[Senate Hearing 113-379]
[From the U.S. Government Publishing Office]
S. Hrg. 113-379
THE STATE OF U.S. RETIREMENT SECURITY: CAN THE MIDDLE CLASS AFFORD TO
RETIRE?
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HEARING
before the
SUBCOMMITTEE ON
ECONOMIC POLICY
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
ON
DISCUSSING THE CURRENT STATE OF RETIREMENT SECURITY, FOCUSING ON THE
CHALLENGES FACING ASPIRING RETIREES FOLLOWING THE RECENT FINANCIAL
CRISIS AND HOW THE LEVEL OF RETIREMENT SECURITY IMPACTS THE ECONOMY
__________
MARCH 12, 2014
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
______
U.S. GOVERNMENT PUBLISHING OFFICE
89-649 PDF WASHINGTON : 2015
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Dawn Ratliff, Chief Clerk
Taylor Reed, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Economic Policy
JEFF MERKLEY, Oregon, Chairman
DEAN HELLER, Nevada, Ranking Republican Member
JOHN TESTER, Montana TOM COBURN, Oklahoma
MARK R. WARNER, Virginia DAVID VITTER, Louisiana
KAY HAGAN, North Carolina MIKE JOHANNS, Nebraska
JOE MANCHIN III, West Virginia MIKE CRAPO, Idaho
HEIDI HEITKAMP, North Dakota
Andrew Green, Subcommittee Staff Director
Scott Riplinger, Republican Subcommittee Staff Director
(ii)
C O N T E N T S
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WEDNESDAY, MARCH 12, 2014
Page
Opening statement of Chairman Merkley............................ 1
Opening statements, comments, or prepared statements of:
Senator Heller............................................... 2
WITNESSES
Ted Wheeler, Treasurer, State of Oregon.......................... 4
Prepared statement........................................... 29
Monique Morrissey, Ph.D., Economist, Economic Policy Institute... 5
Prepared statement........................................... 30
Robert Hiltonsmith, Policy Analyst, DEMOS........................ 7
Prepared statement........................................... 36
Kristi Mitchem, Executive Vice President, State Street Global
Advisors....................................................... 9
Prepared statement........................................... 39
Additional Material Supplied for the Record
Prepared statement of Jack VanDerhei, Ph.D., Research Director,
Employee Benefit Research Institute............................ 46
(iii)
THE STATE OF U.S. RETIREMENT SECURITY: CAN THE MIDDLE CLASS AFFORD TO
RETIRE?
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WEDNESDAY, MARCH 12, 2014
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Subcommittee on Economic Policy,
Washington, DC.
The Subcommittee met at 3:10 p.m. in room SD-538, Dirksen
Senate Office Building, Hon. Jeff Merkley, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF SENATOR JEFF MERKLEY
Senator Merkley. I call this hearing of the Economic Policy
Subcommittee of the Committee on Banking, Housing, and Urban
Affairs to order.
The American dream is a powerful concept that has driven
generations of Americans to strive for a better life. However,
the American dream is not limited just to the idea that through
hard work and determination an American can obtain a good
living wage job and provide for a family.
Not limited to that, it is also very much a part of our
dream that hard-working Americans will not have to live in fear
of their old age--that hard work, prudent saving, and a strong
safety net will allow them to develop a substantial nest egg to
support themselves throughout retirement and, possibly, leave
something behind for their spouse or children.
Recent reports and projections show that in the decades to
come, Washington's actions, particularly concerning Social
Security, will have an increasingly profound effect on whether
our dream of a secure retirement matches the reality. The ways
Americans save for retirement have changed substantially over
the past 30 years, including a significant shift from defined
benefit plans to defined contribution (DC) plans, which place
substantially more risk and responsibility on the individual.
There is also significant evidence that many Americans are
unable to adequately save for retirement. At least half of
single households did not have any retirement assets in 2010,
and the median amount of retirement assets for married
households was only about $10,000.
Some of these challenges are a direct result of the great
recession, but others are long-term problems exacerbated by the
recent crisis. Decades of stagnant wages coupled with suddenly
lowered home values leave working class Americans facing
increasingly steep challenges to being able to save adequately.
In fact, many young workers find themselves with yet another
growing impediment in the form of ballooning student loans.
All of these challenges amplify the importance of Social
Security, which today provides, on average, about 40 percent of
income for seniors and disabled Americans and creates a safety
net for workers and their families. Among seniors who receive
Social Security benefits, 23 percent of married couples and
about 46 percent of single persons rely on Social Security for
the vast bulk of their income--90 percent or more of their
income.
Given the current projections, Social Security will,
without question, play an enormous role in providing retirement
security for Americans. We are fortunate to have joining us
today a panel of experts in the economics of retirement
security. I hope we can have a robust conversation about the
challenges facing American families and how we can enhance U.S.
retirement security as a whole.
So thank you very much for coming. I am now going to turn
to my colleague, Senator Heller, for an opening statement.
STATEMENT OF SENATOR DEAN HELLER
Senator Heller. Chairman, thank you, and to our witnesses,
thank you for taking time from your busy schedules to be with
us today.
Every day American families wonder if they will have enough
savings to enjoy a comfortable and stable retirement in the
future. As a new generation of Americans prepare to reach
retirement age, we are getting a clearer picture of the
evolving retirement landscape.
Over the last few decades, new and diversified retirement
options have been created in an attempt to increase savings and
provide additional retirement income. A growing number of
today's workers are preparing for retirement through defined
contribution plans like 401(k)s and individual retirement
accounts, IRAs, that allow families to accumulate financial
assets from investments in stocks, bonds, and mutual funds.
These retirement accounts, along with the development of
rules allowing for increased after-tax contribution allowances
and ROTH plans, are further expanding individuals' abilities to
contribute earnings to their retirement plan. Although these
are positive developments, many Americans are still struggling
to save for retirement.
The economic downturn and housing crisis have had a
particular negative impact on the financial situation of many.
In my home State, Nevada, Nevadans are still grappling with one
of the highest unemployment rates in the Nation, and for many,
their home values are under water. For those individuals who
are struggling to get by, retirement is a distant dream.
Until the economy improves, Nevada will remain at a
disadvantage when preparing for retirement. In order to combat
this crisis, Washington must implement policies that return
America's economy back to a period of optimism and growth. The
more people that can return to work, the more retirement
opportunities will become available to them.
And for that, I want to thank all our witnesses again for
attending today's hearing. I look forward to hearing your views
on the current state of Americans' retirement security. I hope
that our discussion will shed some light on the important
issues affecting individuals' ability to financially prepare
for their retirement, particularly how current Federal policies
are affecting retirement preparedness and what we can do to
better prepare all Americans. So thank you. I welcome each of
your views as panelists. Thank you, Mr. Chairman, for holding
this hearing.
Senator Merkley. You bet. And now I will introduce our
witnesses. Ted Wheeler is the Treasurer of the State of Oregon.
He holds a B.A. from Stanford, a Master's in public policy from
Harvard, and an M.B.A. from Columbia. Were there no other
colleges left to apply to for other degrees? It is a pleasure
to have you travel out from Oregon. Thank you for joining us.
He has served as Treasurer of Oregon since 2010. He has
actively pushed for State-level coordination and action in
addressing retirement security challenges. In 2013, he
advocated for legislation successfully in Oregon that created a
State retirement savings task force to consider the trends,
current laws, and saving options, and to provide
recommendations to the 2015 State Assembly.
He also convened a bipartisan round table of national labor
organization representatives, financial industry leaders, and
State treasurers to discuss options to help private sector
workers without retirement savings plans through their
employers. Thank you very much for joining us.
Monique Morrissey has her Ph.D. in economics from American
University and B.A. from Swarthmore. She is an Economist at the
Economic Policy Institute specializing in retirement security,
labor markets, and financial markets. Since joining EPI in
2006, she has focused on a range of issues, including--this is
quite a list of things that you have worked on over these
years--Social Security, pensions, other employee benefits,
household savings, tax expenditures, older workers, public
employees unions and collective bargaining, Medicare
institutional investors, corporate governance, executive
compensation, financial markets, and the Federal Reserve.
She is a member of the National Academy of Social
Insurance. Prior to joining EPI, she worked at the AFL-CIO
Office of Investment and Financial Market Center. Thank you for
joining us today.
Mr. Robert Hiltonsmith is a Policy Analyst at Demos, a
public policy think-tank based in New York. He has an M.S. in
economics from the New School for Social Research and a B.S. in
mathematics and philosophy from Gilford College. He joined
Demos in March 2010 to provide research and analysis on issues
surrounding retirement security in the United States, with a
particular focus on how these issues affected young people.
He has written on a wide variety of topics, including tax
policy, fiscal policy, health care, and the labor market. His
research has been widely covered in the press, including the
Washington Post, Newsweek, Market Watch, Reuters, and
Kiplinger. He has appeared on regional and national television
and radio, including Fresh Air, Frontline, the Lehrer Show, and
Fox Business News. Thank you very much for coming down from New
York to join us.
Our next panelist, I know that Senator Elizabeth Warren had
hoped to be here in time to introduce you, but she is not able
to make it this quickly. We are expecting her in a few minutes,
so I am going to go ahead and introduce you.
Kristi Mitchem is Executive Vice President of State Street
Global Advisors and head of the Americas Institutional Client
Group. She earned her B.A. in political science from Davidson
College and M.B.A. from Stanford Graduate School of Business.
In this role, she is responsible for the strategic direction
and leadership of State Street Global Advisors growing
institutional business.
Prior to joining State Street, she worked at BlackRock
where she most recently served as Managing Director and head of
the U.S. defined contribution business responsible for building
with a focus on delivering products for individual 401(k)
investors. She has over 17 years of experience in the defined
contribution and equities markets.
So with that, we are going to put 5 minutes on the clock
for each of you. We will ask you to try to stay within that.
There is a little flexibility, but we would like to be able to
get through all your remarks and have time to ask some
questions and have some dialogue. Mr. Wheeler.
STATEMENT OF TED WHEELER, TREASURER, STATE OF OREGON
Mr. Wheeler. Senators, thank you for having me here. It is
an honor. For the record, my name is Ted Wheeler. I am the
Treasurer for the State of Oregon. In that capacity, I am
responsible for managing the State's $87 billion investment
operation, protecting the State's strong credit rating, and
providing banking operations to over 1,000 local jurisdictions.
But before I held public office, I worked for a private
sector financial management firm that focused predominantly on
private sector retirement tools. I was a senior management
executive in that capacity.
I want to thank you for shining a light on the critically
important issue of retirement security for the middle class.
More needs to be done and quickly to reduce the profound
economic impact of what I believe is a generational crisis, a
crisis that threatens to plunge seniors into poverty, disrupt
entire families, and impact the economy on a significant scale.
In Oregon, as across the Nation, a lack of sufficient
retirement savings threatens family security and quality of
life. What was once considered a matter of personal
responsibility is increasingly becoming a public crisis, an
economic crisis, whereby people who do not save adequately for
retirement then put additional burdens on costly safety net
programs, both at the Federal level and at the State level.
Senators, time is not our ally on this matter. In the State
of Oregon, our older adult population is expected to double in
the next 20 years; and yet, only about half of Oregon's private
sector employees have access to retirement planning options at
their place of employment. A recent study by AARP-Oregon
concluded that one out of every six employees between the age
of 45 and 64 in our State have less than $5,000 in retirement
savings. This is a demographic tidal wave which threatens to
swamp us.
We all understand that it is hard to save. We understand it
is particularly hard for the middle class that has been beset
by stagnating wages, escalating costs of higher education, and
uncertainty about future costs of health care, among other
things.
But what our constituents are telling us and what the data
clearly shows is that people are focused on their short-term
economic needs and they are not as focused on long-term
retirement security options. A huge number of Oregonians are
relying predominantly on Social Security for retirement,
something for which the program was never intended. In the
absence of Social Security in our State, 40 percent of older
adults would live in poverty.
In December, I helped to convene a bipartisan round-table
of elected State treasurers from across the country. They
agreed that retirement security demands America's attention.
And next week, as laid out in Oregon's bipartisan legislation,
I will convene the first meeting of a new task force that will
look at ways that we can incent more retirement savings and
potentially expand pooled and professionally managed investment
options for Oregon workers.
Among the questions we will attempt to answer: What options
are available to bolster the savings of employees who do not
have options through their place of employment? What should be
the role of the State's successful investment operations, if
any? And what options are available to protect the State and
private sector employers against liability, pool resources to
keep costs low, and that create portable, accessible, and
voluntary options for Oregonians?
I think it is appropriate that States are taking on this
issue in parallel with your efforts here in Congress. Different
States are going to come up with different innovations and
different solutions, in large measure based on different
expectations about the role of Government. But it is my hope
and my expectation that those different ideas and solutions
will only contribute to a positive dialogue, much in the same
way that the States came together to help the Federal
Government pass the 529 tax laws which provided robust savings
vehicles for higher education and job training.
In conclusion, I will just remind everybody that this is a
bipartisan issue, that it is an urgent issue, and that I want
to thank you, in particular, Senator Merkley and Senator
Heller, for your focus on an issue of retirement security,
retirement security that is moving farther away for many
Americans and is out of reach already for some. Thank you for
your attention to this.
Senator Merkley. Thank you very much. Dr. Morrissey.
STATEMENT OF MONIQUE MORRISSEY, Ph.D., ECONOMIST, ECONOMIC
POLICY INSTITUTE
Ms. Morrissey. Thank you, Chairman Merkley and Ranking
Member Heller, for inviting me to testify on the state of
retirement security in the United States.
My name is Monique Morrissey. I am an Economist working on
retirement issues at the Economic Policy Institute, a
nonpartisan think-tank focusing on the needs of low- and
middle-income workers.
Retirement security improved significantly in the post-war
decades as Social Security expanded and participation in
employer-based plans grew. However, the 1980s began a period of
retrenchment. Social Security cuts that are still being phased
in reduced retirement benefits by almost one-fourth. Meanwhile,
private sector employers replaced secure pensions with 401(k)
plans, shifting costs and risks onto workers. Though this could
have broadened access by making it easier for employers to
offer benefits, participation in employer-based plans declined
in the new millennium.
Though assets in retirement funds have grown faster than
income in the 401(k) era, retirement security worsened as
retirement wealth became more unequal and outcomes more
uncertain. 40 percent of families approaching retirement have
nothing saved in retirement accounts and 10 percent have
$12,000 or less. Though the median amount for older families
with savings is $100,000, this is not even enough to purchase a
$5,000-a-year joint life annuity at 65.
As my co-author and I found in our Retirement Inequality
Chart book, a family in the 90th percentile has nearly 100
times more retirement savings than the median family, which has
a negligible amount. All told, households in the top fifth of
the income distribution account for more than two-thirds of
savings in retirement accounts.
There are stark differences by race, ethnicity, and
education, as only white households and college graduates are
more likely than not to have retirement account savings. An
already bad situation was made worse by the collapse of the
housing bubble and financial crisis which wiped out $13
trillion in household wealth and left many homeowners under
water. This is particularly tragic for minority families whose
net worth fell by more than half.
