Saving Retirement in the Face of America's Credit Crises:

Short Term and Long Term Solutions

Oral Testimony

***Committee on Education and Labor***

***The Impact of the Financial Crisis on Workers' Retirement Security***

***1:00, 2181 Rayburn House Office Building***

Tuesday October 7, 2008

Teresa Ghilarducci

Irene and Bernard L. Schwartz Professor of Economic Policy Analysis at
The New School for Social Research Department of Economics

79 Fifth Avenue NY, NY 10003

<ghilardt@newschool.edu>

212-229-5901 extension #2

As Congress reacts to the modern financial order changing forever, we
should also realize that individual retirement plans based on that
financial order, have also changed forever. In the last few weeks, we've
been confronted with older worker and retirees' lives being turned
upside down; their panic tops-off an already existing state of chronic
anxiety about retirement futures. Much of both -- the panic and
anxiety - is caused by the corrosive effects of 401(k) and 401(k) --
like plans[^1], including IRA plans. 410(k) plans have not expanded
pension coverage, increase the savings national rates; though they did
add to the profits and growth of the financial sector and extracted ever
increasing tax breaks from the Treasury.

**Short Term Solution to the Retirement Crises**

Short term, I propose that since 401(k) accounts and the like are
financial institutions \-- the bank about where 38% of the workforce[^2]
can intend to save for their retirement \-- Congress let workers trade
their 401(k) and 401(k) - type plan assets (perhaps valued at mid-August
prices) for a Guaranteed Retirement Account composed of government bonds
(earning a 3% return, adjusted for inflation). When the worker collects
Social Security, the Guaranteed Retirement Account will pay an inflation
adjusted annuity, based on the accumulated funds.

How would this work? Take a 55 year old who had \$50,000 in his 401(k)
account in August and faces job loss and eroded assets because of the
erosion of his retirement accounts.[^3] Let him swap out the \$50,000
for a guarantee of \$500 per month[^4]. The economy is probably in a
recession, but a guaranteed income from his former 401(k) removes a
source of financial anxiety, and \-- this is not trivial -- it end
fruitless discussions with brokers and financial sales agents, who are
also desperate for more fees and are often wrong about markets.

**Long Term Solution to Eroding Retirement Income Security**

Because there is a long run retirement crises, not in Social Security,
but in the heavily tax-subsidized, private, voluntary, and commercial
tier of our nation's retirement income security system, about half of
workers will not have enough income after age 65 to replace, the bare
necessity, 70% of their pre-retirement income according to Boston
College's Retirement Risk Index. The erosion is primarily caused by
Congressional bias towards 401(k) plans, their fundamentally flawed
design and little regulation.

Going forward, I propose Congress establish universal Guaranteed
Retirement Accounts and the federal government deposit \$600 (inflation
indexed) in those Guaranteed Retirement Accounts every year for every
worker.

Every worker (not in an equivalent defined benefit plan) would save 5%
of their pay into their Guaranteed Retirement Account to which the
government pays a 3% inflation-indexed guaranteed return. Workers would
earn pension credits based on these accumulations.

The 5% target comes from the basic math that an average earner saving 5%
of pay over a life time with a guaranteed 3% rate of return plus
inflation would supplement their Social Security benefits to achieve a
70% replacement rate at retirement. In other words had GRA been in
effect instead of 401(k) plans an average earner reaching 65 today would
have accumulated enough to pay about 1% for every year of service. (This
rate is equivalent to the average defined benefit pension plan payout
because it its inflation indexed.)

This basic math, though, comes up against the basic reality that many
Americans can not afford to save that much. That is why workers'
contributions would be mitigated by a \$600 a year contribution from the
federal government indexed for inflation which will be paid for by
scaling back substantially the tax breaks for 401(k) type accounts. The
\$600 defrays the expense for most low and middle class workers (it pays
for all the contribution for a minimum wage worker). Employers could top
it off, pay a portion, and workers could add to it.

