.
Chairman Miller. I would like, to say you might want to
direct yourself--I know you came in late and didn't get an
opportunity to hear Dr. Ghilarducci's suggestions about
allowing a swap-out of 401(k)s for government bonds.
Mr. Kucinich. If you could, I would appreciate it if you
would just give me a synopsis.
Chairman Miller. I will let the author do that. I am
smarter than that.
Ms. Ghilarducci. I will do it in 15 seconds. I propose that
you offer up to 401(k) asset holders now a swap-out of their
toxic assets for a government guarantee, so you do for them
what you have done for the banks.
Mr. Kucinich. I am ready with the legislation, Mr.
Chairman.
Chairman Miller. You have to run faster than that. If I
might--thank you. Oh, Mr. Holt--I am sorry--Mr. Holt.
Mr. Holt. Thank you, Mr. Chairman, and thank you for
arranging this hearing. I thank the witnesses. I apologize for
arriving late. I was caught up on some of what has transpired.
I would like to ask Dr. Weller, if I may, a little about
the savings problem. You state that low- and middle-income
workers are particularly vulnerable in retirement because of
low levels of savings, and you suggest the use of various kinds
of progressive incentives.
Could you describe a little bit more, if you haven't
already put this in the record, dollar-for-dollar matching, tax
credits, et cetera, to encourage savings? And who would provide
those incentives? Is this going to be another obligation of the
Federal Government? How could that be done?
Mr. Weller. There are basically, the way I would describe
it, three different approaches. All would require essentially
taking back the current tax incentives for saving, largely tax
deductibility off contributions to qualified plans and
replacing them with something else. You have professor
Ghilarducci's proposal where everybody would get a $600 flat
amount.
You have the proposal of my colleague and friend, Gene
Spurling, where it would be a match of--I think 20 percent is
Gene's proposal, if I am remembering correctly. Again, it is
intended to be revenue-neutral in that case by taking back some
of the tax deductions that you have.
And then the third part that a number of people, including
myself, have proposed is to match--to give additional matches
to low-income people, let's say a 2-for-1 match or 3-for-1
match that would gradually be phased out. Again, that could be
done, either revenue-neutral by taking back some of the tax
deduction incentives that you have, or by taking back some of
the tax cuts that were implemented since 2001 and pay for that.
For instance, some of the estate tax reductions.
So those are generally the three approaches to make the tax
incentives under the current system substantially more
progressive.
Mr. Holt. Mr. Orszag, or others, would you care to comment
on the effectiveness of those kinds of incentives?
Mr. Orszag. I would say the effectiveness of the current
tax system is relatively low in encouraging net additions to
saving. And I touched upon this earlier. But the reason is that
the current tax incentives are tilted towards--for each dollar
of contribution--towards higher income households who more
easily can shift assets, and the evidence suggests that is what
they do. They shift assets from tax accounts into the tax
preferred accounts, and when you are just shifting assets
around you are not getting any new saving.
So a lot of these ideas are aimed at trying to focus
incentives on lower- to moderate-income households who don't
have as many other assets, and therefore any dollar--any assets
outside of retirement accounts--any dollar that shows up in a
401(k) plan from them is much more likely to be new saving
rather than just asset shifting. And that is important.
Mr. Holt. Dr. Ghilarducci.
Ms. Ghilarducci. I used to be a fan of progressive
incentives, and that experiment is over. My reading of the
research is that the systems that work, either in this country,
and when people are--defined benefit systems, big employer
groups, or, in the Netherlands, Australia, and in other
systems--the only thing that works is a mandatory tier on top
of a basic state plan. In this country it would be Social
Security.
So I have proposed a mandatory universal pension system on
top of Social Security where workers would save 5 percent of
their income all their working lives and much of that would be
subsidized by a rearranging of the government subsidies that we
have now that don't work for 401(k).
Mr. Holt. Quickly in the moment I have remaining, let me
ask about what appears to be a disincentive, which is something
known as ``reserve plus'' that allows you to have a debit card
where you can draw on your 401(k), pay it back over 60 months
at 2.9 percent above prime. Should we allow that?
Mr. Weller. I am usually not a big fan of outlawing
financial products, but I call this the subprime version of the
401(k) world, yes. Because it is exactly 3 percent more. It is
enormously punitive. It is exactly the wrong direction to go in
401(k)s.
I know that Members of Congress have proposed outlawing it,
and I think that is probably the right direction.
Mr. Bramlett. Just to follow up to the comment on
progressive versus mandate, to me it is either/or. In other
words, if you mandate the system it works. If you don't mandate
the system, then it has to be progressive.
The small employer is the one who has the--the employee of
the small employer has the lowest 401(k) account balance. They
have about one-third of the average account balance of a
Fortune 500 company. They typically also do not have a defined
benefit plan, so they have the smallest amount. So there has to
be incentives for the small employer to establish 401(k) plans
which are tax incentives for the highly paid people. And that
works to some degree, not to a perfect degree. To take that
away and not go to a mandatory system is probably not going to
work. It is one or the other.
Mr. Orszag. Could I just add one other counterproductive
thing, which is that in many cases we are encouraging people to
save in 401(k)s and IRAs. And then it is often the case, and
people will experience this to some degree during an economic
downturn like today, that because of the asset tests that apply
in programs like Medicaid and Food Stamps and other means-
tested benefit programs, we have encouraged people to save. And
then if they do, we often then cut off their access to programs
that help them during economic downturn, which, from a rational
economics perspective, is effectively a tax on saving.
So on the one hand we are trying to encourage saving
through the Tax Code, and on the other hand we have a huge
potential disincentive to saving through the asset tests that
apply to many of these programs, although there have been some
improvements recently.
Chairman Miller. Thank you. I am a little concerned that we
are here having this discussion and we are using the language
that might be appropriate to yesterday, last year, 2000. We act
as if this is the same, and if you just hang onto your 401(k),
your pension plans, whatever you do, it will all come back to
you. Some of you may be too old and it won't come back in time,
but for most of you it will come back.