Just as workers' retirement prospects are increasingly
affected by economic shocks, researchers at the New School,
which is Robbie's alma mater, have shown that 401(k) plans also
contribute to macroeconomic instability. Where Social Security
helps shore-up household incomes during recessions, 401(k)
plans encourage older workers to retire in boom times and hang
on to jobs when asset values are depressed.
401(k) plans were invented by a benefit consultant working
on a bonus plan for bankers. Congress never intended for them
to replace traditional pensions as a primary investment
retirement vehicle, and they are poorly designed for this
purpose. Because 401(k) plans limit the scope for risk pooling
and forego economies of scale, contributions to these plans
must be nearly twice as high as traditional pensions to ensure
a similar retirement income in retirement.
In addition, few participants have the time or ability to
make good investment decisions. IRAs, primarily composed of
funds rolled over from 401(k)s, offer fewer protections and
typically have even higher fees. Our retirement system, which
never worked well for low-income workers, now also fails the
middle class. Our first priority should be expanding Social
Security to replace some of the benefits cut in 1983 and better
protect beneficiaries from rising health costs.
Second, we should take steps to preserve existing defined
benefit pensions in the public and private sector. Contrary to
conventional wisdom, most public pensions are in reasonably
good shape, and those that are not are in trouble because
elected officials neglected to make required contributions over
many years. The focus should be on preventing this from
happening in the future, not reneging on promises to workers or
switching to defined contribution plans.
Third, we should address some of the worst problems of
401(k)s and IRAs before encouraging workers to save more in
these plans. The Thrift Savings Plan offered to Federal workers
is one model for reform because of its low fees, limited
investment options, and the availability of low-cost annuities.
However, it does not resolve the fundamental problems of market
risk and upside-down tax subsidies.
Fourth, we should explore ways to make defined contribution
plans more like defined benefit pensions, while recognizing
that many private sector employers are not in a position to
take on long-term liabilities. Senator Harkin's USA Retirement
Funds and the California Secure Choice plan are two examples of
this approach.
Last, but not least, we should reconsider our reliance on
tax incentives for retirement savings. This approach is
inherently inefficient because there is no way to guarantee
that tax subsidies encourage people to save more, as opposed to
shifting funds to tax-favored accounts. Nevertheless, a subsidy
in the form of a refundable credit or Government match would be
much more efficient and fair than the current system.
EPI's Guaranteed Retirement Account plan proposed
converting tax subsidies for retirement savings into flat
credits to offset the cost of universal accounts earning a
modest rate of return guaranteed by the Federal Government. EPI
is working on a variation with a Government guarantee that uses
a balancing fund to maximize the share of retirees who achieve
a target rate of return. Thank you very much.
Senator Merkley. Thank you very much, Doctor. We will now
turn to Mr. Hiltonsmith.
STATEMENT OF ROBERT HILTONSMITH, POLICY ANALYST, DEMOS
Mr. Hiltonsmith. Thank you, Chairman Merkley and Ranking
Member Heller, for the opportunity to testify today.
I am Robbie Hiltonsmith. I am a Policy Analyst at Demos,
which is a public policy organization working for an America
where we all have an equal say in our democracy and an equal
chance in our economy.
I am happy to be here today to testify on the state of
retirement security because as our other panelists have said,
we really are at a crucial point here in that retirement
security has declined immensely over the past 10 and 20 years,
but it really is one of the lynchpins of economic security for
the middle class.
One of the reasons, as other panelists have alluded to, is
these--are the issues with 401(k)s and IRAs, defined
contribution-type plans which have become the primary
retirement savings vehicle for most Americans. It is on those
that I am going to focus my testimony today.
So in 2012, less than half of all private sector workers in
the United States participated in workplace retirement plans.
However, even those actively saving are still at risk of
retirement security primarily because they have access only to
a 401(k)-type plan. And as Senator Merkley mentioned in his
opening remarks, these plans place all of the risk of saving
for retirement on workers, exposing them to the risk of losing
their savings in a stock market plunge or outliving their
retirement savings, among others.
I was going to quote the stats that Monique already used.
But, you know, 40 percent of people approaching retirement have
nothing saved and even those that do the median amount is not
enough to provide a secure retirement income. And it is, in
fact, because of these issues with 401(k)s, these risks and
high fees, that contribute to this retirement inadequacy.
So I will talk about the four major types of risk that
401(k) participants face, which are market risk, longevity
risk, leakage risk, and contribution risk. So market risk.
During the last stock market plunge, 401(k) and IRA assets lost
$2 trillion in value and have only, for many, have only
recently, mostly in the past year, seen their balances go
beyond where they were.
So longevity risk, which is the possibility that account
holders that outlive their retirement savings is, of course,
increasingly worrisome as life expectancies of mostly higher
earners rise. We know they are not rising much for the lower
end of the income distribution. And individuals generally
under-estimate their own probabilities of living to an old age,
which makes this particularly difficult for them to calculate
how long they are going to actually need to live.
So leakage from 401(k)s through pre-retirement withdrawals,
loans, and cash-outs zapped nearly $75 billion from retirement
accounts in 2010, and that was about a quarter of all money
that was put into them.
And finally, we will talk about contribution risk. Workers
under-contribute for three main reasons. Either they are not
earning enough, which is one of the major problems here we are
dealing with. They do not trust 401(k)s and financial markets
in general, or they may not have the financial literacy to
understand how these plans work or how much to contribute.
The effect of this contribution risk is especially evident
in lower contribution rates among workers of color. They have
rates for Latinos and African-Americans who do have lower
average incomes, and surveys show trust for the initial markets
less, trailing significantly behind contribution rates of white
and Asian Americans.
Finally, the many fees charged by the funds in which 401(k)
assets are invested make it even more difficult to accumulate
sufficient savings. These fees, often around 1 percent of
assets per year, can seem small. Over a lifetime, it can
compound significantly to drain workers' savings. According to
one of our reports, they can reduce the size of a typical
household's nest egg at retirement by about 30 percent.
The issue is not that, of course, people are paying fees;
it is that they are paying excessive fees, of course. They are
paying fees that do not need to be paid. And there are a lot of
factors contributing to these excessive fees from savers' and
plan sponsors' lack of knowledge and, two, advice from plan
investment advisors that often runs counter to savers'
interests, in part due to the compensation structure of many of
these financial advisors.
One recent study estimates that savers lose an average of
nearly 1 percent in returns due to what they call fiduciary
loss, which are, in essence, poor choices by plan fiduciaries,
and in part due to poor or counter-productive advice by their
financial advisors.
So Monique summed up pretty well a lot of different things
we need to do to fix this, but it seems pretty clear that
401(k)s do need to be significantly reformed or even replaced
if we are going to have individual savings plans be the primary
retirement vehicle for most Americans.
Senator Merkley. Thank you, Mr. Hiltonsmith. Ms. Mitchem.
STATEMENT OF KRISTI MITCHEM, EXECUTIVE VICE PRESIDENT, STATE
STREET GLOBAL ADVISORS
Ms. Mitchem. Good afternoon, Chairman Merkley, Ranking
Member Heller, and Members of the Subcommittee. Thank you for
this opportunity to talk about the state of the U.S. retirement
system and the role of the employer in helping to ensure
retirement adequacy for the middle class.
My name is Kristi Mitchem and I am an Executive Vice
President for State Street Global Advisors, the investment
management arm of State Street Bank and Trust Company. State
Street Global Advisors is one of the largest asset managers in
the world, entrusted with over $2.3 trillion in assets.
Importantly, we manage more than $305 billion for 401(k) and
other defined contribution investors.
Having worked with retirement plan sponsors for the
majority of my career, I recognize the important role that
employers can play in assisting workers with retirement
preparation. My objective today is to highlight the success
that we are having with the largest employers in the United
States that are helping their workers to achieve retirement
adequacy within the context of a DC-dominated system, and to
suggest ways in which we can make this success more universal
by removing barriers that currently prevent many smaller
companies from offering well-structured retirement savings
programs.
When it comes to individual retirement planning and
preparation, we believe the great divide is more around
employer size than employee income level. Large employers are
much more likely to provide a retirement plan, and when they
do, the plan produces better results for those employees that
participate in it regardless of their income level.
I would highlight several statistics for you that
illustrate the impact of employer size on retirement readiness.
Eighty-nine percent of large companies offer DC plans. However,
only 14 percent of small employers sponsor some type of plan
for their employees to save for retirement. The average savings
rate in large plans is 7.3 percent. For the smallest plans,
that drops to only 5.6 percent. The average account balance in
the largest plans is over two times the average across all plan
sizes.
The question then becomes, why have large plans been more
successful in developing individually funded plans that work?
The answer, in my view, lies in the fact that the largest plans
in the United States are leveraging changes in public policy
and incorporating insights from behavioral finance to drive
real improvements in retirement readiness. Specifically, they
are taking steps to automate good behaviors, simplify choices,
and enhance transparency, such as auto-enrollment, auto-
escalation, and simplified investment menus.
A recent study conducted by the Employee Benefit Research
Institute underscores the impact of these measures in helping
employees achieve retirement adequacy. EBRI estimates 85 to 90
percent of younger middle-class workers participating in a plan
that incorporates both auto-enrollment and auto-escalation
would achieve retirement readiness.
So how do we replicate the large plan experience in the
small plan market? Part of the answer, in our view, lies in
helping convert small employers into large plans by supporting
the pooling of retirement assets. Specifically, we would
recommend that the current nexus requirements be eliminated for
participant-funded retirement programs and that a safe harbor
be offered to participating members of a multiple-employer DC
plan, provided that certain best-in-class plan design features
such as auto-enrollment and auto-escalation are incorporated.
Developing and encouraging the use of pooled plans would
reduce the barriers to plan adoption among small companies by
spreading the administrative and personnel-related costs across
a number of employers. Importantly, it would also help smaller
plans achieve the kind of fee leverage that larger plans now
enjoy.
In other words, access to pooled plans would make
retirement plan provision more attractive to small employers
and would allow participants in these plans to keep more of
what they save through lower plan expenses.
In conclusion, one of the unique facets of the U.S.
retirement system is that the employer plays a central role in
helping individuals to plan and save for retirement. What may
not always be well understood, however, is that this workforce-
centered design actually motivates savings in individuals that,
left to their own devices, would not save.
A recent study shows that half of DC participants strongly
agree or somewhat agree with the following statement: I
probably would not save for retirement if I did not have a
retirement plan at work. And for those with a household income
of less than $50,000, that response rate increases to 70
percent.
Given the important role that employers play in enabling
retirement savings, it is only natural that any exploration of
how to improve the system begin with an examination of why
certain employers are achieving success and others are not. In
our view, the dominant explanatory variable is plan size. We
have presented solid evidence that the largest employers in the
United States are creating plans that work by incorporating
auto-features and using their size and their scale to drive
down costs.
The next step in the evolution of DC plans should be to
bring aspects of that model to a wider range of plan sponsors.
In our view, this can be accomplished, in part, by supporting
the creation of well-structured, multiple employer plans. Thank
you again for the opportunity to testify on the importance of
ensuring retirement security for America's middle class. I
would welcome any questions you might have.
Senator Merkley. Thank you very much for all of your
testimony. We are going to turn first to Senator Warren for
questions because she has an appointment that means she will
have to leave in a few minutes. So we wanted to give her a
chance to get her part of this dialogue underway.
Senator Warren. Thank you very much, Mr. Chairman. It is
very gracious of you and thank you, Ranking Member Heller, for
letting me do this first.
Such an important topic and I have a whole stack of
questions I would like to get through, and I am particularly
interested in what you raised, Ms. Mitchem, about the
importance or the opportunities presented if we look into
pooling retirement plans for small employers. I really think
getting more small employers into retirement systems is the key
to getting more employees into retirement systems. So thanks
very much on this.
I want to ask another question, though, about fees. Fees
charged to administer and invest in retirement savings plans
have an important impact on retirement security. The
differences in fees may seem very small, but compounded over a
lifetime of savings, they can make a huge difference. So I did
a little math on this. For a median income worker who starts
contributing 5 percent of her salary at the age of 25, having
401(k) fees that are set at 1 percent of assets, as compared
with a quarter of a percent in assets, would leave that worker
with $100,000 less at the time of retirement, forcing an
additional 3 years of work to make up the difference.
If the fees are 1.3 percent, the cost at retirement would
jump to over $300,000, and she would have to save 7.5 percent
of her salary, a 50 percent increase, over her entire lifetime
to make up that difference. In other words, fees matter.
In 2012, the Department of Labor implemented new rules for
the first time that required disclosure of fees in 401(k)
plans. So I just wanted to ask briefly, what has been the
impact of required disclosure on fees? Anyone who would like to
do that? Ms. Mitchem?
Ms. Mitchem. I would be happy to take it and I would like
to qualify that my commentary is really going to refer to the
large plan market because that is what we service
predominantly.
Senator Warren. Fair enough.
Ms. Mitchem. But if we look specifically at the largest
plans in the United States, what we saw is that on the basis of
that regulation, in combination, I would add, with other
important trends like the move to lower cost index funds, has
actually resulted in a decrease in fees of about 20 to 25
percent. So not only do fees matter, disclosures matter.
Senator Warren. Absolutely. And that is driving down costs
which means helping people have more secure retirements. Let me
then take that to the next place. It is starting to help in
401(k) plans, but we still do not have anything in individual
retirement accounts. So individuals picking out IRAs are aware
of the impact of fees. It is important that they be aware of
the impact of fees on the bottom line.
There is more money held in IRAs than there is in 401(k)s,
$5.3 trillion versus $3.5 trillion in 2012. And about 95
percent of the money in IRAs comes from funds that were rolled
over from 401(k)s. And yet, there is no requirement that IRA
fees be disclosed. Instead, companies could use misleading
advertisements for no-fee IRAs that might actually have fees,
and fees can be buried deep in legalese in different parts of
the document.
So I want to ask, is there a principled reason why we
should not require the same kind of disclosure for IRAs to make
it clear up front what the fees will be for families? Mr.
Hiltonsmith, would you like to jump in on that?
Mr. Hiltonsmith. Sure. I absolutely do not think there is
any principled reason why we should not require that
disclosure, but just to build on what Ms. Mitchem said, I
actually think that the fee disclosures, both for 401(k)s and
potentially for IRAs, need to go further than they do now.
Senator Warren. Please say more.
Mr. Hiltonsmith. Yeah. I mean, just from my own discussions
with people and with reporters who have been reporting on the
issue, they have been finding people really confused by the
disclosures, that sometimes they are appearing on Page 26 of
their statements, and in some cases, they are not really saying
very much more than they did before in that you still had--you
always had that table of expense ratios and now you have got a
different table and people still are not understanding, as you
mentioned, the lifetime impact of these things, how big of a
difference that 1 percent versus half percent versus, you know,
25 basis points makes.