**Advantages of a GRA?**

First, this is a fiscally responsible plan. Rearranging tax breaks is
revenue neutral, efficient and fair because the current tax breaks.[^5]
High-income earners get a much higher subsidy than anyone else because
they are more likely to have a 401(k) and contribute more.[^6] This
design has shocking results: 6% of taxpayers with incomes over \$100,000
per year get 50% of the tax subsidies.[^7] And, for all this effort, the
nation gets no extra savings and workers no extra retirement security
(see Appendix). At most, this complicated system creates economic
activity when accountants happily transfer money between taxed accounts
to tax-sheltered accounts and tax payers foot the bill.

Worse, the inefficiency is growing: the value of tax expenditures for DC
plans is projected to grow 49 percent while those for traditional plans
are projected to fall by 8.9 percent between 2009 and 2013. The sooner
we admit that our 30 year experiment with 401(k) accounts has failed the
sooner we can use these precious government subsidies efficiently and
equitably.

Second, GRAs are responsible because they are prefunded. A government
agency connected to the Thrift Savings Plan and Social Security (for
administration efficiency) governed by trustees representing workers,
business, and the public, invests the GRA contributions in a range of
assets, like the sovereign wealth funds of Alaska, Alabama, New Mexico
Wyoming, and many other nations do to ensure the federal government can
pay a 3% inflation-indexed rate of return to the Guaranteed Retirement
Account lifetime annuities.

Third, GRAs are universal;

Fourth, GRAs provide adequate retirement income and encourages people to
save more;

Fifth, the money is locked away until retirement;

Sixth, the payout is for a person's life;

Seven, every America has the opportunity to save in a low cost,
professionally managed account with guaranteed returns.

GRAs are better than automatic IRAs. Automatic IRAs add complicated
requirements on small and medium sized employers. Automatic IRAs expand
the risks workers already face in individual retirement account plans:
the risks they won't save enough because of high fees and wrong in
investments choices; the risk financial markets tank, the risk of
inflation eroding income and that you will out-live your money.
Automatic IRAs cause deadweight losses to the economy because, net of
fees, 401(k) and other individual retirement accounts are among the
lowest earning among all financial vehicles. Add the risks of
preretirement - withdrawals, moral hazard, and adverse selection
Automatic IRAs would entrench inefficiency and risk and a dollar of
retirement income becomes more expensive to fund. Automatic IRAs are
worse than nothing.

**Disadvantages of GRAs**

Scaling back 401(k) deductions going forward may put pressure on vendors
to lower fees and boost returns. Also people like the option of saving
at work for hardships. Fine, Congress may to subsidize precautionary
savings but don't call them retirement accounts. Put them in a separate
category.

Should we mandate savings in a recession? Yes, as long as fiscal policy
provides for short term stimulus. No one is proposing we suspend Social
Security taxes in recessions. Households need a source of disciplined
savings over the business cycles; it is not the job of households to go
in debt and spend wildly to get us the nation out of recessions. This
ethos -- debt-led consumer spending \-- got us in the trouble we are in.

**Predicted Popularity of Guaranteed Retirement Accounts**

Even before the financial crises of September 2008, workers are catching
on that Congress needed to provide more secure sources of retirement
income security.

Surveys show less than 50% of people think they will live comfortably in
retirement and, crucially, that they bear personally responsibility for
their supplements to Social Security benefits. Though they accept the
responsibility \-- they want the government to help.[^8] Over 77% of
people support mandated pensions.

In 2006, HSBC bank asked 21,000 workers in 20 nations what the
government should do about the expense of aging societies- on average,
workers preferred compulsory savings to any other policy. A third of
Americans wanted the government to force them to save more for
retirement; far fewer; 16% would support a tax increase; and, only 9%
wanted the government to reduce benefits.[^9]

In October 2007, a whopping 91% of Americans told a Wall Street Journal
poll that the government should do something to secure retirement and
41% said they were not hearing enough from the Presidential candidates
about retirement income issues.[^10]

**Conclusion**

American workers know we have a short term and long term pension crises
but it is not with Social Security but with the voluntary,
self-directed, commercial- account - based pension system. The loss of
retirement security is a reversal of fortune and the result of very
specific flawed governmental policies that have been biased toward
401(k) plans, rather than the result of technological change or the
logical consequences of global economic trends. That is the good news.
Government policies eroded pensions government can help secure workers'
retirement futures. If you implement the short term 401(k0 asset swap
and Guaranteed Retirement Accounts, we can look back at the financial
crises and bailout and know Congress did permanent good for workers'
retirement income security.