My sense is that this somehow is different. In just the
negotiations over the recovery plan, we watched the Secretary
of the Treasury, essentially with his partner, the Chairman of
the Fed, sort of like Butch Cassidy and Sundance, they kicked
open the doors of the Congress, they said give us $700 billion,
no questions asked, and no liability. That is after four times
they told us they thought they had it contained. I don't fault
them. But I still think that they were looking as if this was
sort of typical.
I am maybe one of the oldest guys in the room here, but I
don't remember when we had an implosion of the housing market,
that we had an implosion of financial institutions, what now
appears on a worldwide scale, implosion of the credit markets
and the seizing of the credit markets and an implosion of the
stock market. I don't know how you just get well tomorrow the
way you did yesterday. There is something wrong in this
equation here.
I think for the millions of families and certainly for the
families that I visited this weekend in my district, the fear
factor is huge and they don't see the availability of resources
to them to get well. They are openly talking about if they can,
deferring retirement; or if they can, go back to work; if they
can, they hope the housing market recovers, because they may
own their home or they may have a loan on it. They are not in
trouble with the home, but they know the value is dropping
rapidly and that was part of their saving and retirement plan.
So in every window they look out, there is trouble. And the
idea that, well, you just gather yourself and hold on and in 3
to 7 years it will all be back. The Japanese waited 12 or 14
years before it ever got back. And now more and more people are
saying instead of this being deep and long--I mean shallow and
long, this is going to be deep and long in terms of the
recovery.
And so I just think that we as policymakers have got to
think about what do we do for these people who are in this fix?
We are going to inherit them one way or the other if they don't
have adequate resources for their retirement. We are going to
inherit them in public expenditures for nutrition, for savings
for health care. And a lot of people don't want to see
themselves in that position. They wouldn't talk in those terms.
But the margin between being in a public program in health care
and health care is not too great anymore today. And you don't
control it. And this is why we are having this hearing.
I don't know if Dr. Ghilarducci's proposal is right, or
what used to be the Orszag plan, or the other plans, talking
about how we rationalize----
Mr. Orszag. I didn't know I had a plan.
Chairman Miller. You worked on one for years, in your other
life. But the point is, somehow we have to rationalize what is
the security going to be, the financial security going to be
for American citizens who worked their entire lives? I think
that has been thrown into the abyss at this moment. Maybe I am
wrong and maybe this is something like we have seen before.
Except most of the people that saw this before I call them mom
and dad, you know, so I don't know how this--and that is why I
guess people are kind of blowing by the ``recession'' word. But
they are thinking when it was cataclysmic, it was something
other than that. And this starts to look very cataclysmic for
middle-class families, very cataclysmic for middle-class
families.
I was struck, I was crossing the Golden Gate Bridge,
listening to the discussion of the financial situation on the
radio and about what is happening to families, and there was
the largest sailboat in the world, $125 million I think spent
on a sailboat cruising around San Francisco Bay. And I thought,
my God, what has happened here?
And I am deeply concerned that people are--you know, we
did--somehow this economy did a magnificent job of lifting a
huge number of senior citizens out of poverty with health care,
with Social Security, with economic expansion and the rest of
that.
I am really very concerned about whether or not there is a
significant cohort of people, 45 and older--maybe I am starting
too young, but I think this is a serious dislocation that has
taken place--that are going to be in a position to provide for
their wherewithal for themselves, their family, and their
immediate family. And I just am very concerned that the idea
is, well, you know, dollar cost averaging, you all get back
there. I don't know that that is the case.
Mr. Orszag. Could I make a comment, because I would agree.
I think the period we are experiencing is arguably the greatest
collapse in confidence that we have experienced since the Great
Depression. And one of the frustrations is that even before
this immediate period, as has already been remarked upon, both
the pension system and the health care system and other aspects
of our--the way in which we conduct our economic activities had
imperfections, were tattering or fraying, and the political
system does not deal well with gradual long-term problems like
retirement security or like rising health care cost.
So I think a key question out of this crisis, is there an
opportunity to refashion things that had to be refashioned
anyway in a much more sensible way? And I would hope that the
Congress and other policymakers, as we struggle with a very
challenging economic environment, will look to trying to solve
those underlying problems, because we can do that. I am
confident that we can do that if we seize an opportunity to
refashion things in a way that actually will work better for
not only the American public but for the public fisc.
Chairman Miller. I think that people in good faith
invested. Some people took more risk than they should have.
Some people took more debt than they should have. All those
things happened, and that is human nature and that exists and
that is typical and we recovered from those ideas.
But when you are talking about the pace of the implosion
here, the loss of $2 trillion, Peter, in a very short period of
time in pension assets, $2 trillion, and then you kick that
with the loss of equity in homes, that is multi-trillions of
dollars for individuals. Whether they are in mortgage trouble
or not, they have lost that value and they had plans for it.
Maybe they were wrongfully placed, but that is what was going
on in America.
We have got to think about now that health care system can
trip them up, the pension system can trip them up, the
unemployment system can trip them up, and they really do engage
in a personal catastrophe, and their ability to recover from
that is nil, I think probably, given what their age is.
But these other systems, as you point out, that aren't
properly designed for today's economy and today's society are
also really hazards to them at this point in terms of them
entering into bankruptcy or whatever financial difficulties
they find on the road.
Mr. Weller.
Mr. Weller. If I my may, I think the numbers are
staggering. If you look--actually, if wealth had stayed the
same relative to income since 1999, households would have
another $11 trillion in wealth, so clearly the last 7 years----
Chairman Miller. That is a huge chunk of wealth, the
stripping of wealth that has taken place.
Mr. Weller. We have certainly set an incredible wealth
destruction machine into motion over the last 7 years. And that
is only one part of the overall equation. You have to remember
at the same time we have not kept pace in terms of employment
generation, for instance. That is one of the biggest sources of
wealth for families is their labor income, and we have not kept
pace in terms of employment generation relative to population
growth.