And so, I really do think that not only do we need
potentially some kind of standard for it, that these things
need to be up-front and in some, you know, clear format like
with credit cards might be required with them, and that also we
really do need to give them some kind of estimate of how much
of a difference, you know, these fees can make over a lifetime,
because when they see 1 percent, they are like, Oh, you know,
that does not seem like very much. But they do not realize that
it is 1 percent of assets every year and that, in essence, is
reducing their returns by 1 percent, you know, is the other way
to think about it.
Senator Warren. Well, thank you very much and I am out of
time and I do not want to take more here, but I really do want
to say, it sounds like such a small point, but getting not just
disclosure, as you rightly say, Mr. Hiltonsmith, disclosure
that is clear, that is in the same place on every document,
that is reported in exactly the same way that it covers
401(k)s, that it covers IRAs.
And I will throw in the pitch what would have been my third
question is when people rollover from 401(k)s to IRAs, that
moment of marketing, that we make sure that people are fully
informed. It is not the only thing we need to do in the
retirement area. We need to do a whole lot more. But this is a
step we ought to be able to do and do quickly. So thank you
very much for having the hearing and thank you for your
indulgence in letting me go first, and thank you all for
showing up here today. Thank you.
Senator Merkley. Thank you. Thank you very much, Senator
Warren. I wanted to turn to Dr. Morrissey, to some of your
testimony. Your testimony makes very clear that Social Security
is the foundation of so many Americans' retirement. According
to the Social Security Administration's estimates, in 2011,
nearly 64 percent of beneficiaries depend on Social Security
for over 50 percent of their income, and 35 percent depend on
it for 90 percent of their income.
Just to round those off, for one-third of the recipients or
beneficiaries, it is the vast bulk, 90 percent or more; for
two-thirds, it is at least half. And that is a very significant
role to play. Social Security payments in that context keep a
lot of our seniors out of poverty. Just 7 percent of Social
Security retirees are below the poverty line. I think that
should be claimed as a significant victory in the war on
poverty.
But a lot of folks are right at the poverty line. And so,
it is a very modest amount of assistance, which is why we are
so interested in other vehicles. But, Dr. Morrissey, do you
think the current Social Security benefits are enough to meet
seniors' expenses, or do seniors deserve a modest raise in
order to pay for medication, to put food on the table? Can
Social Security do even more to provide retirement security for
my citizens in Oregon and certainly the citizens of our entire
Nation?
Ms. Morrissey. Yes, I very strongly feel that we should be
expanding Social Security. In recent years, a lot of the talk
inside the Beltway has been about cutting it. Fortunately, we
have managed to avoid that. But I do not think most people are
aware of the fact that benefits have already been significantly
cut.
And when these benefits were cut in the early 1980s, and
these cuts are still being implemented, nobody envisioned that
we were going to, at the same time, be reducing the quality of
benefits in the private sector plans at the same time, and also
nobody envisioned that we would have the great recession, which
is a once-in-a-lifetime catastrophe as far as the economy.
So for all of these reasons, those changes were in the
wrong direction and we should be reversing these cuts. So I do
not like to think of it as expanding Social Security as much as
restoring benefits that were cut earlier that were
understandable at the time, but that in retrospect were a
mistake.
And yes, I completely agree that people do not realize that
even though the poverty rate for seniors is fairly low, many,
many seniors have modest incomes just above the poverty line
and my colleagues at the Economic Policy Institute have
documented there are many seniors--especially older women, who
are very close to poverty or live very modestly.
Another way of looking at it is, if we need more retirement
income, we can do it two different ways. We can urge people to
save more and while continuing the cuts in Social Security that
are still being phased in, or we can say, Well, nobody is over-
saving, so we should expand this very efficient, very cost-
effective system and, at the same time need to rely less on
these savings plans that have just not worked very well.
Senator Merkley. Well, I do feel that as we see the
decrease of defined benefit programs in the private sector, it
greatly increases reliance on the defined benefit Social
Security program, and I strongly agree that we can do more to
strengthen this program. So thank you for that point.
I want to turn to Treasurer Wheeler. While the conversation
was going on on disclosures, I believe you were shaking your
head or nodding and I am not sure if that was an affirmative or
disagreement, but do you want to comment a little bit from your
experience on the disclosure side?
Mr. Wheeler. Yes. Thank you, Senator Merkley and Senator
Heller. I absolutely agree. My experience was and continues to
be that it is not just disclosure of the fees, just as the rest
of the panelists had indicated. It is the understanding of what
those fees actually mean. And so, we heard a pitch for
disclosure. We heard a pitch for consistency in that
disclosure. So one vendor to another vendor to a third vendor
and so on. You are going to see those fees presented in exactly
the same format, in the same manner.
And then there has to be an understanding of what is
underlying those fees. As Senator Warren pointed out, the
miracle of compounding is very powerful when you are talking
about a savings tool, and it is absolutely damning when you are
talking about compounding fees that you are paying. And people
need to understand what that actually means. So it is
consistency, it is simplicity, and it is just, frankly,
disclosure. I am profoundly in support of all three of those
things.
Senator Merkley. And do you agree with the sense of
extending that into the IRA realm?
Mr. Wheeler. I absolutely do. The end result for a consumer
is exactly the same. They are in those vehicles for the purpose
of saving for their retirement. So from my own personal
perspective, it makes sense that you would have similar,
consistent, and clear disclosure requirements for both.
Senator Merkley. You noted in your testimony--actually, my
time is up, so I am going to turn this over. Well, I think we
might go through a couple rounds of this----
Senator Heller. I think so, yes.
Senator Merkley.----as long as we have time to do so.
Senator Heller. Mr. Chairman, thank you. Mr. Wheeler, in my
previous life, I was Chief Deputy State Treasurer. I was hoping
some day I would become State Treasurer of Nevada. Instead, I
became a United States Senator, I guess.
But needless to say, the questions that I have--do you, in
your position, current position, do you manage the public
employees' retirement system for Oregon?
Mr. Wheeler. Senator Heller, the answer is affirmative. The
State treasury, in combination with the Citizen's Council,
manages the public pension, the investments in the public
pension.
Senator Heller. So that is a commission that you are a part
of, a commission that you are part of?
Mr. Wheeler. Absolutely, yes, sir.
Senator Heller. How much was that, $86 billion?
Mr. Wheeler. Today the pension itself is about $68 billion,
but in addition to that, we have other trust funds that we are
responsible for, which total about $87, $88 billion today.
Senator Heller. You talked about, in your testimony, a task
force. Can you give me any update on how that is going?
Mr. Wheeler. The task force was just convened. It is
actually meeting for the first time in the next couple of
weeks. So we have not actually had the opportunity to meet yet.
Senator Heller. What are the goals of that task force?
Mr. Wheeler. So the goals of the task force are, first of
all, to identify potential savings tools, to identify the
current baseline situation with retirement security in the
State of Oregon. Each State has different issues. For example,
in our State, we know that retirement insecurity
disproportionately skews toward women head of households,
toward minority head of households, toward small business
employees, and as a small business State, that is of importance
to us.
We are also supposed to evaluate any tax incentives that
either currently exist or could potentially exist in the future
that might help incentivize savings. We are supposed to look at
the impact of pooled and professionally managed solutions on
retirement security for the State of Oregon. And finally, we
are supposed to come back to the 2015th legislative session
with any particular ideas that fit within the sideboards that
were provided to us by the legislature in the original
legislation.
Senator Heller. Is there any suggestion that the public
employees retirement system should be involved in individual
retirement accounts?
Mr. Wheeler. There is no suggestion that in the State of
Oregon we will have public sector--excuse me. There is no
indication and, in fact, we are required not to have members of
the public participating in the public employee retirement
system. Amongst the sideboards that were placed on the
legislation, we are not increasing the risk to the State of
Oregon through whatever means we recommend to the legislature.
So the answer would be no.
Senator Heller. Is your system healthy today?
Mr. Wheeler. Senator Heller, I believe the State of
Oregon's system is healthy. We have gone through three rounds
of reforms on the liability side. Today, our pension system is
funded at 92 percent, excluding side accounts. It is funded at
98 percent, including side accounts. At the beginning of this
recession, we were 107 percent funded. At the height of the
recession, we were only 42 percent funded. So scrapping our way
back to 92 percent makes me happy.
And I might further say that the investment pool was
recently identified as the number one pension investment pool
in the United States for pensions in excess of $1 billion in
the 1-, 5-, and 10-year period. So I would answer yes, we are
healthy today.
Senator Heller. So using your numbers, are you 8 percent
unfunded? You have an unfunded liability of 8 percent?
Mr. Wheeler. We have an unfunded liability, yes.
Senator Heller. What is the dollar amount of that?
Mr. Wheeler. The--I do not have the current number with me,
but I could easily provide that.
Senator Heller. OK, OK. The only reason I ask is that
Nevada is, quote-unquote, healthy also and they are about $10
billion unfunded. I worry sometimes about the health of these
pension plans and what is deemed to be healthy today and what
is not deemed healthy.
Let me ask you another question. You know, in your position
that if you are collecting Social Security and you have a State
or municipal retirement also, that they reduce your Social
Security by the amount that you receive in these pensions. What
are your thoughts on that?
Mr. Wheeler. Senator Heller, I have not actually given this
thorough consideration, so I would be reluctant to give an
answer here in front of a Congressional Committee. It is
something that I would want to consider carefully before you
giving you an answer.
Senator Heller. Anybody have an opinion on that? I do. I
mean, if you have put----
Senator Merkley. Would you please let us know, Senator
Heller?
[Laughter.]
Senator Heller. I mean, if you put a lifetime of savings
into Social Security and you are also participating in a
municipal, State, local pension plan, that is your money. Why
the Federal Government deems it is necessary to remove that
money from your Social Security only because you have another
pension plan, because you were responsible enough to have
another pension plan, I think, is a mistake.
So if we are ever looking for something coming out of this
Committee that I think would help those that are on Social
Security, it is to make sure that they receive all the funds
that they have actually put into it. It is their money. For the
Federal Government to take it away from them because they are
in a plan that you help manage, I think, is vastly unfair,
vastly unfair. I think at that, I will turn it back to you.
Senator Merkley. Thank you very much. I want to turn, Dr.
Morrissey, to a comment you made in your testimony, that if you
have $100,000 at retirement and you convert it to an annuity to
start at age 65, that you would not even be able to purchase an
annuity that was equivalent to $5,000 per year. Or let me
translate, that is roughly $400 per month.
In that case, if someone is getting Social Security in the
range of about $1,400, that is equivalent--and I am asking this
as a question, but my impression is--that is equivalent to
having $300,000 to $400,000 in the bank when you retire.
Ms. Morrissey. Yes, it is. People tend to undervalue Social
Security and are not aware of how much retirement wealth is in
the form of Social Security benefits. When I said that these
are the savings people have, I did not include measures of the
value of Social Security benefits. If you include those,
overwhelmingly, Social Security is by far the largest component
of retirement wealth and it has been the case since Social
Security grew to a substantial program.
Senator Merkley. Thank you. I think that it helps me get my
hands around how significant those monthly payments are, or
even a modest private sector pension, how it is equivalent to a
sizable amount of savings.
Mr. Hiltonsmith, you mentioned the excessive fees. Is there
any type of regulation or oversight of the level of fees that
apply to IRAs?
Mr. Hiltonsmith. Are you asking me if there are currently
any?
Senator Merkley. Yes.
Mr. Hiltonsmith. Not that I know of. Not that I am aware
of, in any case. Monique, I am not sure if you know more about
that.
Ms. Morrissey. What was the question?
Mr. Hiltonsmith. Is there currently regulation on IRA fees?
Ms. Morrissey. Not that I am aware of, no. In fact, I think
it is kind of the wild west.
Mr. Hiltonsmith. Yes.
Senator Merkley. It is my impression that a significant
number of fees are taken off the top before the returns are
distributed. In that case, are the fees clearly disclosed to
individuals?
Mr. Hiltonsmith. No.
Senator Merkley. I mean, it is just an issue of the format?
Mr. Hiltonsmith. Yes, the disclosure is there but it is
hidden?
Senator Merkley. It is hidden, or is it that there is not
disclosure?
Mr. Hiltonsmith. You know, I think it is a mix of these, in
a sense. You know, I do not think people do understand that
they are taken off the top, that when you see on your statement
that you have gotten 10 percent returns for the past year, that
those returns would say 12 percent before fees or 11 percent
before fees. You know, I do not think they understand that that
is, in essence, the way that they work.
And then, you know, furthermore, as Senator Warren and
people have mentioned, they really understand just the
magnitude of the impact of that over a lifetime, particularly
with this, you know, compounding.
Senator Merkley. Thank you. I will come back to you in a
moment, Ms. Mitchem. I wanted to turn quickly to Treasurer
Wheeler. You mentioned that half of the private sector
employees do not have an employer who provides a savings
option, a retirement savings option. Do you have any specific
suggestions for how more employers could be induced to provide
such a retirement option?
Mr. Wheeler. Senator Merkley, in deference to the Committee
work that we are about to embark on, I do not want to jump to
the solutions, but there are a number of solutions that have
been preferred here that would center around incentivization,
around pooling resources to reduce the cost, around
professional management to increase the return opportunities.
But in deference to my colleagues on the task force, I do not
want to get to the answer statement about what we are going to
offer.
Senator Merkley. OK, great. I hope that as your task force
proceeds, that my team can stay in contact and share that with
the Committee because I think that would be relevant.
Mr. Wheeler. Yes, sir.
Senator Merkley. Ms. Mitchem, I wanted to invite you. You
had some thoughts on the fee issue, disclosure issue?
Ms. Mitchem. Yes. I just wanted to make sure that we were
clear, that IRAs are regulated by the SEC. They invest
predominantly in mutual funds. Mutual funds have very, very
clear requirements with regard to fee disclosures, both in the
prospectus as well as the short form prospectus.
So I think the question is less about are the fees being
disclosed. It is more about, do participants actually have the
knowledge and the interest and the time to understand those
fees and the impacts that they have on their investments,
whether that be in an IRA or in a large DC plan.
I also think it is important to note, even if we just think
about the name of it, an individual retirement account. The
cost of those accounts are going to be more expensive because
they are provided to individuals as opposed to large collective
organizations. So I would just highlight that I do think there
are things that we can do to help with the fee equation in the
IRA market by looking at the 401(k) plan market.
I think one of the things that we could do is we could
actually provide incentives for employers to keep employees in
the plans post-retirement. I think another thing that we could
do is we could foment broader access to retirement income
options on 401(k) menus.
So one of the very interesting things that we find is when
we look at 401(k) menus today, they are dominated by
accumulation options. You can invest in the S&P 500 index. You
can invest in the Lehman Aggregate index. What in most cases
you cannot invest in is a strategy that helps you de-accumulate
your assets.
So in order for people to stay on plans, to continue to get
the fee savings that come with scale, we need to actually
provide plan sponsors to offer lifetime income and longevity
hedging within the 401(k) plan context.
Senator Merkley. Thank you. That response raised a whole
series of questions which maybe we will be able to come back to
in a few moments.