Table 1

+---------------------------------+----------------+------------------+
| Tax Subsidies for Retirement    | **2009**       | **2009 growth to |
| Plans                           |                | 2013 estimated** |
|                                 | **\$ Billion** |                  |
+---------------------------------+----------------+------------------+
|                                 |                |                  |
+---------------------------------+----------------+------------------+
| DB plans                        | \$45.67        | -8.9%            |
|                                 | Billion        |                  |
+---------------------------------+----------------+------------------+
| 401(k) (325 B) Individual       | \$75. 70       | 49.5%            |
| retirement plans and Plans      | Billion        |                  |
| covering partners and sole      |                |                  |
| proprietors (\"Keogh Plans\")   |                |                  |
+---------------------------------+----------------+------------------+

EBRI calculations Original data from Executive Office of the President,
Office of Management and Budget, *Analytical Perspectives, Budget of the
Untied States Government, Fiscal Year 2009*
[www.whitehouse.gov/omb/budget/fy2009/](http://www.whitehouse.gov/omb/budget/fy2009/)

Appendix:

**The Savings Paradox**

Savings rates should be higher now than at any time in the history of
the United States. The American workforce has never been more educated
and people with more education save more. Middle-aged workers save more
than any other age group and there are an estimated 73 million baby
boomers in the U.S. who are between age 48 and 63 in 2008. High income
people have higher savings rates the richest Americans have gained the
most income since the 1990s. Further, as national income grows the
demand for normal goods grow because when people have money they buy
more of what they want Ipods, better health, and retirement "leisure:"
witness the 1960s and 1970s, when, as the economy grew, older people
lived longer AND retired earlier.[^11] And, in an attempt to further
increase retirement savings Congress has relentlessly expanded tax
breaks for retirement savings since the 1980s.

The value of the favorable tax treatment for retirement savings is at an
all-time high 110 B, while its effectiveness is at an all time low.

To be clear, saving is hard. Humans often lack the foresight,
discipline, and investing skills required to sustain a savings plan. But
human characteristics haven't changed as much as retirement savings as
eroded.

The deep decline in national savings rates showed up in the 1990s when
employers started to reduce their contributions into defined benefit
pension plans[^12], these plans were a main driver of national savings.
The expansion of 401(k)-type plans did not boost savings for three
reasons: they supplanted already existing defined benefit plans, were
cheaper for the employer, and did not expand pension coverage to people
who had no pension plan. This is surprising: although 401(k) - type
plans are growing,[^13] they don't expand pension coverage. Instead,
they replace existing traditional pension plans. When groups of workers
who ordinarily don't have pensions get them \-- poultry workers,
janitors, home-health care workers, etc. \-- it is most likely because
they are included in a newly negotiated collectively-bargained defined
benefit plan.[^14]

Defined benefit plans are institutionalized, contractual forms of saving
that happen automatically at work. Workers have little discretion about
whether to save or spend. Workers can't opt out, decide how much to
invest, or take out lump-sum payments without difficulty. Even though
401(k) plans do not increase pension coverage nor secure retirement
income, people like their portability and like to watch their
individuals accounts grow. People do not like the financial and
investment risks, or the risks of outliving their money, inherent in
401(k) accounts.

Therefore we understate the true spending on pensions because the U.S.
Gover**n**ment maker uses "tax expenditures" -- the value of the tax
code's exemption of income generated for certain activities -- to
encourage workers and the nation's business owners to spend their income
in socially approved ways.