And I think that gets me back to a larger point. We can
debate, we can certainly agree on how to build a better
retirement plan. But I think this may, as challenging as these
times are, certainly be an opportunity to rethink what kind of
economy do we want and how do we make sure that we get growth
back on track?
Certainly the last 7 years have shown us how not to get it
back on track. And how do we then translate job economic growth
into job growth, into wage growth so that families are well
prepared? So I think this could be an opportunity to really
start thinking and talking about what does a solid, short-term,
medium-term, long-term economic recovery plan look like? And I
think that is ultimately what is needed to recover these
trillions of dollars that have been lost.
Chairman Miller. I just don't see that people have the
assets to recover. Wages haven't kept up with the real cost of
living. So, again, where do they turn to make this recovery? To
spend less? We already know that they are taking on huge
amounts of debt just to stay even.
Mr. Weller. They are turning to local governments. I think
we are going to see more demands on local and State governments
because that is often where the social services, the first-line
defense are being paid. And ultimately local governments have
to make the choices between providing education, health care,
and social services.
Ms. Ghilarducci. But I think Congress has helped.
Chairman Miller. We must help.
Ms. Ghilarducci. I have proposed that you provide special
issue bonds so that people can swap out their 401(k) eroding
assets, once and for all, and that will be a permanent asset
for them to use at retirement. So that is a very short-term
proposal.
I also urge Congress to think about helping people
restructure their other debt. Interest rates are going up. Stop
that. Let people rejigger their debt. That usually happens in
bankruptcy court. Do a fast track for that restructuring of
debt.
Also going forward, don't have a tax system that subsidizes
those sailboats when there is a financial crisis. And the way
that you subsidize that middle tier of retirement accounts,
turn those tax deductions into tax credits. The fairest way I
have come up with, the easiest, simplest one, is $600 for
everyone, going forward.
Chairman Miller. Mr. Bramlett.
Mr. Bramlett. I keep going back to $528 billion in
securities intermediation, what is a future value of that? And
we have allowed the 401(k) participants for 25 years to
essentially be preyed upon by the financial services
institutions. We have had a body of law called ERISA that says
every plan's sponsor must act in the best interest of the
participants, and they have a fiduciary obligation to do so.
And they haven't, and it is clear.
There is now a whole slew of plaintiff lawsuits, about 20
of them. They may generate something tantamount to what the
tobacco suits have generated in terms of capital. But
everything you mentioned is all financially related. We are
talking about a bloated financial system that is not necessary
for us to function as a good economy. And that threatens not
only us, individual retirement income, it threatens us as a
country.
If we are just trading and selling each others' stocks and
bonds and insurance, and young minds are going off and sitting
in front of Bloomberg screens and buying and selling IBM all
day long, what are we going to be providing the world? And so
we need serious financial reform of the financial services. We
need people to be given access to the real economy at the
lowest possible cost.
Chairman Miller. Mr. Andrews.
Mr. Andrews. Thank you, Mr. Chairman. I think we are all
prisoners of our present circumstances, and I think the
Chairman has liberated us from that for a minute. And I would
echo what he says in this regard. I don't think the question is
whether we are in a recession or not. I think we clearly are. I
think the question is, how are we going to deal with what I
would view as a shift of the tectonic plates that underlie the
domestic economy?
I don't think we are in the middle of a blip in the
business cycle. I think we are in the middle of a fundamental
long-term change in the way Americans work and save and earn
and spend. And I would argue there are two things different
about our present circumstances.
One is that capital can move at the speed of light. Labor
cannot. In the 1970s when there was a recession, an auto plant
would lay people off, but it couldn't just rematerialize in
Asia in a week. Well, now a call center essentially can. A
financial services back office essentially can. So that is the
first change.
And then the second one is that I think there no longer is
an American economy. There is a global economy of which we are
a part. So decisions, bank failures that happened in Europe
last week, had a profound effect on the ability of small
businesses in my district to borrow money. Problems in the
Japanese economy had an effect on the price of commodities that
my construction firms use to either hire or not hire
bricklayers and welders and electricians. So this is all
reality.
So given that, I would argue that the last 100 years of
economic history in this country can be characterized as
resolving or negotiating the tension between preserving the
dynamism that makes new companies and new industries grow, but
providing a safety net or a floor below which decent innocent
people cannot fall.
Teddy Roosevelt answered that question with antitrust laws.
Franklin Roosevelt answered that question with the New Deal.
Lyndon Johnson answered that question with the Great Society.
And I think it is our time to answer that question now. And I
think the tools from the 1970s or fifties or sixties don't work
because the circumstances are different. And we find ourselves
in a situation with retirement savings where an increasing
number of people are not in a defined benefit plan. They are in
a sort of ``wild wild west'' of the defined contribution world
where there is a fiduciary duty to safeguard assets, and it is
a fiduciary duty taken very seriously by plan sponsors and
vendors. They do a very good job.
But of course that fiduciary duty does not extend, by
definition, to the preservation of wealth. Those are not the
ground rules of a 401(k) or defined contribution plan. The
present system is built on choice by the individual worker or
investor or retiree. So if that is the case, I would come back
to my earlier questions about whether the range of choices are
adequate or sufficient to protect the interests of people. And
I think that focuses on three questions:
One, are workers getting sufficient independent investment
advice? I think the answer is no. And I think we have to figure
out a way they can get that advice.
The second is how many workers are offered the most stable
and safe choice? The question I began with in my first round of
questions--and Michele has found in the 51st annual survey of
profit sharing 401(k) plans, an interesting piece of data: that
the percentage of plans that offer a cash equivalent or CD
money-market-type option, which I would argue is sort of the
safest thing out there right now, is only 47 percent. So half
of the plans, at least according to this document, do not offer
what I would regard as the safest vanilla--but I don't just
regard it that way, by the way. So do wealthy investors. They
are flocking to the T-bill market in droves right now. So I
think we have to revisit that.
But here is a question I want to ask more directly for Ms.
Ghilarducci. Your proposal, which would institutionalize in
statute a whole different kind of choice for people where they
could opt into this guaranteed income plan, is this an
irreversible choice? If we adopted your idea and someone opted
in, could they ever opt out again, or are they in for good?