Senator Heller. Ms. Mitchem, in your testimony, you said
that retirement plan participants believe that they needed to
save about 14 percent of their income, pre-tax wages for a
retirement plan. How did you come to that conclusion?
Ms. Mitchem. We actually produce a survey of plan
participants twice annually. We go out and we ask actual plan
participants, a random sample, statistically significant, what
they believe is important to save for retirement and that is
how we came up with the 14 percent.
Senator Heller. So it is now State Street's opinion?
Ms. Mitchem. No.
Senator Heller. It is the survey that comes out.
Ms. Mitchem. It is a survey. It comes from participants.
And the reason why I think it is so powerful, if I might,
Senator Heller, is because what it proves is that by auto-
enrolling participants, we are actually auto-escalating them up
to a significant percentage of----
Senator Heller. Explain that to me, auto-enrolling.
Ms. Mitchem. OK. So auto-enrolling means that when you come
to work for a corporation, we automatically put you in the
plan. You do not have to do anything. And if we set your
initial contribution rate at 6 percent and then we provide for
what is called auto-escalation, so each year that you stay with
us we actually increase your savings rate by a percent, we can
get you up to those levels.
Senator Heller. Are you increasing the employer
contribution on that? Is that what you are doing?
Ms. Mitchem. Well, what happens is both the employee and
the employer increase their contribution in many instances.
Senator Heller. OK. How do you manage with the risk and
volatility of the markets today? If you take a look at the
Federal Reserve and the very, very low interest rates that you
have today, how could someone plan today knowing that these
rates, frankly, are manipulated to the low standards that they
are today in order to make sure that you have saved enough
money? I mean, I know it is killing seniors today.
Seniors today that have money that is already invested with
these low bond rates and everything else making it very, very
difficult. How does someone at 25 years of age know what the
rate of savings is going to be if you have the Federal Reserve
making the kind of decisions and actions that they have been
taking in the last 5 years?
Ms. Mitchem. So I think the simple answer is they cannot
know, and much of the best planning really relies on average
returns. And so, the hope is, obviously, that if you save a
reasonable amount of your pre-tax income, that over time you
will achieve the types of returns that we have actually
achieved in the past.
The other thing that I would just note there is that the
most important contributor to what you have at the end of the
day is what you put in. So we really do need to focus on
getting people access to 401(k) plans and ensuring that they
are putting enough away.
In terms of investment options, I would always recommend a
well-diversified investment default. So that is a strategy that
has a mix of different asset classes, stocks and bonds, to
generate the types of returns that are hopefully capable of
pushing people toward retirement adequacy.
Senator Heller. Any other comments? Mr. Hiltonsmith, do you
have a 401(k)?
Mr. Hiltonsmith. I do indeed. I have two of them.
Senator Heller. Oh, you do?
Mr. Hiltonsmith. I have had trouble getting them into one.
Senator Heller. In your testimony, you talked about
reforming or replacing them. Do you want to reform or replace
your own 401(k)?
Mr. Hiltonsmith. I spent the last 2 years doing that at
Demos actually. We had a poor plan and I think this actually
indicates one of the difficulties with, you can know all--you
know, you can even have the knowledge of portfolio
diversification and fees, but through your employer have little
opportunity to change the plan your employer selected if it is
not good. And so, this is what I have spent the past years
doing at Demos, is getting us into a better plan.
Senator Heller. So you have replaced?
Mr. Hiltonsmith. Yes. I did get us to switch plans to a
lower fee and, hopefully, a better option.
Senator Heller. But is that not what we are trying to
achieve here in the marketplace, is lower fees? I mean, you had
an opportunity to do that. If you look at your 401(k)----
Mr. Hiltonsmith. Absolutely.
Senator Heller.----and taking out 1 percent, you are not
happy with 1 percent because you are educated enough to know
that that may be 30 percent of your plan?
Mr. Hiltonsmith. Absolutely.
Senator Heller. Did you shop for lower rates? And you are
able to do that. Why would the average American not also be
able to do that, also?
Mr. Hiltonsmith. Well, I have an employer who is kind
enough and collaborative enough to be able to listen. A lot of
people do not feel like they are in that position, their jobs,
or that they can actually push that even if they do have that
knowledge. And then, of course, there is the whole problem with
half employers or half of people not being covered by an
employer plan whatsoever. We will have that, nearly half.
Senator Heller. That is an issue. What would you replace it
with then? Because you are talking about reforming and
replacing 401(k)s. What would you reform or replace it with?
Mr. Hiltonsmith. Well, we need an option that shares some
of these features that everyone here has talked about. One that
does have better risk pooling, you know, that has better
annuity options, that actually really does follow you from job
to job.
As I mentioned, I have spent 2 years trying to roll my one
401(k) into the other and have yet to succeed. So it is not
always an easy process. So something that, you know, so instead
of having to go from 401(k) to IRA back to 401(k) to IRA and
being for somebody of my age, 10, 15 times throughout their
career, potentially, or maybe hopefully not, but for some of
us, you know, we really need something that is portable and
that, you know, has low fees, that is pooled, something that is
a simpler option for people.
But that, as Ms. Mitchem said, you can contribute through
your employer because that is really, as we have seen, if you
have contributions through the employer, that is really where
you get people to save and somebody's future, like auto-
enrollment and auto-escalation really, really help because a
lot of times, people do not even know it is coming out of their
paycheck, to be honest.
Senator Heller. Very good. Thank you.
Mr. Hiltonsmith. Thank you.
Senator Merkley. I think you were reminding us, Mr.
Hiltonsmith, how much younger you are than we are when you talk
about 10 or 15 more jobs.
[Laughter.]
Senator Merkley. Returning to this conversation about fees
and disclosure, I was looking at a description of some of the
fee structures that are in different accounts. This is a
summary from the Consumer Federation of America. And it
mentions there are front-end loads, back-end loads, redemption
fees, deferred sales fees, revenue-sharing fees, maintenance
fees, sales charges.
How is an average person to get their hands around this and
evaluate and compare plans? Anyone want to jump into that?
Ms. Mitchem. I would just say, you know, I think it is very
difficult for the average person to become their own chief
investment officer. It takes hours and hours and hours, as you
know, to become expert on something as complex as finance. And
so, I think that is why we need to make sure that really the
center of our retirement security system is with the employer
and with fiduciaries that are capable of understanding fees and
making these decisions on behalf of plan participants.
Senator Merkley. So one idea that I recall from the Card
Act debate--and this may have been Senator Wyden's bill, but if
it is not, Senator Wyden, do not take offense. But it was an
idea of rating cards according to their fee structure to help
citizens have an easy handle. This is a five-star--I think it
is a five-star rating. And so, folks who are sophisticated
could evaluate all these front-end, back-end.
I am wondering, is something like that a possibility as
something that would be helpful for consumers, Dr. Morrissey?
Ms. Morrissey. We certainly need to make fee disclosure
more simple and salient and to make people aware of the
cumulative effect of fees, how they erode your balances over
time. That said, I had a similar experience as Robbie with
trying to switch in our own employer. We ended up not
switching, and the reason being that we economists were not
able to convince many of the other staff people who were just
looking at the historical returns at some of these actively
managed funds, and to them that was what they were focusing on,
not the fees. There is a limit to how heavy-handed, frankly,
the economists could be in terms of saying, the historic
returns on these actively managed funds are not what you should
be focusing on.
Anyhow, so there is this tendency to be locked into high-
cost plans. It is very hard to switch them out. So it is not
competitive in any real sense. It is very hard to change plans
and it is very hard to make people understand how these fees
function.
For that reason, I think we do need much better disclosure.
We need to do it in a way that illustrates to people the
cumulative effect in terms of eroding account balances. But I
also think that we need to move toward a structure more like
what the Federal employees have in the Thrift Savings Plan
where you really have a limited number of investment options
and all of them make some sense.
Now, that said, I actually have some issues with the TSP. I
think that their life cycle funds, which are about to become
potentially the default investments, are very aggressive. But
nonetheless, at least, you know, each of those funds--you can
make it a defensible case for why you should invest in them,
whereas a lot of what we have with the investment options in a
lot of 401(k)s and IRAs, really, nobody should be investing in
them.
Senator Merkley. So I have 1 minute before I turn this
conversation back over. So is there a connection between some
of the higher fee structures and the sales commissions that go
to those who are marketing the funds? Is that a concern? Does
anybody want to weigh in on that?
Mr. Hiltonsmith. Sure, I would be happy to quickly. Yeah,
absolutely. We are doing it the way--not only the sales
commission for some of the marketers, financial advisors, but
honestly, even for the way that the planned--you know, the plan
custodians and plan record-keepers get their revenue as well.
They get, you know, these--it is called revenue-sharing
payments from the mutual funds that they put in a particular
plan.
So there is a couple layers where--and both the commissions
and these revenue-sharing payments are usually, you know, some
kind of share of the fees charged by a fund. So this really
can--you know, there are several layers of this where there can
be incentives to push higher fee funds kind of against people's
best interests.
So it is not to say the employers do not, you know, have a
fiduciary duty to look out for the lowest fee funds, but in
many cases, like with Demos, I mean, honestly, before I came
there, nobody had any idea that paying 1.7 percent for an
international fund was not the best, or .9 percent for our
index fund.
Senator Merkley. To clarify, are you saying the revenue-
sharing payments went to the employer or to the original sales
force?
Mr. Hiltonsmith. So that the revenue-sharing that I am
talking about is between the mutual funds and kind of the plan
record-keepers, the people who bundle the mutual funds and
other vehicles into plans.
Senator Merkley. I see.
Mr. Hiltonsmith. So, for example, if you have one
corporation's name on a 401(k) and other mutual funds in that
plan, there is a revenue-sharing between those mutual funds and
that bundler, and then there is also the front-end commission
and stuff that you talked about as well.
Senator Merkley. Thank you.
Senator Heller. Mr. Chairman, thank you. Mr. Hiltonsmith, I
want to come back to you for just a minute because of some of
the numbers that you reported, talking about the 1 percent fee
accumulated over a lifetime may be as high as 30 percent. It
was just pointed out to me that in your calculations, it did
not include the employer contributions. Can you tell me why you
did not include the employer contributions in that calculation?
Mr. Hiltonsmith. Yeah. You know, for one, having the
employer contributions, the fee still comes off those, so that
kind of--the 30 percent calculation is really just based on
what percentage, because the way to really think about fees is
what percentage of overall returns, long-term returns they are
eating up.
So if we talk about an aggregate dollar amount that it
costs, like as Senator Warren referred to, $100,000 to
$200,000, then yes, employer contributions would affect that,
but not this kind of what share of, you know, how much it
lowers the overall nest egg by that percentage. That would not
change whatsoever.
But we did not include employer contributions because,
honestly, there has been a tendency toward fewer contributions
by employers. We have seen their share. There is a number I
like to quote. Their share of plan expenses has gone to--they
used to pay about 20 percent of all plan expenses on the
expense side and now they pay about 9 percent.
But also, the amount that they are matching, the generosity
and stuff, in many cases, has gone down. You have seen the news
infer some corporations trying to cut their matches and, you
know, many small businesses do not match or do not have the
luxury to match whatsoever. So we kind of want to just focus on
what you yourself put in, in our calculations.
Senator Heller. Ms. Mitchem, in Nevada, and I always hate
to say this, we have the highest unemployment, highest in
foreclosure, highest in bankruptcy, and you can imagine now how
many people are now risk-averse to what has happened in the
last 5 years. How has this changed savings and investment plans
for the average American after what they have seen in the last
5 years?
Ms. Mitchem. So I think you are absolutely right in that
participants' attitudes toward risk have shifted. The question
then becomes whether that really impacts their ultimate
allocations. And what we find generally is that most
participants never make a change, at least for several years,
to their initial investment allocation.
So their attitudes may have changed, but the likelihood is
that it probably has not been reflected in how they invest. I
would also note that one great corrector for that just to come
back to auto-enrollment, is auto-enrolling people and putting
them into a well-diversified default fund.
So it actually takes those sort of periodic times when
people may be overly risk-averse, just at times when perhaps
they should be accepting risk and corrects for that through a
well-diversified default.
Senator Heller. Does the auto-enrollment allow an
individual to determine the risk they are going to take?
Ms. Mitchem. No. I mean, auto-enrollment is typically
placed into a qualified investment default alternative, or
QDIA. There are three types of QDIAs permitted under the safe
harbor by the Department of Labor. One of those is a target
date fund, which we have discussed.
Another is a balanced fund which generally meets a
demographic test for being suitable for the employee population
at large. And the third is a managed account, which would be a
customized allocation just for a specific individual. If an
individual, once being auto-enrolled and defaulted, decides to
make a change to the investment option, they can do so.
Senator Heller. OK. I want to thank all the witnesses for
being here today. I am not able to ask any more questions, but
I certainly appreciate your time, your energy, your efforts,
and your testimony and what you have brought to the table
today. So thank you. Mr. Chairman, thank you.
Senator Merkley. Thank you very much, Senator Heller. I
wanted to go back to the conversation about why a lot of
employers do not set up a plan. Treasurer Wheeler, you noted
that half employers, or at least maybe it was half the
employees, do not have an employer who provides a plan.
At one point I was an executive director of a small
nonprofit, and I thought, you know, there should be some form
of option here for employees. And I was told to take a look at
the SIMPLE IRA, acronym SIMPLE. And so I did, and after several
important meetings of trustees of the nonprofit, I presented
this and said this is how it will work, they approved it, and
we set it up.
It was pretty easy to set up and it was pretty easy to
operate and it was a fairly modest minimum requirement. I was
just trying to check it while Senator Heller was speaking. But
I think it is the same now as it was then, which was a
requirement of 2 percent, matching the first 2 percent of your
employees' contributions, or 2 percent of their wages up to
that amount that they contribute.
And so, I look at that and I think, given that this is a
fairly modest employer contribution, and I think the whole idea
behind the SIMPLE IRA was, hey, we have a problem with
employers dealing with complex 401(k)s or other vehicles, let
us just make something very straight-forward.
Why has that strategy not worked? What could we do to
encourage more employers to set up a modest retirement
structure for their employees? It is like raising their
employees' income since the employees can set aside those funds
tax-free. It seems like a win-win. Any thoughts on that?
Mr. Wheeler. Sorry about that, Senator. I do have some
thoughts and this is something that I hope that our task force
in Oregon focuses a considerable amount of time on. Your
supposition is correct, that if we could create a pooled
product and if that product was simple, if that product was
cost-effective, if it was easily accessible by employees, it
makes sense that more people would want to save for retirement,
since our constituents tell us this is something they would
like to have.
Some of the current obstacles that we have already
anecdotally come across: If you are a small business employer,
and in our State, Senator, most people are employed by small
businesses, the small business owner typically does not have a
lot of time to give toward things like setting up a retirement
plan.
That, in combination with retirement plan providers who,
frankly, are not that interested in supplying an institutional
quality retirement plan to a very small business, the economies
of scale that come into play with a large employer also hold
true on the fee side. It is just more productive from the
perspective of a provider to find a large employer as opposed
to a micro-employer.