In 2007, Social Security and Medicare cost \$800 billion. Tax
expenditures for retirement plans -- traditional employer pensions
(defined benefit plans), 401(k) plans, Individual Retirement Accounts,
other savings vehicles dedicated for disbursement at older ages, and
exemptions of Social Security and other federal pensions from tax --
totaled over \$156 billion in 2007.[^15]

In 2004, taxes not collected on pension contributions and earnings equal
a fourth of annual Social Security contributions and, at over \$114
billion, are perversely larger than household saving of over \$102
billion.[^16] The tax breaks were supposed to expand pension coverage
and increasing retirement security.

Pension tax breaks are deductions from income; high-income earners get
more breaks than low-income workers. If a lawyer earning \$200,000 makes
a \$1000 contribution to his 401(k) plan, he reduces his income tax by
\$350. If his receptionist, earning \$20,000, makes the same \$1000
contribution (which is much less likely), she will save only \$150 in
taxes. The Brookings Institution and Urban Institute calculate that the
3% of taxpayers with incomes over \$200,000 per year get 20% of the tax
subsidies.[^17] And, for all this effort, the nation gets no extra
savings. At most, this complicated system creates economic activity when
accountants happily transfer money between taxed accounts to
tax-sheltered accounts and tax payers foot the bill. The value of tax
expenditures for 401(k) plans is projected to grow 49 percent while
those for traditional plans are projected to fall by 2.1 percent between
2009 and 20013. [^18] (The estimated tax expenditures for 401(k) plans,
Individual Retirement Accounts, and Keogh plans in 2009 is estimated to
be \$75.1 billion and for defined benefit plans \$45.7 billion.)

In sum, the shift towards 401(k) plans increases tax expenditures, does
little to expand retirement savings, and favors workers who need the
help least. All told, the tax subsidies are not meeting a public
purpose. The top heavy benefits for 401(k) plans create a sad paradox:
since 1999, tax expenditures for retirement plans grew by 20%, while
retirement plan coverage fell.

**401(k) plans Exist Because They are Cheaper for Employers; but they
Earn Subpar Returns**

If 401(k) plans are so bad why are there so many of them? Though workers
don't gain much from 401(k) plans, some employers and Wall Street firms
do. I followed 700 firms over 17 years and found that firms that adopted
a 401(k) lowered pension expenses by 3.5 -- 5% without sparking worker
complaints.[^19] Since 401(k) plans are voluntary, many (about 20%)
workers who can don't bother to contribute "leave money on the table" by
not accepting the employer match. Employers' contributions are 26% lower
than they would be if everyone participated.[^20] Employers could pay
the match to every worker, as they do under defined benefit plans.
Because workers have to trigger the match, and some don't, 401(k) plans
boosts profits at the expense of retirement income security. Firms find
sponsoring 401(k) plans is more profitable than sponsoring defined
benefit plans. For firms, defined contribution plans are less costly,
less risky, and can be funded with their own stock, not with hard cash.

Wall Street firms collect over \$40.5 billion annually in 401(k)
fees.[^21] Yet, brokers and human resources often tell workers the fees
on their accounts are zero. A good way to see what workers lose when
they invest in a 401(k) plan rather than a group--based pension fund is
to compare what each earns after fees are subtracted. A comprehensive
study by Dutch and Canadian researchers Ron Bauer and Keith
Ambachtsheer[^22] found that U.S defined benefit plans -- where
individuals do not direct their own accounts -- earned a 2.66% higher
return NET of fees on equities than did retail mutual funds. In Canada,
the skim was even higher; the retail mutual funds earned 3.16% less.
(These shortfalls are the averages for the 25 year period between 1980
and 2004.) The gap makes sense -- investing in retail funds means
investors pay for advertising, shareholder profits, and glossy
brochures. Add the fact that workers buy high and sell low -- because
people follow the leaders and buy stock as its rising in value and sell
when its falling \-- and you have self-directed accounts earning much
less. This isn't just a leakage, it's a levee break. Hidden from view,
workers are unwittingly transferring huge sums of money to financial
firms.