Ms. Ghilarducci. Yes, they are in for good; like you are in
Social Security, which is actually the only thing that is
working now.
Mr. Andrews. So they wouldn't get the upside if things turn
back up again?
Ms. Ghilarducci. What you get is a 3 percent guarantee from
the government, plus inflation.
Mr. Andrews. Would you cap the assets that someone could
choose to put in? What if I had--which I do not--$20 million in
a DC plan? Could I put all of it in this?
Ms. Ghilarducci. Yes. It is capped 5 percent up to the
Social Security maximum; otherwise you are subsidizing
millionaires.
Mr. Andrews. Is it open to any age group? Is it open to
young people like myself?
Ms. Ghilarducci. Yes, that is the point.
Mr. Andrews. When this cash is collected--let's say that my
constituents en masse swap for this idea--who holds the cash?
How do they invest it? Under what ground rules do they invest
it?
Ms. Ghilarducci. The cash is held by TARP, by the critter
that you just created, by the Federal Government; and the
Federal Government will invest it and hold it in the way that
you all are seeing fit. The point is that you can do it better
than any other financial institution that is around. The
government is now a financial institution.
Mr. Andrews. If the Federal Government makes a profit on
this, if we would pay out 3 percent present value and make 6 or
7 the way we hope the TARP program does, sort of, who gets to
keep the profit? What do we do with it?
Ms. Ghilarducci. I have that figured out. There would be a
board of trustees that would decide how much of a reserve fund
the government needed, and if you went above that, then they
would pay extra interest. I am in TIAA-CREF for college
professors; TI is actually very similar to the plan that I am
proposing. We all love it. It is a hybrid, DC/ DB plan, and
those of us who are young and conservative, we have most of our
money there and we are doing just fine in this financial
crisis, like many other people in hybrid DC plans, DB plans.
Mr. Andrews. My time has expired. I want to thank the panel
for very thought-provoking testimony this afternoon.
Mr. Scott. Thank you, Mr. Chairman.
Mr. Weller, you mentioned that the home equity as a
function of income is the lowest since 1974?
Mr. Weller. 1976. The ratio of home equity relative to
disposable income is the lowest since 1976.
Mr. Scott. What about home prices?
Mr. Weller. Haven't they fallen 10 percent since last year?
We have a lot more to go.
So we have a lot more to go.
Mr. Scott. Are the home prices as a multiple of income at a
low range or high range?
Mr. Weller. They are at the higher range still, but the
problem is that for the past 10 years we have increased
mortgages faster than home values, and thereby we have
leveraged houses. At this point, homeowners own, on average,
about 46 percent of their homes.
Mr. Scott. And that is a fairly low percentage?
Mr. Weller. That is the lowest since 1952, since the
Federal Reserve has started collecting data.
Mr. Scott. We have heard all about the defined contribution
plan, where you define what you put in but don't know what you
are going to get out, as opposed to the defined benefit plan,
where you know what your pension is going to be when you get
it. Now, all of the stock market decline, if you are in a
defined benefit plan--are any people in a defined benefit plan
at risk because of the collapse of the stock market?
Ms. Ghilarducci. No. Only if they are employer-sponsored
defaults. There is some risk that if it is underfunded, they
won't have improvements, but much less risk.
Mr. Scott. So as long as the corporation, the employer is
solvent, their benefit is protected?
Ms. Ghilarducci. You also have the government guarantee,
the Pension Benefit Guarantee Corporation.
Mr. Weller. You have also got to remember the largest group
of American workers with the defined benefit plans are State
and local government employees. We presume that they
won't all go bankrupt.
Mr. Scott. When I was in the State legislature, the stock
market was doing great, and some years we figured we didn't
have to contribute anything. Other years, it even did better,
we actually took a little bit out to fund the rest of
government. I assume the private employers were doing the same
thing.
Mr. Weller. That is correct.
Mr. Scott. Now when the market goes down, can they afford
to make up--I mean what do they have to do when the market goes
down precipitously?
Mr. Weller. Under the current system, they have to start--
depends, again, on the rules of the system they are in. Depends
on how many reserves they have. But they have to make up the
shortfall faster than before. But the problem is that we didn't
really build up more reserves than we had in the past. So it is
entirely possible that a private sector underfunded plan can
move towards a crisis situation and then ultimately require
substantial additional contributions from the employer.
So far, yes, I think we can do more. I agree we should do
more in terms of building plans to build up buffers and require
them actually to build up buffers during the good times, so
that when the bad time happens----
Mr. Scott. Continue to make contributions even though it
looks like it is well funded.
Mr. Weller. Correct. I have suggested 120 percent of
liabilities as the target you should fund to, not 90 percent or
100 percent, but really build up a buffer.
Mr. Scott. Not 65 percent, where a lot of them are now.
Mr. Bramlett. If Britain is any sign, DB plans will be gone
from this country before too long.
Mr. Scott. I am sorry?
Mr. Bramlett. If Britain is any sign of what will happen,
DB plans will be gone, because these employers with these heavy
restrictions will not want to continue. So they will keep
terminating them and terminating them.
Mr. Scott. Because they want to shift the risk of the
market going up and down from the corporate to the employee.
Mr. Orszag. Can I just comment on that? That trend has been
going on for a while. One reason is that workers have
undervalued the risk protection that they get through a defined
benefit plan. I wouldn't want to hazard guesses here, but it is
plausible the kind of experience that we are currently going
through will refocus attention on why that kind of protection
is very valuable. If that were to occur, then firms would start
to offer something that workers saw as valuable.
Mr. Weller. It is certainly the case that some employees do
not fully value the DB plans, but I think we also have got to
look at what happened in Britain that has driven employers
away, and has also happened in the U.S., and that is changes in
the valuation rules that make the contributions from the
pension plans substantially volatile and have ultimately led a
lot of employers to abandon their plans. I think that is
something Congress should revisit.
Mr. Scott. If I could, Mr. Chairman, very quickly. What
effect on all of this will the recent legislation, the $700
billion bailout, have on all the problems we are having with
pensions?