There are other issues as well. A lot of small business
owners already struggle with the issue of mobility of their
workforce, and while 401(k)s and the like are, in fact,
transportable, they go with the employee. They can roll them
over into other plans. For an employer that is looking at an
employee who is not going to be there for very long, it may not
just be worth the effort.
So if we could create some sort of a pool that is
successful, that is simple, that has low fees, that has
institutional quality fund management for those types of
employers, I believe there would be a strong interest in it,
Senator.
Senator Merkley. Thank you very much. Anyone else want to
jump in on this question of how do you--and I should note that
I should expand to if anyone has comments on the myRA, which
the President put in his State of the Union as one approach to
fill in for folks who do not have access to retirement plans,
wants to share any thoughts on that, on that policy proposal?
Ms. Mitchem. I guess I would just make two comments. I
think with regard to myRA, it gets at the heart of the
conversation we are having today, which is how do we actually
expand access and get a larger percentage of American workers
actually covered by workforce retirement programs.
And then I think with respect to your smaller plan
question, again, I would probably go back to much of what I put
in my testimony, which is, everything that we see in the
context of behavioral economics tells us that if we want
someone to do something, let us make it easy for them to do it.
Let us make it simple and let us make it straight-forward.
And I think if we can bind some of the features of SIMPLE
with some changes that allow multiple employers to pool their
retirement assets together, I think that we could get--or at
least go a long way toward increasing access at the smaller end
of the marketplace, and that is certainly what I would suggest.
Senator Merkley. And when you say that, does it resonate
with what Treasurer Wheeler just referred to?
Ms. Mitchem. It absolutely resonates with what he is
referring to. I think that, you know, one of the things that I
really liked about what Treasurer Wheeler said is that one of
the nice things about really fomenting more collective pools of
retirement assets is that they would spur innovation from
providers, I think, and a relatively under-served market would
get more attention and that would be a good thing.
Senator Merkley. So one thing I was struck by in one of
your testimonies was the comment that 401(k)s and IRAs are
inherently less efficient. I think the comment was by a factor
of 50 percent. Was that your comment, Dr. Morrissey?
Ms. Morrissey. Yes.
Senator Merkley. Now, in a normal defined benefit, if you
die, then you are no longer pulling funds from the pool on an
IRA or a 43(b) or 401(k). If you die, you still have a balance
that goes on to your estate. Is it because of that estate
effect that a defined benefit pension plan is so much more
efficient?
Ms. Morrissey. That is part of the explanation. And, in
fact, for this reason, you could argue then that we are
overstating the case. By the way, I came up with that
calculation. But independently, also, the National Institute on
Retirement Security came up with similar estimates, and in my
case, I had help from Ron Gebhardtsbauer, who is a very well-
known actuary, and he checked my numbers and I thought he had
also independently come up with similar figures.
It does assume that the average person with a DC plan is
going to die and bequeath some to their heir, because they need
to have a little bit extra set aside for longevity risk, but a
lot of the difference also had to do with, we were assuming,
for example, I forgot exactly, but I think a 100-basis-point
difference in the rate of return. So there were other
inefficiencies worked into the system.
But some of it is because you do have to set aside a little
bit extra because you just do not know how long you are going
to live and you do not have access to a cost-effective annuity.
Senator Merkley. OK. Related to this, there was a comment--
and this was also yours, Dr. Morrissey--that the tax
expenditures, so the money that we provide through the Tax Code
to support retirement, that the vast bulk of it goes to the
best-off Americans.
Actually, this may not have been from you, but this is the
statistic I have in front of me, that 66 percent of the tax
expenditures to help folks plan for retirement goes to the
richest one-fifth of Americans, and that the bottom 40 percent
get only 7 percent of those tax expenditures. So essentially,
we are spending our public resources, if you will,
overwhelmingly to help the best-off who have the least need for
retirement. Is there anything about that observation that
provides insights on ideas for changing how we do this?
Ms. Morrissey. Well, first of all, yes, I did--we estimated
that it is even more than that, but I think CBO's numbers are
that about two-thirds. So either way, most estimates are that
about two-thirds go to the top income quintile. Avoiding the
whole issue of how these tax expenditures actually work, which
is that they incentivize investment income rather than
incentivize savings, it is striking if you look at President
Obama's earlier proposals to expand the Saver's Credit, and
also at his more recent proposals to limit the tax deferral to
28 percent, the cost of the former is on the order of $3
billion a year and the cost savings from the latter is about a
billion dollars, compared to the total cost of these tax
expenditures for DC plans, which is on the order now of about
$60 billion or $70 billion. President Obama's proposal to
expand the tax Saver's Credit, which would do it in a very
smart way--by making it refundable, and also a fixed amount. It
would be 50 percent match, like a Government match.
He was also raising the limit for the eligibility up to, I
think, $85,000 for married couples. So this is an enormous
expansion of the Saver's Credit, and yet, the cost would amount
to about $3 billion per year. So we are spending $60 billion,
$70 billion a year and this supposedly big dramatic change in
the Saver's Credit, which I wholeheartedly support, would still
only cost a fraction of what we are already spending.
Likewise, the proposal to limit the amounts going to the
very wealthiest people by capping it at 28 percent only saves
about a billion dollars a year. So if both proposals, which I
think are both good ideas, were implemented, it would only have
a very small effect on the cost. I mean, it would only be a
minor correction.
They are well worth doing. They are a politically difficult
lift, I understand that, but it is an illustration of just how
bad the problem is and how even things that are vehemently
opposed by the industry are really actually just minor
corrections of an overwhelmingly bad system.
Senator Merkley. Thank you. Ms. Mitchem, did you want to
comment on this?
Ms. Mitchem. Yes. I was just going to comment that, we do
find that auto features are really a great equalizer, and there
is some recent research that was actually done by Brigitte
Madrian and a group of researchers out of Harvard University.
And specifically, they looked at a Fortune 500 company that was
implementing auto-enrollment and auto-escalation.
And they looked at it pre and they looked at it post. Pre,
they found the kind of distinctions that we are talking about
where groups, on the basis of race and ethnicity, and even sex,
did not participate at the same levels in the 401(k) plan.
Senator Merkley. I am afraid to ask. Which gender is the
better saver?
Ms. Mitchem. Well, actually, women, without auto-enrollment
actually under-save.
Senator Merkley. Oh, under-save?
Ms. Mitchem. Yes, along with blacks, Hispanics, lower-
income workers, younger workers. So those are the people that
actually fall out of the system when you do not use auto-
enrollment and auto-escalation. When you use auto-enrollment
and auto-escalation, we find it to be the great equalizer.
So, you know, the reality is that everyone suffers from
inertia, but people who are under-educated or maybe do not
trust markets actually suffer from inertia at an even higher
degree. So when we combat inertia with smart things like auto-
enrollment and auto-escalation, we get better results for
everyone, and, I think, ultimately a much more even
distribution of the tax incentives across income groups, race
groups, and sexes.
Senator Merkley. That is very interesting. I will follow up
on that study. Thank you. Mr. Hiltonsmith?
Mr. Hiltonsmith. I would just add one minor thing to that,
that I think auto-enrollment is certainly helpful, but can only
go so far as far as correcting these disparities in who is
getting the tax benefits, because, you know, as of right now,
as we know, the cap on tax deferred savings is $17,500 a year.
There are some ways to get around that actually.
But, you know, we have to think of what percentage of
workers can actually afford to save $17,500 a year. So, you
know, even if we get more people into plans and get them saving
more, you know, somebody who makes $50,000 a year just is not
going to be able to save that much, while someone who makes
$300,000 a year probably can.
So, I mean, you know, there--based on the level of that,
you know, that cap, I think that is going to--inequality is
going to remain no matter what we do.
Senator Merkley. Point taken. Let me turn to the auto-
enrollment. When I set up the SIMPLE IRA for the nonprofit, I
sat down with each member of the team and said, Please, just
sign up. Fill out this form. In a month from now, you can get
off if you want. But look, where else are you going to get 100
percent return, because we are matching the funds you set
aside.
And folks who made that initial decision at that point, as
you pointed out, there is a lot of inertia, that people tend to
stay with what they have done. Now, when you are talking about
auto-enrollment, is it then--is it legal now for an employer to
basically automatically sign people up without them signing
anything that says, Yes, you may take X amount out of my
paycheck? Does that extend to almost all the retirement
vehicles? Can you do auto-enrollment now in the SIMPLE plan,
for example?
Ms. Mitchem. You can. So auto-enrollment is provided for
under the Pension Protection Act, another specific exemption
that was written by the DOL. It does have certain requirements
that go along with it, so there are notification periods. So
you need to let people know that you are actually going to be
auto-enrolling them into a plan, so that is an important
consideration.
A second thing that you need to do to qualify for the safe
harbor is to place the assets that come in under auto-
enrollment in what is called a qualified default, and we
already had a discussion around what those are. And the third
thing is you have to meet certain thresholds with regard to
employer matching, to qualify for the safe harbor.
Senator Merkley. And then you mentioned auto-escalation.
Ms. Mitchem. Yes.
Senator Merkley. And is that a set percentage that changes
as people's income goes up or is that----
Ms. Mitchem. So generally in the United States, auto-
escalation is done with what they call a time factor. So the
most common implementation that we see is that employers will
escalate contributions on an annual basis at 1 percent. And
when we talk about things that could really improve the system,
even in the large plan market, I think you have hit on two
really critical ones.
The first is this idea of inertia. If we auto-enroll people
at 3 percent, where do they stay? 3 percent. And left to their
own devices, incidentally, most people would save at the 6
percent level. So one of the things that we need to do is we
need to encourage large plans to be auto-enrolling and using an
initial contribution rate of 6 percent.
The second thing we need to convince large plans to do is
be more aggressive around these escalators for contributions.
As I mentioned today, it is 1 percent per annum. I would love
to see that be 2 percent.
Senator Merkley. Folks, our time has run out. Just this
conversation has raised so many different pieces of this
puzzle. So it provides a lot of food for thought. I am
certainly going to be sharing many of these ideas with my
colleagues as we wrestle with this nationally.
As a number of you noted, this is not just an issue for the
individual person, but it is an issue for our national economy,
for generational issues, for folks' dependence on a safety net
or lack of need to depend upon a safety net. And so, it is an
item of great interest to Congress. I appreciate the insights
that all of you have brought to this gathering.
I need to formally note something. Hold on a minute. The
record will stay open 7 days. Members of the Committee may
submit questions to all of you, and if you would be so kind as
to respond to their questions, we will include that in the
record. It would be very helpful. Thank you. With that, I
adjourn this hearing of the Subcommittee.
[Whereupon, at 4:36 p.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF TED WHEELER
State Treasurer, State of Oregon
March 12, 2014
My name is Ted Wheeler and I am the State Treasurer in
Oregon. In that capacity, I manage the State's investment
program, protect our strong credit rating, and oversee the
protection of public deposits for more than 1,000 local
governments.
Before I entered elected office, I worked in the financial
services industry including at a Portland investment firm
called Copper Mountain Trust, which specialized in private
sector retirement planning.
I am also a fiduciary for the financial interests of
Oregonians, and my concerns about the future of Oregon families
are what bring me here today.
Thank you for your attention to the critically important
matter of retirement security for the middle class. More needs
to be done, and quickly, to reduce the profound economic impact
of what I believe is a generational crisis, which threatens to
plunge seniors into poverty, disrupt entire families and impact
the overall economy.
In Oregon and across the Nation, a lack of sufficient
retirement savings threatens family security and quality of
life, and could place an increasingly heavy burden on social
safety net programs
Time is not our ally.
In Oregon, with bipartisan support, we decided to take a
hard look at retirement security. Oregon's senior population is
projected to double in the next 20 years. At the same time,
roughly half of workers have no retirement savings option at
work, and a study released last year by AARP Oregon found that
one in six Oregonians aged 45-64 has less than $5,000 in a
retirement savings account.
That puts off some pretty big alarm bells. This is a
demographic wave and we are about to get swamped. It is quickly
moving from the realm of being a personal issue to becoming a
social issue.
We know it's hard to save, especially for the middle class.
It's harder to make ends meet with stagnant wages, skyrocketing
post-secondary education costs, and uncertainty about the
future of health care. As I travel the State, the stories I
hear simply confirm the data: Oregonians prioritize today's
pressing economic needs over the retirement savings needs of
tomorrow and too many will be woefully underprepared.
Many may not be able to stop working. For too many, the
golden years could be fool's gold.
A huge number of Oregonians are primarily dependent on
Social Security for retirement. The typical benefit for the
roughly half a million Oregon retired workers in 2012 was
$15,287 a year.
How significant is it: Without Social Security, the elderly
poverty rate in Oregon would have increased from 1 in 14 (7
percent) to 2 in 5 (40 percent).
In December, I helped to convene a roundtable of State
Treasurers and we agreed that this subject deserves America's
attention.
Next week, as laid out in our bipartisan legislation, I
will convene the first meeting of a new task force to consider
how Oregon can help incent more retirement savings, and to
potentially expand the availability of pooled and
professionally managed funds for workers.
Among our questions will be the following:
1.) What options can we create, expand upon, or new models can we
create to bolster the savings of private sector employees who
currently do not have access to a plan through their employer?
2.) What role, if any, can the successful investment program
run by the State Treasury play in this effort?
I think it is appropriate that these conversations occur at
the State level. Different States will have different solutions
based in large part of their differing expectations of
government.
Those innovations and conversations can help to guide your
conversations about Federal policy, much like States' efforts
helped to shape the 529 laws that provide beneficial tools to
save for higher education and vocational training.
Again, thank you for your audience and your awareness that
retirement security is getting further away--if not
unreachable--for too many Americans.
It's a bipartisan concern and time is not our ally.
Thank you for this opportunity.
______
PREPARED STATEMENT OF MONIQUE MORRISSEY, Ph.D.
Economist, Economy Policy Institute
March 12, 2014
How has the financial structure of Americans' retirement evolved over
the past 50 years?
Retirement security advanced in the postwar decades. Participation
in employer-based plans increased from 25 percent of private-sector
workers in 1950 to 45 percent in 1970 (public sector workers were
already largely covered) (EBRI 1998). Social Security became nearly
universal and benefits expanded. The Social Security contribution rate
more than quadrupled in the second half of the 20th century to pay for
cost-of-living adjustments and other new benefits (Martin and Weaver
2005; SSA n.d.).
The 1980s began a period of retrenchment. Social Security cuts
enacted in 1983 gradually raised the normal retirement age, delayed
cost-of-living adjustments, and taxed some benefits. Legislation
enacted 10 years later increased the taxation of benefits. The National
Academy of Social Insurance has estimated that the 1983 and 1993 cuts,
when fully implemented, will reduce Social Security retirement benefits
by 24 percent (Reno 2013).
