States offer promise in addressing retirement crisis

By Charles E.F. Millard | December 3, 2015 1:23 pm | Updated 3:43 pm

John Dean Charles E.F. Millard

The Department of Labor's recent proposal to allow states to create retirement savings programs for private-sector employees is finally doing something about America's coming retirement crisis. Republicans and Democrats should support it.

Corporations and small businesses struggle to balance profitability with genuine concerns for employees' well-being. Defined benefit plans have long-dated, volatile, expensive and risky liabilities that can be beyond the ability of many employers to manage or afford. And for small businesses, even offering a 401(k) plan can be a challenge. It can be expensive and it can be very complicated legally, as compliance with the Employee Retirement Income Security Act and fiduciary duties can be daunting.

A tidal wave of baby boomers will retire in coming years. They will live longer in retirement than any previous generation, but they are less prepared for retirement than their parents were. Longevity is a blessing, but it makes planning and saving for retirement more challenging than ever before — especially for those who are unprepared. It may be late to solve these problems for boomers, but the generations that follow will face the same issues.

The problem is hard to see because it will not show up through any dramatic event. There is not a looming cash crunch like the debt limit to concentrate everyone's focus. Rather, the gradual erosion of living standards for the elderly will be the depressing norm.

For most Americans, defined benefit pensions are a thing of the past. In 1983, more than 60% of workers had defined benefit pension plans. That number has now fallen to about 25%. In a defined contribution plan, such as a 401(k), all the risk, all the investment responsibility and all longevity planning are on the shoulders of the individual rather than the company that in the past would have provided the defined benefit plan.

Only half of all private-sector workers are enrolled in any employer-provided retirement savings plan, whether defined benefit or defined contribution. Unfortunately, even for those who do have a 401(k) or individual retirement account, the news is only slightly better. According to the Federal Reserve System, the median combined 401(k) and IRA balance for working households approaching retirement is barely more than $100,000. That may sound like a lot, but that only allows a 70 year old to count on income of $4,000 to 5,000 a year.

Many workers have modest amounts in savings accounts not designated for retirement, or they might have equity in their homes. Yet, even if we count those assets, Boston College's Center for Retirement Research estimates the aggregate “funding gap” for at-risk households to maintain living standards exceeds $7 trillion.

With Social Security (if it exists at all), other social programs, some savings and family support, most seniors will not experience devastating poverty and crushing loss. But the secure retirement they expected — with hobbies, some travel and family time, maybe financially assisting grandchildren — will just not materialize. Plans for that trip to the Great Wall of China will run into a wall.

Without action, baby boomers and the generations to follow will have to adjust their vision of retirement, old age, longevity and standard of living to a new, discouraging point of view. It seems great to live longer, but what if we simply cannot afford to do so?

It does not have to be this way. Other countries have found solutions, and many individual states in this country are seeking solutions, too.

In Australia, every employer is required to contribute 12% of pay to a retirement plan, called superannuation funds. In the Netherlands, employer and employee participation in the retirement system is mandatory, and about 20% of each employee's pay goes toward his or her pension. And when they retire, they must receive an annuity rather than a lump sum.

In 2012 the United Kingdom launched the National Employment Savings Trust, a system that is required for employers and automatic but voluntary for employees. This allows lower-income workers, in industries that do not offer retirement benefits, to develop some level of low-cost, long-term retirement savings.

It is easy to understand why Washington does not address this issue. The dysfunction of our nation's capital does not need description here. Beyond that, this topic is complex, involves mathematics and a focus on the fact that we will all die, and it at least touches on the famous third rail of American politics — Social Security.

Some states, however, are trying to take action. In 2012, California passed the Secure Choice Retirement Savings Trust Act. The law aims to create a system in which small businesses will be required to provide payroll deductibility for employees to put 3% of pay into a retirement system to be professionally managed by an institution akin to the California Public Employees' Retirement System. Enrollment will be automatic but employees can opt out. The California Secure Choice Retirement Savings Investment Board has been meeting monthly for two years in the process of designing investment and retirement plans and communications strategies.

Other states like Illinois have enacted similar legislation. Still others have wanted to follow these leads, but the states have been concerned their approaches might violate various terms of the dense, prohibited-transaction-waiting-to-happen federal legislation known as ERISA. The Labor Department's announcement Nov. 16 of new rules make clear that these plans would not violate ERISA. That is a posture with which both Republicans and Democrats should be able to agree. These rules will allow states to be laboratories to address this pressing problem.

In the absence of federal action on pension reform, these state initiatives offer some promise. But they still will require significant contributions to make them work. Remember that the Dutch system is the envy of the world because it requires savings of about 20% a year into a retirement plan. There is no free lunch — or retirement plan.

If we can all learn to save more, and we make these changes to the system, then we might avert the crisis. With increases in longevity, maybe we'll live long enough to see the change.

Charles E.F. Millard, director of the Pension Benefit Guaranty Corp. during the George W. Bush administration, is managing director and head of pension relations at Citigroup, New York. The views expressed are his own.