Ms. Ghilarducci. There is a provision for the bailout to
help out defined benefit plans. I think Congress can do more to
recognize that extracting more contributions in a recession
from corporations will just, like the Pension Protection Act
does, just accelerates their decline. So we didn't focus on how
to help defined benefits plan in this hearing. Perhaps we
should have. But you can use some of the provisions in what you
just passed and actually double back and repeal some of the
aspects of the PPA.
Mr. Scott. That would mean it would make less contributions
to the plans?
Ms. Ghilarducci. To give them some relief during the
depression, and then implement what Christian Weller has
proposed, is to make the target 120 percent of liability.
Mr. Scott. Temporarily they would be less solvent than they
are now?
Ms. Ghilarducci. Yes, but they won't disappear.
Mr. Weller. The proposal I testified before Congress
several years ago, we would smooth the assets and the
liabilities over 20 years. That would require fewer
contributions during bad economic times but substantially more
contributions during good economic times, and your target would
be about 120 percent of liabilities. I think that still seems
like a completely reasonable proposal to me, but it is exactly
the opposite direction from where the PPA went in 2006.
Mr. Bramlett. Which is why a lot us in the industry call
the Pension Protection Act somewhat of an oxymoron, because of
the fact it actually encouraged the termination of defined
benefit plans rather than encouraged their preservation.
Chairman Miller. Ms. Clarke.
Ms. Clarke. I want to add another dimension to the
questions that I have asked today. Everything we are talking
about is relative to your position along the financial
spectrum, and a concern I have out of my district is the large
numbers of single-headed female households. With wage
discrimination lowering a woman's lifetime earnings, thereby
reducing the amount of money that women put into their pension
plans, 401(k)s generally inhibiting their ability to save for
retirement, women, and women of color, suffer more adverse
effects than their male counterparts when it comes to wage
discrimination.
My question is twofold. First, can you discuss the impact
that the current financial crisis is having on women, women's
retirement security in general, and if any of you know, what
effect does this current financial crisis have specifically on
retirement security for women of color? And then I have some
other follow-up questions.
Ms. Ghilarducci. We just had a conference on this at my
university. Women generally do poorly in retirement security
because they live longer. So it is lower wages, lower savings
rates, and these longer lives. So that has to be put into
place.
The good news is that for many low-income single women the
most valuable source of retirement income security is Social
Security. Since you didn't touch Social Security 2 years ago,
the good news is they didn't have that many assets so they
haven't lost that many. However, their chronic problem still
persists.
There is a good case to be made to expand Social Security
now to solve the problems of very high risks of poverty of
older women. So that is another subject. But we go back to the
fact that when we had a financial crisis this deep, the
response was the Social Security system and aid to families
with dependent children. It was a massive income replacement
and income security bill.
Ms. Clarke. My next question is to Mr. Jerry Bramlett. I
haven't heard this explicitly yet but I am trying to get a
sense of how the recent financial crisis impacts current
retirees, those who are already living off the proceeds of
their 401(k) accounts. Can you give me a sense of what they
would be going through right now if they are actually living
off that?
Mr. Bramlett. There is a lot of encouragement in the
financial services industry to invest in equities. And I
believe that that is rooted in the fact that people make more
money when they sell equities than when they sell other types
of vehicles. That is why you see a lot of things slanted
towards equities.
A lot of people are told at retirement, Gosh, you know,
you're going to live another 15, 20, 25 years. The market
always rebounds in a 10-year period, or whatever. You can
afford to have a large percentage in equities. And so we do
have an inordinate amount of people in retirement who do have
large exposure to equities and are being hit very hard. I don't
know the exact numbers on that, but I know I have heard a lot
of stories about that.
The other thing to remember, 60 percent of all participants
in 401(k) plans make an election and they never change it
again. So, 60 percent. So if I retire, I leave my money in a
401(k) plan, and I start to draw down on it, I am probably not
making any changes either.
Here, again, that is why there is a need for more oversight
for these individuals, more help, more maternalism, if you
will, but it needs to not be the people who are making the
money off of the products, which has been the case the last 25
years.
Ms. Clarke. Just in closing, you stated that due to the
current financial crisis, certain retirement funds such as real
estate investment funds have announced that they are frozen and
not available for distribution to participants due to the
liquid nature of their underlying assets. You suggest that
Congress should examine whether investments subjected to this
susceptibility are appropriate.
My question to you is: Can you suggest some investments
that would be appropriate, meaning that they would not be
susceptible to the liquid nature of the underlying assets?
Mr. Bramlett. One of the things that is required under
ERISA is that a person be an informed, prudent person. If they
cannot be informed and understand what they are doing, they
need to hire an outside expert. So the whole idea is you can't
just look at the label, you have got to look at the underlying
securities themselves. You need to hire outside independent
investment advice, understand how they are being paid, who is
paying them to help you look through these vehicles.
There are certain situations where a real estate fund, for
instance, because of its very nature could freeze up on you and
you can't create liquidations. There are other real estate
funds in which you can. So it is not as if real estate should
not be an investment in a 401(k) plan, it is just the nature of
the vehicle should be highly liquid. That was the basis of
404(c), was that people be able to trade from one fund to the
other without any kind of restrictions.
Now, people have found themselves locked in. The same thing
goes for interest contracts with back-end loads, redemption
fees, all these little things that they get hit with whenever
they try to move money around. They should have some freedom in
order to be able do that. And it should be on the burden of the
plan sponsor as fiduciary, held under the law of ERISA, to be
able to make sure that happens.
Ms. Clarke. Thank you, Mr. Chairman.
Chairman Miller. Mr. Holt, you can have the last question
here.
Mr. Holt. Thank you again, Mr. Chairman. I thank the
witnesses. It is a reminder that I think this committee has
some action to take if we are supposed to give shape to the
retirement situation of America's workers. I, of course, lament
the decline of the defined benefit programs, but since it has
gone that way, let me ask about defined contribution.