In the private sector, defined-benefit pensions were largely
replaced by defined-contribution plans, shifting costs and risks from
employers to individual workers. In 1989, full-time private-sector
workers with retirement benefits were divided roughly equally between
those with defined benefit pensions and those with defined-contribution
plans, including roughly 20 percent who had both. By 2010, 50 percent
of these workers had a defined-contribution plan and 22 percent had a
defined-benefit plan, including roughly 13 percent who had both
(Wiatrowski 2011).
In theory, the shift from defined-benefit pensions to defined-
contribution plans could have broadened access by making it easier for
employers to offer retirement benefits. However, participation in
employer-based plans, which peaked at just over half (52 percent) of
prime-age wage and salary workers in 2000, fell to 44 percent in 2012.
This occurred even though the Baby Boomers were entering their 50s and
early 60s when participation rates tend to be high (Copeland 2013;
Morrissey and Sabadish 2013).\1\
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\1\ This is based on Current Population Survey data for wage and
salary workers aged 21 to 64. Overall participation is even lower: 39
percent of all workers in 2012 (Copeland 2013). An employer survey, the
National Compensation Survey, which tends to show somewhat higher
participation rates, also shows a declining trend (EBRI, n.d.).
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An increase in the labor force participation of women and, more
recently, older workers helped mitigate the impact of the shift toward
a do-it-yourself retirement system. The labor force participation of
Americans 65 and older is now higher than it has been in half a century
(author's analysis of Bureau of Labor Statistics data). However,
working longer is not an option for many older Americans. About 40
percent of workers retire earlier than planned due to poor health,
caregiving responsibilities, job loss, or similar reasons (Kingson and
Morrissey 2012). Many other older workers continue working under
difficult conditions, unable to retire from stressful and physically
demanding jobs, or end up among the long-term unemployed.
What have been the recent trends in U.S. retirement assets?
As 401(k)s replaced traditional pensions and the population aged,
assets in individual and pooled retirement funds grew faster than
income. By 2010, average savings in retirement accounts had surpassed
the value of annual household income. However, retirement insecurity
worsened as retirement wealth became more unequal and outcomes more
uncertain (Morrissey and Sabadish 2013).
Mean household savings in retirement accounts increased from around
$24,000 in 1989 to around $86,000 in 2010. However, the growth was
driven by a small number of households with large balances. Median
savings--the savings of the typical household with a positive balance--
peaked at around $47,000 in 2007 before declining to $44,000 in 2010 in
the wake of the Great Recession, even as the Baby Boomers were entering
their peak saving years (Morrissey and Sabadish 2013).
For many demographic groups, the typical (median) household has no
savings in retirement accounts, and balances are low even when focusing
only on households with savings. For groups for whom there is
sufficient data, only white households, married couples, and college
graduates are more likely than not to have retirement account savings.
Even for these households, savings are very unequally distributed
(Morrissey and Sabadish 2013).
Most Americans approaching retirement have little or nothing saved
in retirement accounts. In 2010, 40 percent of families in their peak
saving years (aged 55-64) had nothing saved in retirement accounts and
10 percent had $12,000 or less according to data from the Federal
Reserve Survey of Consumer Finances (Bricker, et al., 2012; Rhee 2014).
Though the median amount for families with savings was $100,000, this
is not even enough to purchase a $5,000 a year joint life annuity
starting at age 65 (author's analysis of Bricker, et al., 2012).\2\
---------------------------------------------------------------------------
\2\ Author's analysis using the Thrift Saving Plan Retirement
Income Calculator on March 7, 2014, based on an annuity interest rate
of 2.875 percent, a 50 percent survivor annuity, and rising payments to
offset inflation.
---------------------------------------------------------------------------
Home equity and other forms of wealth may also be tapped for
retirement. Net worth, like retirement savings, has risen faster than
income since 1989 and grown more unequal (Morrissey and Sabadish 2013).
Taking into account home equity and other assets and liabilities,
median net worth for older families was $179,000 in 2010--close to the
median home value (Bricker, et al., 2012; U.S. Census 2012).
Retirement account savings are very unevenly distributed. In 2010,
a household in the 90th percentile of the retirement savings
distribution had nearly 100 times more retirement savings than the
median (50th percentile) household, which had a negligible amount. The
top 1 percent of households had over $1.3 million in retirement account
savings. All told, households in the top fifth of the income
distribution accounted for 72 percent of total savings in retirement
accounts (Morrissey and Sabadish 2013). Assuming upper-income
households receive tax subsidies at least proportional to their share
of savings, this suggests that the lion's share of tax subsidies for
retirement savings go to high-income households.
Retirement-income inequality has grown because most 401(k)
participants are required to contribute to these plans in order to
participate, whereas workers are automatically enrolled in defined-
benefit pensions and, in the private sector, are not required to
contribute to these plans. Higher-income workers are more likely to
participate because they have more disposable income and are more
likely to work for employers who provide matches (CBO 2013; Morrissey
2009). In contrast, middle- and lower-income workers find it difficult
to save for retirement, especially since inflation-adjusted wages for
most workers have stagnated over the past four decades. Higher-income
households also have a higher investment risk tolerance, allowing them
to better take advantage of retirement savings incentives that depend
on investment earnings.
Disparities in retirement savings partly reflect differences
between workers at different life stages and between those with and
without accounts, some of whom may be covered by defined-benefit
pensions. However, focusing only on workers in their early to mid-50s
with retirement account savings, the mean is still 2.5 times larger
than the median. In contrast, defined-benefit pension benefits appear
fairly equally distributed among older participants, with the mean
benefit only slightly larger than the median benefit (Morrissey and
Sabadish 2013).
There are stark differences by race, ethnicity and education. Black
workers' participation in employer-based retirement plans, including
defined-benefit pensions, used to be similar to that of white workers,
but has lagged in recent years. Hispanic workers, who have always had
low participation rates, have fallen even further behind. As a result
of this and other factors, white households have roughly six times as
much saved in retirement accounts as Hispanic and black households. A
similar gap exists between college-educated and high school-educated
households (Morrissey and Sabadish 2013).
Lower-paid groups are ill-served by a retirement system that shifts
costs and risk onto workers, including the risk of outliving one's
retirement savings. Women, blacks, Hispanics, and seniors aged 80 and
older are more likely to be economically vulnerable in old age, defined
as having an income that is less than two times the supplemental
poverty threshold (Gould and Cooper 2013).\3\ Though women by some
measures are narrowing gaps with men, this is mostly because men are
faring worse and because married women are less dependent than they
used to be on their husbands' benefits. Unmarried people, especially
women, tend to be less prepared for retirement than their married
counterparts.
---------------------------------------------------------------------------
\3\ This is based on Current Population Survey income measures that
exclude lump-sum (as opposed to periodic) distributions from retirement
plans. However, data from the Survey of Consumer Finances and other
sources suggests that retirement account savings for these groups are
modest.
---------------------------------------------------------------------------
The retirement crisis is growing. It is often suggested that future
retirees, who are less likely to accrue pension benefits, will have
more saved in retirement accounts when they retire than Baby Boomers,
many of whom were covered by traditional defined-benefit pensions at
some point in their careers. However, the Center for Retirement
Research has found that workers today tend to have lower wealth-to-
income ratios than earlier cohorts at similar ages, with younger
cohorts at greater risk (Munnell, et al., 2012). Even before the 2008
downturn, wealth-to-income ratios were stagnant despite lower defined-
benefit pension coverage, declining Social Security replacement rates,
rising Medicare premiums, and other reasons younger workers should be
saving more (Delorme, et al., 2006). As a result, the Center estimates
that 62 percent of GenXers are at risk of seeing a significant drop in
living standards at retirement, compared with 44 percent of Baby
Boomers (Munnell, et al., 2012).
How did the financial crisis and aftermath affect retirement security?
Retirement prospects were hit hard by the collapse of the housing
bubble and ensuing Great Recession. The share of households with
savings in retirement accounts contracted after the downturn. The drop-
off was particularly sharp among older households, a bad sign for Baby
Boomers' retirement prospects. Though aggregate savings in retirement
accounts continued to grow faster than income, retirement savings grew
more unequal and the median account balance declined (Morrissey and
Sabadish 2013). Household net worth took an even bigger hit, as the
bursting of the housing bubble resulted in a $13 trillion loss of
household wealth (Bosworth and Smart 2009).
What roles have homeownership played in the ability of the middle-class
to retire?
Historically, most household savings have taken ``brick and
mortar'' form, which had advantages and disadvantages. On one hand,
traditional 30-year fixed-rate mortgages were a form of enforced saving
and provided many people with secure low-cost housing in retirement. On
the other hand, household assets were not diversified. Even before the
housing bubble burst, regional declines could result in homeowners
facing job loss and collapsing home equity at the same time.
Many families borrowed to buy homes in the bubble years only to
find themselves underwater--with negative home equity--after the bubble
burst, a situation exacerbated by the disadvantageous terms of many of
these loans. This was particularly tragic for minority communities who
had earlier been shut out of housing markets. According to a Pew
analysis of Survey of Income and Program Participation data, the real
net worth of Hispanic and black households fell by 66 percent and 53
percent respectively between 2005 to 2009, compared with 16 percent
among white households (Kochhar, et al., 2011).
What are the macroeconomic impacts of retirement security issues?
The shift to a retirement system based on individual savings means
that workers' retirement prospects are increasingly affected by shocks
to stock and housing markets and broader economic trends.
In the past, cyclical downturns in the economy prompted increases
in early retirements, as measured by declines in the share of 60-64
year olds in the labor force. Thus, early retirees made way for younger
workers when jobs were scarce. But as 401(k)s have replaced traditional
pensions, early retirement is no longer associated with labor market
weakness but rather with housing and stock bubbles. Thus, in the late
1990s, when labor markets were tight and the stock market was booming,
there was an uptick in early retirement, though the trend toward later
retirement resumed after the dot-com bubble burst. Likewise, the labor
force participation of 60-64-year-olds continued to climb during the
2008-09 recession (Morrissey 2008).
Social Security and defined-benefit pensions have traditionally
acted as automatic stabilizers because benefit outlays increase when
older workers who lose their jobs during recessions decide to retire
and workers in poor health who cannot find jobs apply for disability
benefits. Because retirement benefits are adjusted for earlier
retirement, an unemployed worker's decision to retire early does not
have a large impact on Social Security's finances. However, the drop in
payroll tax revenues and increase in disability take-up during the
Great Recession did exacerbate Social Security's long-term funding
shortfall.
In the last two recessions and weak recoveries, Social Security's
helpful countercyclical properties were countered by the procyclical
effects of 401(k) plans. Thus, the number of beneficiaries receiving
retirement (Old Age and Survivor Insurance) benefits in 2008-2013 was
roughly the same as the Social Security actuaries predicted before the
recession, though disability take-up increased (author's analysis of
the 2007 and 2013 Social Security Trustees reports).
Nevertheless, Social Security prevented the Great Recession from
being worse than it would have been in its absence or if benefits had
been cut as part of a fiscal ``grand bargain.'' In a recent working
paper, Federal Reserve economists William B. Peterman and Kamila Sommer
found that Social Security was very effective at mitigating the effects
of the recession, particularly for poorer and older Americans (2014).
Likewise, Ghilarducci, et al., (2011) found that Social Security
generally has a positive effect on macroeconomic stabilization, while
401(k) plans exhibit a destabilizing effect on the economy.
These two studies use sophisticated models and statistical
techniques to estimate the countercyclical effects of Social Security.
However, Social Security's role in cushioning the effects of the
downturn is also evident from a simple chart, below, showing a
statistically significant correlation between the growth in the
unemployment and the growth in Social Security benefits by State.
Social Security is also helpful when the economy faces a chronic
demand shortage because it is mostly a pay-as-you go system--
redistributing from current workers to current retirees and other
beneficiaries--and beneficiaries tend to spend their income more
quickly than workers. In comparison, advance-funded pension and savings
programs tend to reduce aggregate demand.
What are the major challenges facing Americans in preparing financially
for retirement? How well do currently available retirement
products, such as IRAs and 401(k)s, meet the needs of
consumers? How can they be improved to better meet the needs of
today's working families?
401(k)s are an accident of history. In 1980, a benefit consultant
working on a cash bonus plan for bankers had the idea of taking
advantage of an obscure provision in the tax code passed 2 years
earlier clarifying the tax treatment of deferred compensation and
adding an employer matching contribution (Sahadi 2001; Tong 2013).
Though 401(k)s took off in the early 1980s, Congress did not intend for
them to replace traditional pensions as a primary retirement vehicle,
and they are poorly designed for this role. Few people have the math
skills, financial sophistication, or time to make sense of often
conflicting financial advice and make sound investment decisions. IRAs,
primarily composed of funds rolled over from 401(k)s, offer even fewer
protections and typically have even higher fees (Munnell, et al.,
2013).
By limiting the scope for risk pooling and intergenerational risk
sharing, the shift from defined-benefit pensions to individual accounts
has increased the investment, longevity and inflation risks faced by
participants. Individual savers also forgo economies of scale in
investment management and administration. As a result, contributions
must be nearly twice as high with 401(k)-style plans as traditional
pensions to ensure a similar income in retirement (Almeida and Fornia
2008; Morrissey 2009).
Problems caused by the loss of risk pooling are exacerbated by poor
decisionmaking aggravated by a lack of transparency and conflicts of
interest. For example, voluntary annuitization introduces adverse
selection problems that make it expensive for individuals to hedge
longevity risk--a problem aggravated by the difficulty individuals face
in navigating tricky annuity markets as well as their tendency to
undervalue income streams and underestimate the risk of living well
into their 80s or 90s.
Investment risks faced by individual investors are often poorly
understood even among supposed experts. Individual investors are often
led to believe that bull and bear markets cancel out over time, or that
target-date funds shield them from risk. They naively interpret excess
returns as a sign of a good investment going forward. They are often
lulled into a false sense of security if stock returns are high, fail
to rebalance in the wake of rallies, or simply gamble on all-stock
portfolios. Risk taking is encouraged by tax subsidies whose value
depends on investment earnings, making these particularly ill-suited
for lower-income workers, who are rationally more risk-averse. Thus, at
the opposite extreme, some individuals choose to invest very
conservatively throughout their working lives or lock in low returns by
selling in the wake of market downturns.
What role can employers, government, and other parties play to improve
retirement security? What specific policies would enhance U.S.
retirement security? How are States affected by and working to
address retirement security issues?
Our first priority should be expanding Social Security benefits as
proposed by Sen. Tom Harkin, Rep. Linda Sanchez, and others. Such
measures could replace some of the benefits cut in 1983 and restore the
progressivity of lifetime benefits as life expectancy grows more
unequal (Morrissey 2013; Waldron 2007). The Harkin-Sanchez bill would
also better protect seniors and other beneficiaries from the rising
cost of health care and other increases in the cost of living that
erode the value of their benefits.
We should also take steps to preserve existing defined-benefit
pensions in the public and private sector. Contrary to the conventional
wisdom, most public employee pension plans are in reasonable shape
despite the effects of the financial crisis. Those that are in the
worst shape got that way because elected officials neglected to make
actuarially required contributions, so the focus should be on
preventing this from happening in the future, not reneging on promises
to workers.