How serious a problem is the lack of diversity in the
equities employees who are encouraged to buy in their own
company, for example? There have been some changes and some
different patterns, I think. But is that a serious problem and,
if so, what is to be done about it? Is this legislation that we
should be considering?
Mr. Orszag. I consider it to be a very serious problem.
Again, there are some risks that in a 401(k) plan are
unavoidable, especially if you are trying to get over the long
term some expected return. But overinvesting in an individual
stock is not sound financial theory, and overinvesting in a
single stock that happens to be your employer is particularly
problematic because you are not only exposed to that company's
well-being through your job but also through your retirement
fund.
It is extraordinarily difficult to come up with any
scenario where on average for workers it makes sense to be
investing so dramatically in your own employer stock. Again,
something like 7 percent, so 1 out of every 15 workers has 90
percent or more of their account balance in their employer's
stock. It is very difficult to justify that kind of lack of
diversification under any finance theory.
We had discussions earlier about the different funds that
are offered, trying to move toward diversified funds, and just
briefly I would note that while the CD and money markets were
only offered by about half the funds, bond funds and stable
value funds and what have you would raise that number
dramatically and get you close to 100 percent.
But I think moving towards defaults where people are
automatically invested in diversified low-cost index funds
offers the most auspicious way forward for balancing the
various tradeoffs. I can't justify the over concentration in
employer stock that pervades the pension system.
Mr. Holt. Other witnesses, and in particular should we be
imposing requirements?
Mr. VanDerhei. Could I add some actual real data here? The
numbers Peter gave had been very representative of what the
situation had been prior to Enron. For 20 million individuals
that we track, in 2006 the number has gone down to only 7.3,
which admittedly is still a large number that have 90 percent
or more.
The good news is what is going on with respect to the new
participants. A lot of that money, as Peter and others have
mentioned, is very sticky. Once the money is put in company
stock, oftentimes people do not diversify out. The good news is
if you look at the new individuals, people who have been in the
plan 2 years or less, the number now that have 90 percent or
more in company stock is down to 4.8. That had been up as high
as 11.1 percent.
Mr. Andrews. Will the gentleman yield?
Mr. Holt. Looks like Dr. Ghilarducci and Dr. Weller want to
get a word in.
Yes.
Mr. Andrews. To what extent is that attributable to the
QDIA provision?
Mr. VanDerhei. That is exactly the point I was going to
make. We don't have the ability to go back and break out to the
extent to which employers have either allowed diversification
more rapidly on the part of the employees and/or change----
Mr. Andrews. That is very material to Mr. Holt's question
though because it is happening by default. That is nice, but it
is not really addressing the problem he is raising. Right?
Mr. Bramlett. One option in our plan, BenefitStreet plan,
we don't have individual asset classes, we only have
portfolios. A lot of the advisers who come to us, a lot of them
especially who use ETFs, low-cost index funds, do not have
individual asset classes, they only have portfolios, be they
target-date portfolios or target-risk portfolios. So one very
simple way to do it is to simply eliminate the ability of an
individual to buy an individual asset class within a plan. That
may seem a little Draconian, but that would guarantee you
immediate diversification for all employees.
Mr. Weller. You can never really make a DC plan as
efficient economically as a DB plan. But one big step forward
is exactly what Peter said, a well diversified default low-cost
index can go a long way, according to the calculations. You can
really improve retirement savings by 20 percent by simply
giving a better investment option.
Ms. Ghilarducci. A dollar in a defined benefit plan goes
further than a dollar in a defined contribution plan because of
fees, because of the asset allocation. If you do limit single
stock in a plan, that is a good idea. You also might have the
effect of smoothing out the volatility in the stock market
because a place where companies lard up their stock value is by
shoving it onto their employees. So you have these
microeconomic good effects as well.
Mr. Holt. Thank you again, Mr. Chairman.
Chairman Miller. Thank you very much. I want to insert in
the record a statement by Ranking Member Buck McKeon and also a
statement from the American Benefits Council.
[The statement of Mr. McKeon follows:]
Prepared Statement of Hon. Howard P. ``Buck'' McKeon, Senior Republican
Member, Committee on Education and Labor
The American economy is in the midst of a serious downturn,
constrained by a global credit crisis and burdened by the weight of
toxic assets that have made it more difficult for businesses large and
small to maintain their day-to-day operations, much less to create the
new jobs our economy needs.
The stock market is often a reflection of the nation's mood, and
today's widespread economic uncertainty can be seen clearly in the
stock price rollercoaster ride of the past few weeks. And while it
would be easy to dismiss the woes of the stock market as merely
impacting the wealthy, the reality is that millions of Americans rely
on investments in planning for retirement. Because of this, a downturn
in our financial markets can have a real impact on workers' retirement
security.
An increasing number of workers rely on 401(k)-type savings plans,
in which they invest pre-tax earnings that are often matched by their
employer. These plans are portable and protected, in that an employer
or a union can never take away the benefits an employee has accrued.
A smaller share of workers participates in defined-benefit plans,
in which a plan sponsor--usually an employer or a union--agrees to pay
an established benefit throughout retirement.
While these plans--defined-contribution and defined-benefit--have
many differences, both are impacted in large measure by the overall
health of our economic system and by investment performance in
particular. 401(k)-type savings plans are invested directly, usually
managed by workers. Defined-benefit plans require plan sponsors to
manage millions in assets over a period of many decades, requiring
effective management of resources and risk. With the collapse in recent
years of a number of defined-benefit plans, we have seen the risk to
workers and retirees when plans are not effectively managed, or when
benefits are over-promised and under-delivered.
The current downturn in our financial markets has brought
considerable uncertainty, particularly for those workers nearing
retirement. More than half of people surveyed in an Associated Press-
GfK poll released last week said they worry that they will have to work
longer because the value of their retirement savings has declined.
Particularly for those workers whose savings were held in too risky a
portfolio for their savings goals, or for those who were not well-
diversified, these are difficult times.
Recognizing the challenges Americans face in planning for
retirement, Congress passed crucial reforms in 2006--through the
``Pension Protection Act''--to shore-up defined-benefit plans, increase
participation in defined-contribution plans, and, importantly, to allow
workers to access high-quality investment advice in managing their
retirement savings. In these times of financial turmoil, those reforms
should help to make a real difference for workers and retirees.
Today's hearing is an important first step in examining how the ups
and downs of the financial markets impact workers' retirement security.
However, this issue cannot be understood in a vacuum. Our committee
does not have jurisdiction over the government sponsored enterprise
mortgage giants Fannie Mae and Freddie Mac, but it is clear that the
appropriate committees in both the House and Senate must ask the tough
questions and hold to account those who allowed these agencies to put
us on this path to economic instability.
And while I commend Chairman Miller for holding today's hearing, it
is critical that Congressional oversight in this area not be limited to
pre-election political theater. Members on both sides of the aisle
should be permitted to examine these issues when Congress is in
session, and with a full opportunity to explore the causes of the
current financial crisis, the impact on workers and families, and what
can be done to prevent such a catastrophe in the future.''
______
[The statement of the American Benefits Council follows:]
Prepared Statement of the American Benefits Council
Chairman Miller and Ranking Member McKeon, these are indeed
unsettling times for American workers and American employers. The
current difficulties in our financial system are posing a wide range of
challenges for individual American families and American businesses.
One of the challenges faced by American workers is an understandable
sense of anxiety regarding their retirement planning and retirement
security. We appreciate your consideration of these issues in today's
hearing and are pleased to share our perspective on the effect of these
periods of market and financial uncertainty on our nation's employer-
sponsored retirement system.
We appreciate the opportunity to submit this statement on behalf of
the American Benefits Council in conjunction with the hearing you are
holding today on The Impact of the Financial Crisis on Workers'
Retirement Security. The Council is a public policy organization
representing principally Fortune 500 companies and other organizations
that assist employers of all sizes in providing benefits to employees.
Collectively, the Council's members either sponsor directly or provide
services to retirement and health plans covering more than 100 million
Americans.
The Strengths of the Employer-Sponsored Retirement System
The Council and its members have worked collaboratively with this
Committee and with the entire Congress to build an employer-sponsored
retirement system that is strong and resilient and that helps to
advance the retirement security of American families. This successful
system is marked by a number of key characteristics. It facilitates
employer sponsorship of plans, encourages employee participation in
pension programs, promotes prudent investing, insists on transparency,
operates at reasonable cost and is subject to strict fiduciary
obligations and sound regulatory oversight. This is a system that is
built to serve the long-term retirement interests of workers and that
is designed to weather changes in market, financial and economic
conditions, even conditions as anxiety-provoking as the ones we are
experiencing today. We, like you, believe we should always be asking
whether this system can be improved to better serve the interests of
plan participants, and today's economic challenges present another
opportunity to ask such questions. But we believe our current employer-
sponsored retirement system plays a critical role in advancing workers'
retirement security, even when markets, 401(k) account balances and
pension funding levels are down.
The Long-Term Focus of Defined Benefit Plans
Employer-sponsored retirement plans, whether defined benefit or
defined contribution, provide an invaluable supplement to workers'
Social Security benefits and personal retirement savings. Defined
benefit plans provide broad coverage, employer financing, professional
asset management, spousal protections and lifetime income backed by
guarantees from the Pension Benefit Guaranty Corporation. In managing
defined benefit plan assets, fiduciaries must act prudently and solely
in participants' interests and must diversify plan investments so as to
minimize large losses. Defined benefit plan sponsors invest for the
long-term so as to secure the promises employers make to provide
benefits many decades into the future. Unlike some others, defined
benefit asset managers do not have a short-term investment focus.
Pursuant to these legal obligations and investment principles, defined
benefit plan sponsors invest in a broad array of asset classes and have
avoided the heavy focus on mortgage-related investments that has
contributed to the collapse of certain financial institutions and the
weakening of others. As is true of all investors when markets fall,
funding levels in defined benefit plans are down somewhat and this will
impose financial obligations on employers, some of which may be
struggling in the current economic environment. As the Chairman and
Ranking Member are aware, we believe there are certain steps Congress
could take to address these challenges, such as prompt enactment of two
provisions relating to the funding requirements of the Pension
Protection Act of 2006 (PPA). One of these provisions would clarify the
permissibility of asset smoothing under PPA and the other would
institute a more effective transition regime to the PPA funding rules.
Both changes would help avoid undue financial burdens on employers. The
Council has recommended these two steps for some time as we believe
they will assist in providing needed predictability and stability to
the defined benefit system. Given the current economic situation, they
have become even more important.
We also hope to continue our conversations with policymakers
regarding the accounting standards applicable to defined benefit plans.
The Financial Accounting Standards Board has recently adopted new
standards in this area and even more dramatic changes are on the
horizon. These new approaches pose significant challenges for employer
sponsors and contribute to the concern among some that defined benefit
plans are simply too unpredictable from a financial perspective.
The Recent Enhancements to Defined Contribution Plans
Defined contribution plans likewise offer important benefits to
workers, among them choice and control over investments, portability
and access to funds in times of financial distress. As defined
contribution plans have become more dominant in the workplace, Congress
has taken a number of important steps to make these plans even more
successful and to assist plan participants in carrying out their
responsibilities under these plans. The Pension Protection Act, in
particular, strengthened the defined contribution plan system in ways
that fundamentally assist participants--especially in financial
circumstances such as those we face today. PPA encouraged automatic
enrollment so that more employees would participate in plans, it
facilitated default investments, which are a critical component of
automatic enrollment arrangements, it provided new diversification
rights so that employees would avoid the concentrations in company
stock that proved so heartbreaking for the workers at Enron and it
expanded opportunities for investment advice so that employees could
have professional counsel, which is particularly important in times
such as these (most especially for workers nearing retirement). While
implementation of these PPA provisions is continuing, participants are
in better shape to weather the current market downturn because they
have been put in place.