Next, we should address some of the worst problems of 401(k)s and
IRAs before encouraging workers to save more in these plans through
auto enrollment and similar measures. The Thrift Savings Plan (TSP)
offered to Federal workers is sometimes put forward as a model 401(k)-
style plan because fees are kept low by pooling assets and investing in
low-cost passively managed funds. Participants have limited investment
options and are encouraged to convert savings to a low-cost annuity at
retirement (Davis, et al., 2010).
Though the Thrift Savings Plan is an enormous improvement over
401(k)s available to most private-sector workers, it does not resolve
the fundamental problems of market risk and upside-down tax subsidies.
In addition, TSP lifecycle funds, which may soon become the default
investments, are heavily invested in stock, with an equity allocation
ranging from 88 to 54 percent during the accumulation phase (author's
analysis of FRTIB n.d.).
At the opposite extreme in terms of risk, the MyRA plan proposed by
President Obama would invest workers' savings in a Government bond fund
similar to the G Fund, the Thrift Savings Plan's current default
investment. This low-cost saving vehicle is a convenient and cost-
effective way of meeting the needs of the most risk-averse savers,
except that account balances must be rolled over to (often high-risk
and high-fee) IRAs when they reach $15,000.
Some problems with defined contribution plans may be addressed by
making them more like defined benefit pensions. Senator Harkin's USA
Retirement Funds, for example, take advantage of risk pooling,
economies of scale and professional investment management to provide
retirees with secure lifetime incomes. The California Secure Choice
Plan is another innovative approach to providing workers who lack
access to an employer-based pension with a plan that would shield them
from the high costs and risks of 401(k) plans. Neither plan would
require employers to take on long-term pension obligations. Another
option is the Adjustable Pension Plan, currently awaiting IRS approval,
which would reduce, but not eliminate, employers' long-term risks.
Last but not least, we should reconsider our reliance on tax
incentives for retirement saving. This approach is inherently
inefficient, because there is no way to guarantee that tax subsidies
encourage people to save more as opposed to simply shifting funds to
tax-favored accounts. Nevertheless, a refundable tax credit is a more
efficient way to encourage voluntary saving than the current system,
which actually provides a tax break on investment income.
The Economic Policy Institute's Guaranteed Retirement Account plan
proposed converting tax breaks for 401(k)-style plans and IRAs into
flat tax credits to offset the cost of new accounts with a modest rate
of return guaranteed by the Federal Government. The plan was designed
to improve the retirement security of most Americans without costing
taxpayers more than the current system (Ghilarducci 2007).
EPI is working on a variation of the original GRA plan that, like
the original plan and the Center for American Progress's SAFE
retirement plan, would be a pooled and professionally managed fund that
uses a gain and loss reserve to stabilize returns credited to notional
accounts (Davis and Madland 2013). Specifically, the aim would be to
maximize the share of retirees who achieve a target rate of return
while minimizing the share with poor outcomes. In contrast to the SAFE
plan, the new ``GRA 2.0'' plan would smooth cumulative rather than
annual returns. Unlike the original GRA plan, the Government would not
necessarily need to guarantee returns in the ``GRA 2.0'' model.
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______
PREPARED STATEMENT OF ROBERT HILTONSMITH
Policy Analyst, Demos
March 12, 2014
Thank you, Chairman Merkley and Members of the Senate Banking
Committee's Subcommittee on Economic Policy for the opportunity to
testify today. My name is Robbie Hiltonsmith, Policy Analyst at Demos,
a public policy organization working for an America where we all have
an equal say in our democracy and an equal chance in our economy. I am
happy to be here today to testify on the state of U.S. retirement
security, because though retirement security is one of the lynchpins of
economic security for the middle class, it is also proving sorely
elusive for the majority of Americans. One of the major reasons for
this brewing retirement security crisis is the inadequacy and
inefficiency of defined contribution plans. These plans, which include
401(k)-type plans and IRAs,\1\ are the primary ways for most workers to
supplement Social Security retirement income, and it is on the inherent
problems with these plans that I will focus my testimony.
---------------------------------------------------------------------------
\1\ I use ``401(k)'' or ``401(k)-type plan'' as a shorthand to
refer collectively to the many types of similar employer-based
individual retirement plans, including 401(k)s, 403(b)s, 457s, and
Keoghs.
---------------------------------------------------------------------------
According to the National Compensation Survey (NCS), less than two-
thirds of all private sector workers in the United States (64 percent)
were covered by any workplace retirement plan in 2012, and just 49
percent of all such workers participated in their employer plan.\2\
However, the retirement security crisis isn't just limited to the half
of workers who don't participate; even many of those who are actively
saving for retirement are at risk as well, because most U.S. workers
participating in a workplace retirement plan are covered only by an
individual-account, 401(k)-type plan. These plans place nearly all of
the risk on workers, who face the very real possibilities of losing
their savings in a stock market plunge or of outliving their retirement
savings. Even worse, 401(k)s often have high, hidden investment
management, administration, and trading fees that can eat into their
returns, making saving for retirement even more difficult. Though
401(k)s have only become the primary retirement savings vehicle for
workers in the past three decades, the inadequacies of these plans are
already showing in retirement savings data: nationally, as of 2010, 40
percent of households ages 55-64, the first cohort of workers to be
forced to rely on the 401(k), had nothing saved for retirement, and the
median retirements savings among those with any was just $100,000.\3\
These stark figures, along with many others, show that the fees and
risks mean that 401(k)s are make them unsuitable to be U.S. workers'
primary supplement to Social Security in retirement.
---------------------------------------------------------------------------
\2\ U.S. Bureau of Labor Statistics, ``National Compensation
Survey: Employee Benefits in the United States,'' March 2013.
\3\ Federal Reserve, 2009 Panel Survey of Consumer Finances, http:/
/www.federalreserve.gov/econresdata/scf/scf_2009p.htm.
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So, what risks, in particular, does being forced to depend on a
401(k) for the bulk of one's retirement income force workers to
shoulder? Retirement experts generally agree that there are five major
types of risk that 401(k) participants bear. Savers risk losing their
savings to poor investment decisions, which experts term investment
risk; high fees and low contributions (contribution risk); or a
turbulent market (market risk); they also risk outliving their
retirement savings (longevity risk); and being forced to, or unwisely
choosing to, withdraw from or borrow against their savings (leakage
risk). Though many 401(k) proponents believe the private retirement
market can and will mitigate these risks, the continued inadequacy of
Americans' retirement savings after nearly three decades of the 401(k)
suggest otherwise.
The financial crisis and following recession of the past few years
has made the magnitude of the effect of market risk on 401(k)
retirement savings crystal clear. During the stock market plunge of
2008 and 2009, 401(k)s and IRAs lost a total of $2 trillion dollars in
value, while the average 401(k)-holder lost over \1/3\ of his or her
savings.\4\ Retiring during a market downturn generally means either
doing so with vastly reduced retirement savings, which--though
retirees' balances may later recover--can certainly affect potential
retirees' long- and short-term financial planning, or lead them to
postpone retirement, which in turn prevents younger workers from
entering the labor force and worsens the already high youth
unemployment that accompanies such downturns. Just how large of an
impact can market cycles have on 401(k) balances? By our calculations,
if an average worker with retirement savings had retired at the height
of the last big stock market surge in 2000, he or she would have had
over 50 percent more to live on during retirement than if she had
retired in the depths of the last recession in 2009.
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\4\ Monique Morrissey, ``Toward a Universal, Secure, and Adequate
Retirement System'', Retirement USA, 2009.
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Another problem with 401(k)s is investment risk--the possibility of
participants making poor investment decisions. Though the freedom to
choose one's own investments is lauded as a benefit of 401(k)s, in
fact, most actual Americans are extremely ill-equipped to choose among
often inscrutable investment choices. For example, in one study, 84
percent of retirement plan participants thought that higher mutual fund
fees guaranteed better performance,\5\ even though multiple studies
have shown that there is no relationship between the two. 401(k)
participants, despite years of advice from their investment advisors,
generally have no idea how to balance their portfolios, often adopting
an all-or-nothing approach to risk. Twenty-one percent of participants
have more than 80 percent of their assets in stocks and other risky
assets, far too much for any but young savers. Another 38 percent have
none invested in stocks, a far-too-conservative allocation for any
age.\6\ Individualized investing might seem to conform to our Nation's
idealized vision of freedom and individual choice, in reality, leaving
the investment decisions up to financial market professionals would
result in higher returns and lower risk.
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\5\ Neil Weinberg and Emily Lambert, ``The Great Fund Failure'',
Forbes, 2003, http://www.forbes.com/forbes/2003/0915/176_4.html.
\6\ Employee Benefits Research Institute, ``401(k) Plan Asset
Allocation'', 2009.
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Longevity risk, or the possibility that retirees outlive their
retirement savings, is increasingly worrisome as high-income Americans
continue to live longer. Though most know that life expectancies are on
the rise, it's still impossible to know exactly how long we,
individually, will live. When surveyed, individuals, generally,
underestimate their own probabilities of living to an old age.\7\
401(k)s, by their very nature, simply provide a fixed sum to live off
of in retirement; ensuring that sum lasts the rest of one's life would
require exact knowledge of one's exact date of death, a grisly and
impossible prospect. Investment options such as annuities, which can
mitigate longevity risk, remain both prohibitively expensive and are
often extremely complex. The most efficient way to eliminate longevity
risk is to pool such risk among a wide swath of the country, similar to
the approach taken by the Affordable Care Act. Unfortunately, the
structure of the current 401(k) system makes it nearly impossible to do
so.
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\7\ Teresa Ghilarducci, When I'm 64: The Plot Against Private
Pensions and the Plan to Save Them, Princeton University Press, p. 124,
2008.
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At first blush, the fact that 401(k)s allow account-holders to make
early withdrawals or take out loans against account assets to pay for
unexpected expenses might seem to be an advantage of such plans,
helping individuals to smooth out life's little financial curveballs
and potholes. However, the flipside of allowing these early
withdrawals/loans are that they present another risk--commonly referred
to as leakage risk--to adequate retirement savings. Leakage can
significantly damage workers' retirement prospects, particularly those
of younger workers, who lose decades of compounded returns when they
withdraw, cash out or borrow. According to Vanguard, one of the largest
401(k) providers, 3.7 percent of participants younger than age 60
withdrew an average of 29 percent of their total 401(k) balance in
2010;\8\ Even more alarmingly, 18 percent of all 401(k) participants,
and 23 percent of all participants with incomes less than $30,000, had
a loan outstanding at the end of the year. Ten percent of these loans,
Vanguard says, are never repaid, significantly affecting retirement
savings, and the interest lost during the loan period reduces account
balances for repaid and unpaid loans alike. The GAO estimates that such
withdrawals and loans (including between-job cashouts) sapped nearly
$84 billion from retirement accounts in 2006, a number which surely
rose during the recent recession.\9\ Between-job leakage is actually
responsible for the lion's share of this leakage, as significant
pluralities of workers simply cash out their retirement plans when
leaving a job, particularly younger workers. A recent AON study found
that 59 percent of Millennials, and 46 percent of Gen Xers, cashed out
their 401(k)s each time they changed jobs.\10\
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\8\ https://institutional.vanguard.com/VGApp/iip/site/
institutional/researchcommentary/article/RetResGreatR.
\9\ Government Accountability Office (GAO), ``Policy Changes Could
Reduce the Long-term Effects of Leakage on Workers' Retirement
Savings,'' 2009, http://www.gao.gov/products/GAO-09-715.
\10\ http://www.aon.com/attachments/
RetirementReadiness_2010_Report.pdf.
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Finally, perhaps the largest 401(k) risk is contribution risk: the
risk that workers contribute too little to their retirement over the
course of their lifetimes. Workers contribute too little to 401(k)s for
three main reasons: either they're simply not earning enough, they
don't trust 401(k)s and the financial markets in general, or simply
don't have the financial literacy to understand how plans work or how
much to contribute. Employees themselves believe the first reason, lack
of income, is the also the largest, and decades of stagnant wages would
seem to lend credence to their claim. In a 2007 poll, 56 percent of
respondents said that the reason they were not saving for retirement
was because they couldn't afford to save.\11\ Figures on contribution
rates by race confirm this claim; those for Latinos and African-
Americans, who have lower average incomes, trail significantly behind
higher income whites and Asian Americans.\12\
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\11\ The Rockefeller Foundation, ``American Worker Survey: Complete
Results,'' 2007, http://www.rockefellerfoundation.org/uploads/files/
1f190413-0800-4046-9200-084d05d5ea71-american.pdf.
\12\ Ariel/Hewitt, ``401(k) Plans In Living Color,'' 2009, http://
www.arielinvestments.com/content/view/1223/1173/.
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The variety of fees charged by the funds in which 401(k) assets are
invested can, too, make it even more difficult to contribute enough to
individual retirement accounts. These fees, though often seemingly
innocuous single-digit percentages, actually add significantly to the
risk that workers are unable to save enough for retirement. According
to our research, these fees can actually consume 30 percent or more of
the gross (or before-fee) returns earned by savers' investments. Over a
lifetime, these fees can add up to a significant chunk of workers'
savings. According to our model, fees can cost an average household
nearly $155,000, in fees or lost returns, effectively reducing the size
of their nest egg by over 30 percent. How are mutual funds able to take
such a large cut for their services? Mainstream economic theory
provides a simple answer. When consumers of a product, such as mutual
funds, do not have enough information or education to choose rationally
among competing products, suppliers (funds) can charge higher prices.
And that's precisely what happens: undereducated and overworked 401(k)-
holders often do not choose wisely amongst the limited menu of often
opaque and seemingly identical mutual funds that their 401(k) provides.
Employers, too, often lack expertise: employees in charge of many
firms' 401(k)s only administer the plans part time, and thus often do
not have the knowledge necessary to choose amongst nearly identical
401(k) plans, or the incentive or power to push for a plan switch if
their firm's plan is on the higher end of the cost spectrum. And
unfortunately, many IRA brokers and 401(k) financial advisors take
advantage of this lack of knowledge by pushing higher-fee plans on
savers and employers, because they are not required to look out for the
best interests of their clients, and are in fact often incentivized to
push such high fee plans because they receive part of their
compensation from the fees generated by the plans they sell.
Though it has been difficult to quantify the losses due to
``excessive'' fees, in large part because of the lack of publicly
available data on fees charged by 401(k) plans, recent research has
shown large losses due to both savers' and plan sponsors' lack of
knowledge and poor advice from plan investment advisors. One study
estimates that savers lose an average of nearly 1 percent in returns
due to poor choices by plan fiduciaries, in part likely due to poor or
conflicting advice received from their plan financial advisors.\13\
These losses could be partially or entirely mitigated by requiring
financial advisors for 401(k)-type plans give advice in their clients'
best interest.
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\13\ Quinn Curtis and Ian Ayres, ``Measuring Fiduciary and Investor
Losses in 401(k) Plans,'' February 2014.