This Committee has been at the forefront of the recent efforts to
ensure that our defined contribution system is marked by transparency
regarding fees. We share the Committee's strong commitment to ensuring
that plan participants have clear information about the fees they are
charged and that plan fiduciaries have clear information about the
compensation earned by plan service providers. Such transparency
regarding fees facilitates sound decision-making by both participants
and sponsors and helps ensures that fees are reasonable in light of the
services, features and quality provided. As members of the Committee
have noted. when fees are kept at reasonable levels, participants have
more in their accounts at retirement. This is an outcome we can all
support. We look forward to working with this Committee and with the
regulators at the Department of Labor to ensure that changes to fee
disclosure practices are implemented smoothly, in a coordinated fashion
and with sufficient transition periods. We want to be certain that the
advantages of enhanced transparency are achieved without in any way
deterring plan participation or plan sponsorship.
The Added Value of Employer Sponsorship
Regardless of the type of plan (or plans) an employer offers to its
workforce, there is a dimension of employer plan sponsorship that
deserves particular mention as it brings tremendous value to plan
participants in financial circumstances like those we are experiencing.
That is the simple fact of employer plan sponsorship and the fiduciary
oversight that accompanies this employer role. Retirement plan
participants have a fiduciary whose legal obligation it is to act
solely in the interest of participants and beneficiaries and for the
exclusive purpose of providing benefits. The benefits of this employer
sponsorship and fiduciary oversight are manifold--pre-selection of
quality investments, ongoing investment oversight, use of employer
bargaining power regarding fee and service levels and investment
education, to name but a few. In response to current market events,
many plan sponsors have communicated with plan participants and made
information available about key investment principles and the
importance of continuing to calmly review one's financial situation.
Plan sponsors are also devoting particular attention at this time to
their ongoing monitoring of plan investments. Thus, despite today's
market challenges, those who participate in employer-sponsored
retirement plans are fortunate relative to those who do not. We hope to
continue to work with the Committee to expand the number of employers
that sponsor retirement plans and further increase the number of
workers who participate. Certainly we should take no steps that would
frustrate either of these important goals.
The Importance of Financial Literacy
Chairman Miller and Ranking Member McKeon, another issue that is
worth discussing in the context of today's hearing is one that the
Council highlighted in our 2004 report, Safe and Sound: A Ten-Year Plan
for Promoting Personal Financial Security. That is the issue of
financial literacy. While knowledge and understanding of financial
principles cannot completely conquer the anxiety that many Americans
are feeling today, it certainly can reduce such anxiety and can help
prompt sound decision-making in challenging times such as these. In
Safe and Sound, we articulated a goal that ``by 2014, virtually all
households will have access to some form of investment education and
advice and 75 percent of households will have calculated the amount of
retirement savings needed to maintain their standard of living
throughout retirement, as well as the savings rate needed to achieve
this target.'' To assist in reaching this goal and to facilitate the
equally important goal of improving financial literacy generally, our
report recommended (1) expansion of financial education efforts by
employers, the government and other stakeholders, (2) the establishment
of financial literacy requirements at the high school and college
level, and (3) the inclusion in the annual Social Security statement of
a tool to calculate retirement savings goals. Adoption of these steps
will ensure both that Americans are financially prepared for
challenging economic times and equipped with the skills and knowledge
to make sound decisions in times of market turbulence.
The Council sincerely appreciates your consideration of our views.
We look forward to collaborating with the Committee to analyze the
effects of the current financial environment on workers' retirement
security and to determine whether there are any policy steps that can
be taken to promote this security and further strengthen the nation's
voluntary employer-sponsored retirement system.
______
Chairman Miller. The record of this hearing will remain
open for 14 days so members will have an opportunity to submit
additional materials for the hearing record. Also, they may
have follow-up questions. We would ask that you would respond
to those when we forward them to you.
Thank you very much for your time and your expertise and
your experience in this. I suspect this is the beginning of a
new conversation and a new atmosphere about the need to protect
people's retirement and pensions. I hope that we will be able
to continue to call on your expertise as we work our way
through this in the next Congress and the next administration.
Thank you very much.
With that, the committee stands adjourned.
[Additional submission of Mr. Miller follows:]
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[The statement of Mr. Altmire follows:]
Prepared Statement of Hon. Jason Altmire, a Representative in Congress
From the State of Pennsylvania
Thank you, Chairman Miller, for holding this important hearing on
the impact of the financial crisis on workers' retirement security.
The recent events in the global financial markets have highlighted
the vulnerability of American's retirement plans. Over the last year,
American workers have lost nearly $2 trillion in retirement savings.
The problems we are now confronting in the financial market bring to
light the problems that have plagued our nation's retirees for years.
The American Association for Retired People (AARP) reported that in the
last year, 20 percent of baby boomers have stopped contributing to
their retirement plans because they need that money at the end of the
month to make ends meet. Additionally, the AARP found that about a
third of workers in the U.S. are considering delaying retirement as a
result of the housing and financial crisis.
Americans have worked hard throughout their lives believing that
they would one day be able to enjoy retirement, but instead are forced
to put their retirement on hold. Action must be taken to stabilize our
markets and ensure protection for American workers' retirement.
Thank you again, Mr. Chairman, for holding this hearing. I yield
back the balance of my time.
______
[Submission of Mr. Sestak follows:]
U.S. Congress,
Washington, DC, October 21, 2008.
Hon. George Miller, Chairman; Hon. Howard McKeon, Ranking Member,
Committee on Education and Labor, Rayburn House Office Building,
Washington, DC.
Dear Chairman Miller and Ranking Member McKeon: At the request of
Vanguard, a well-established financial institution based in my
district, I am submitting the attached report as written testimony to
be included in the record of the House Committee on Education and
Labor's hearing on October 7, 2008, on ``The Impact of the Financial
Crisis on Workers' Retirement Security''. As I have discussed with the
Vanguard representative, I respect their right to have their views
heard, but I am not necessarily in full agreement with all of their
conclusions.
Sincerely,
Joe Sestak,
Member of Congress.
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[Whereupon, at 3:21 p.m., the committee was adjourned.]