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The 401(k)'s plethora of risks and excessive fees make a convincing
case for what many critics have been saying for decades: this national
experiment in 401(k)-based ``do-it-yourself-retirement'' has been, and
will continue to be, a failure. A new system to replace 401(k)s is
urgently needed. All hardworking Americans need a safe, low-cost secure
account to save for retirement, one that can also provide a lifetime
stream of income when they retire; in other words, an account that
protects workers from the severe risks and high costs of 401(k)-type
plans.
______
PREPARED STATEMENT OF KRISTI MITCHEM
Executive Vice President, State Street Global Advisors
March 12, 2014
Good afternoon Chairman Merkley, Ranking Member Heller and Members
of the Subcommittee. Thank you for this opportunity to talk about
retirement security and the critical impact it plays in our economy.
My name is Kristi Mitchem. I am an Executive Vice President for
State Street Global Advisors, the investment management arm of State
Street Bank and Trust Company. State Street Global Advisors is a
leading asset management firm, entrusted with over $2.3 trillion in
assets under management.\1\ Importantly, State Street Global Advisors
is one of the largest providers of defined contribution (DC) services
worldwide, managing more than $305 billion in retirement plan assets on
behalf of employers and retirement plan participants. Our size and
penetration within the DC marketplace affords me the opportunity to
interact with U.S. DC plan sponsors on a regular basis, informing my
perspective.
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\1\ As of December 31, 2013.
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Having worked with retirement plan sponsors for a decade, I
recognize the important role that employers can play in assisting
workers with retirement preparation. My objective today is to highlight
the success that the largest employers in the United States have had in
helping their workers achieve retirement adequacy and to suggest ways
in which we can make this success more universal by removing barriers
that currently prevent many smaller companies from offering well-
structured retirement savings programs.
Retirement Today
For nearly 50 years, the retirement landscape was dominated by
defined benefit (DB) plans, which provided many Americans with a
monthly lifetime pension. But in more recent decades, the number of
Americans covered by DB plans has diminished substantially. We have
shifted to a system that is much more dependent on self-funded DC
plans. By year-end 2013, DC plans were more prevalent than DB plans in
the United States, as well as globally. This trend is likely to
continue as plan sponsors increasingly look to reduce their pension
liabilities.
DC plans are now the primary source of retirement benefits for
millions of Americans. We believe these plans have the potential to
provide retirement security to the majority of American workers.
However, realizing this potential will require substantial progress
from where we are today. We recognize and applaud regulators and
legislators for acknowledging the existing issues around access,
participation and cost.
In developing solutions to these problems it may be useful to
consider how and where we are having success in retirement preparation
today. Specifically, we believe that many of the largest and most
sophisticated plans in the United States have designed and implemented
adequate, self-funded retirement plans. The challenge we face is
determining the public policy shifts necessary to close the gap between
large and small employers with regard to DC plan provision and
structure.
The ``Great Divide''
When it comes to retirement planning and preparation, we believe
the ``Great Divide'' is more around employer size than employee income
level. Large employers are much more likely to provide a retirement
plan. And when they do, the plan produces better results for those
employees that participate in it. Comparing data from large and small
plans across a number of dimensions illustrates the impact of employer
size on retirement readiness.
Access: 89 percent of large companies offer DC plans;\2\
however only 14 percent of small employers sponsor some type of
plan for their employees to save for retirement.\3\
---------------------------------------------------------------------------
\2\ Bureau of Labor Statistics.
\3\ GAO Study on Challenges and Prospects of Employees of Small
Businesses, July 16, 2013.
Participation Rate: The average participation rate in the
largest plan segment is close to 80 percent. For the smallest
companies that offer a plan, participation rates dip down to
74.2 percent.\4\
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\4\ PLANSPONSOR DC Survey 2013.
Savings Rates: In the largest plans, the average savings
rate is 7.3 percent while for the smallest plans it is 5.6
percent.\5\
---------------------------------------------------------------------------
\5\ Ibid.
Account Balances: The average account balance in the
largest plans is about two times the average across all plan
sizes--$140,000 compared to $63,878.\6\
---------------------------------------------------------------------------
\6\ Inside the Structure of Defined Contribution/401(k) Plan Fees:
A Study Assessing the Mechanics of the `All-In' Fee 2011. Deloitte.
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DC Advances within the Large Plan Market
The largest plan sponsors are clearly outpacing small employers in
the race to provide a viable replacement for DB plans; the question
then becomes why have they been able to create more successful defined
contribution offerings.
The answer in my view lies in the fact that the largest plans in
the United States are leveraging changes in public policy and
incorporating insights from behavioral finance to drive real
improvements in retirement readiness. Specifically, they are taking the
following actions to automate good behaviors, simplify choices and
enhance transparency:
Automatically enrolling new employees.
Automatically increasing contribution rates for
participants over time.
Offering their participants a more streamlined and
simplified menu of investment choices to help participants make
better investment choices.
Embracing well-diversified target date funds as default
investment options to aid participants in managing key
investment risks.
Negotiating lower investment fees on behalf of participants
across all types of investments and asset classes.
Utilizing high-quality, low-fee index based investments
where appropriate on retirement plan investment menus.
Comparing Characteristics of Smaller and Larger Plans
Helping Small Employers Increase Plan Sponsorship
So how do we translate the successful evolution of DC plans
sponsored by large
employers into success for the small employer market? First, we
must remove current obstacles that make plan sponsorship more
challenging for small employers. Unlike large employers, small
businesses often do not have the time, resources and expertise to
administer a retirement plan. The administrative burdens and fiduciary
responsibilities associated with plan sponsorship can be overwhelming
and inhibit adoption.
We believe that if smaller companies could have access to a
multiple-employer plan (MEP) through an industry group or other
association, they would be more likely to offer a workplace retirement
plan. We would therefore suggest that you consider changes to current
policy that would support the growth of multiple-employer DC plans.
Specifically, we would recommend that: 1) the current DOL nexus
requirement be eliminated for participant-funded retirement programs,
and; 2) a safe harbor be offered to participating members of a
multiple-employer DC plan, provided that certain best-in-class plan
design features are incorporated. Developing and encouraging the use of
MEPs would reduce the barriers to plan adoption among small companies
by spreading administrative and personnel related costs across a number
of employers. Importantly, it would also help smaller plans achieve the
kind of fee leverage that larger plans now enjoy. In other words,
access to MEPs would make retirement plan provision more attractive to
small employers and allow participants in these plans to keep more of
what they save through lower plan expenses.
A Future Model for Small Employers
As discussed above, we believe one potential way to close the gap
between large and small plans would be to create a safe harbor for
employers that participate in well-structured, multiple-employer DC
plans. These well-structured MEPs should mimic the largest plans in the
United States by leveraging automation and simplification to drive
better participant outcomes. In our view, the features required for
safe harbor coverage should include:
Auto enrollment starting at a minimum of 6 percent with
default into an indexed target date fund.
Automatic contribution rate escalation at a minimum of 1
percent annually up to a cap of 15 percent.
A simplified investment menu including an index target date
fund, a limited number of core options and a lifetime income
option to help manage longevity risk.
A loan program available only for hardship to prevent plan
leakage.
A total plan expense ratio under a certain limit based on
the size of the MEP.
An optional employer match or discretionary profit-sharing
type contribution.
In order to make participation in MEPs easier and more attractive,
we believe the following additional changes in public policy should
also be considered:
Removal of testing and reporting requirements for employers
under a certain size.
Acceptance of aggregated 5500-type reporting with a
breakdown of contribution amounts by participating employers.
Alterations to the tax code to prevent disqualification of
a multiple-employer plan despite a violation by one or more
participating members.
We believe granting small businesses the ability to participate in
simplified MEPs would send an important signal to the retirement
market. This change would inspire DC plan service providers and
investment managers to create more products tailored to small
businesses, providing a broader range of choices and greater economies
of scale to an underserved market segment.
Are Large Plan Advancements Sufficient?
In the sections above we explored the differences between large and
small plans and suggested potential ways to replicate the large plan
experience in the small plan market. One critical question that we have
not explicitly addressed, however, is whether or not well-structured
plans, such as those currently prevalent at the larger end of the
market, are capable of delivering retirement security to the middle
class. In order to answer this question, we look to data produced by
the Employee Benefit Research Institute (EBRI). In December of 2013,\7\
EBRI's Retirement Security Projection Model (RSPM) analyzed the
potential of DC plans to produce ``adequate'' income replacement for
retirement. EBRI data shows that when plans adopt automatic enrollment
and auto escalation, retirement adequacy rates are high. According to
EBRI, 85 percent to 90 percent of younger middle class workers
participating in plans with auto features are expected to replace 80
percent of their income in retirement.\8\ Importantly, lower income
quartiles also do well under the auto feature condition, with 90
percent of lower income workers expected to replace 80 percent of their
preretirement income.
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\7\ EBRI Retirement Security Project Model findings from EBRI/Jack
Vanderhei testimony to the U.S. Senate Committee on Finance,
Subcommittee on Social Security, Pensions, and Family Policy, Hearing
on Retirement Savings for Low-Income Workers. Statement of record,
Wednesday, February 26, 2014.
\8\ EBRI Assumptions: `` . . . assuming current Social Security
benefits are not reduced, 86 percent of workers in the lowest-income
quartile with more than 30 years of eligibility in a voluntary
enrollment 401(k) plan are simulated to have sufficient 401(k)
accumulations that, when combined with Social Security retirement
benefits, would be able to replace at least 60 percent of their age 64
wages and salary on an inflation-adjusted basis. When the threshold for
a successful retirement financing is increased to 70 percent
replacement, 76 percent of these workers will still meet the threshold,
based solely on the combination of projected 401(k) savings and Social
Security combined. At an 80 percent replacement rate, 69 percent of the
lowest-income quartile will still meet the threshold. It should be
noted, however, that the percentage of those in the highest-income
quartile deemed to be ``successful'' from just these two retirement
components drops to 59 percent from 83 percent when measured against
the 60 percent threshold.''
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Despite these encouraging statistics, there is more that plan
sponsors can and should do to improve the retirement prospects of those
with fewer years to retirement and to provide a buffer for newer
employees. In our view, two of the most impactful steps that plan
sponsors could take to further increase retirement adequacy would be to
utilize more aggressive defaults and incorporate lifetime income
options in their plan menus.
EBRI and other industry associations, such as the Defined
Contribution Institutional Investment Association (DCIIA), have done
extensive research in the area of defaults and demonstrated the strong
relationship between initial deferral rates and retirement adequacy.
Because many employees will ``stick'' at the default rate, it is
important for plan sponsors to choose default savings rates that are
high enough to provide for adequate savings. Increasing the default
savings rates from 3 percent to 6 percent can impact accumulated
balances substantially.\9\ If we double the savings rates of 45-year-
old middle-class workers, their accumulated balances at retirement
would grow by 41 percent.\10\
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\9\ DCIIA: The Impact of Auto-Enrollment and Automatic Contribution
Escalation on Retirement Income Adequacy, Jack VanDerhei, Employee
Benefit Research Institute, and Lori Lucas, Callan Associates. Also see
EBRI September 2012 Notes, Vol. 33, No. 0, ``Increasing Default
Defferral rates in Automatic Enrollment 401(k) Plans: The impact of
retirement saving success in plans with automatic escalation,'' p. 12.
\10\ Based on SSgA assumptions: beginning saving at age 25 at 3
percent per annum, increase of savings to 6 percent per annum at age
45. Contributions are made annually with a static return of 5 percent
per annum and wage growth estimated at 3 percent per annum.
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The provision of lifetime income is another key enabler of
retirement success because investors in these types of strategies
benefit from managing longevity risk. In DC plans where a lifetime
income product is not offered, participants are required to generate
enough savings within their personal retirement plan accounts to
support themselves in the event that they live well past the average
life expectancy (age 82). Investors in lifetime income products
transfer the risk of outliving their assets to an insurer who, by
pooling many individuals together, can manage to the mean life
expectancy rather than the outer bounds of longevity. The broad
adoption and usage of retirement income products in the United States
would materially increase the probability of success for many savers by
decreasing the accumulated savings needed to achieve adequacy by
approximately 20 percent.\11\
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\11\ SSgA calculation comparing the present value of a cash flow
from age 65 to the 90 percent joint survivor age (98) to the present
value of a mortality weighted joint survivor cash flow from 65 until
death. Mortality assumptions based on Social Security cohort life table
for birth year 1950 and cash flows discounted by the Treasury yield
curve from 3/3/14.
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The Voice of the Participant
One very important voice, which we have not considered as part of
our testimony up to this point, is the voice of the participant--the
employee who is or will participate in a workplace savings plan. If
participants tolerate but do not accept automation, it is unlikely to
have lasting impact. Further, if income options are offered but not
embraced, participants will not experience the benefits of longevity
hedging. At State Street Global Advisors, we regularly survey
participants on their attitudes toward a range of issues and have
explored both of these questions. The good news is, our survey results
have shown that Americans want to save for retirement, believe in
automation and would like to see lifetime income strategies
incorporated into DC investment menus.
Highlights from State Street Global Advisors Participant Surveys
In our 2011 DC Investor Survey, we found:
On average participants thought that they should be saving
approximately 14 percent of their pre-tax wages in a retirement
plan.
74 percent of participants surveyed indicated that they
wanted their employer to automatically make them do something
to prepare for retirement.
In our 2012 DC Investor Survey, there was a similar desire for
higher savings rates and automation.
More than half of participants surveyed indicated they
would increase their savings up to 10 percent or more if
automatically increased by 1 percent a year.
With regard to income strategies, our 2013 DC Investor Survey
showed the increasing need for addressing the decumulation phase of
retirement.
Over 60 percent of those surveyed said they plan to take
monthly withdrawals.
7 out of 10 recognize they will need an additional source
of guaranteed income in retirement, separate from Social
Security.
Concluding Comments
One of the unique facets of the U.S. retirement system is that the
employer plays a central role in helping individuals to plan and save
for retirement. What may not always be well understood, however, is
that this workforce-centered design actually motivates savings in
individuals who otherwise would not contribute. A recent research piece
by Holden and Bass (2013) reports that half of DC participants strongly
or somewhat agree with the statement ``I probably wouldn't save for
retirement if I didn't have a retirement plan at work.'' And for those
with a household income of less than $50,000 a year, that response rate
increases to nearly 70 percent.
Given the important role that employers play in enabling retirement
savings, it is only natural that any exploration of how to improve the
system begin with an examination of why certain employers are achieving
success and others are not. In our view, the dominant explanatory
variable is plan size. We have presented solid evidence that the
largest employers in the world are creating plans that work by
incorporating auto features and using their size and scale to drive
down costs. We believe the next step in the evolution of DC plans
should be to bring aspects of that model to a wider range of plan
sponsors. In our view, this can be accomplished in part by supporting
the creation of well-structured multiple-employer DC plans.
Thank you again for the opportunity to testify on the importance of
ensuring retirement security for America's middle class. I welcome any
questions you may have.
Additional Material Supplied for the Record