The unpublished report confirmed that the GRA 3% real rate of return was
a conservative long-run estimate under a range of plausible investment
strategies that a government agency could undertake and not take any
substantial risk of underperforming.[^23]

[^1]: 401(k) -- type plans are defined contribution plans include and
    include the following: 401(k) plans \[about 80% of participants in
    defined contribution plans are in 401(k) plans\]; profit sharing
    plans; money purchase plans; individual retirement accounts; and
    403(b) plans which are 401(k) plans for employees in the public
    sector.

[^2]: Center for Retirement Research Boston College. 2004. \"Eligibility
    and Participation in 401(k) Plans by Age, 2001 and 2004\"
    [http://crr.bc.edu/frequently_requested_data/frequently_requested_data.html
    accessed October
    4](http://crr.bc.edu/frequently_requested_data/frequently_requested_data.html accessesd Ocotber 4),
    2009.

[^3]: Note the macroeconomic destabilizing effects of 401(k) plans \--
    and all defined contribution plans -- when asset values go down;
    people increase their job search just when jobs become scarce. This
    makes the recession worse.

[^4]: This is what the annuity would pay at a 3% inflation rate and a 3%
    real return.

[^5]: The GRA plan as written is budget neutral. If we allow tax breaks
    for the first \$5000 in voluntary 401(k) contributions the plan will
    cost \$25 billion. But know that accounts that allow hardship
    withdrawals are savings for hardship which is different from
    retirement income security.

[^6]: Because the tax subsidies come in the form of tax deductions and
    not credits they are regressive. For example, if a lawyer earning
    \$200,000 makes a \$1000 contribution to his 401(k) plan, he reduces
    his income tax by \$350. If his receptionist, earning \$20,000,
    makes the same \$1000 contribution (which is much less likely), she
    will save only \$150 in taxes.

[^7]: A good paper on the distributional effects of the tax expenditures
    for DC plans is Burman, Leonard E.,William G. Gale, Matthew Hall,
    and Peter R. Orszag. 2004a. Distributional Effects of Defined
    Contribution Plans and Individual Retirement Accounts. Washington,
    D.C.: Urban-Brookings Tax Policy Center.

[^8]: Madland, David. 2008. "Reforming Retirement: What the Public
    Thinks." For the Georgetown University conference on "The Future of
    Retirement Security." Held October 3, 2008. department of History

[^9]: HSBC Bank. "How should governments finance ageing populations"
    <http://www.hsbc.com/1/PA_1_1_S5/content/assets/retirement/2006_for_news_release_final.pdf>.)
    HSBC. 2007. "The Future of Retirement: What People Want."
    <http://a248.e.akamai.net/7/248/3622/7d1c0ed7aa1283/www.img.ghq.hsbc.com/public/groupsite/assets/>
    retirement_future/2006_for_what_people_want.pdf (accessed online
    February 2, 2007).

[^10]: Bright, WSJ.com November 2007 online Harris personal finance poll

[^11]: Ghilarducci, Teresa. 2008. *When I am Sixty Four: The Plot
    Against Pensions and the Plan to Save Them.* Princeton University
    Press, Princeton, NJ. Chapter 1.

[^12]: Bosworth, Barry, and Lisa Bell. 2005. The Decline in Saving: What
    Can We Learn from Survey Data?" Unpublished draft written for the
    7th Annual Joint Conference of the Retirement Research Consortium,
    "Creating a Secure Retirement" (Washington, DC, August 11-12, 2005).
    \<http://www.bc.edu/centers/crr/dummy/seventh_annual.shtml\>.

[^13]: . 401(k) -- type plans are defined contribution plans include and
    include the following: 401(k) plans \[about 80% of participants in
    defined contribution plans are in 401(k) plans\]; profit sharing
    plans; money purchase plans; individual retirement accounts; and
    403(b) plans which are 401(k) plans for employees in the public
    sector.

[^14]: From 1999- 2005, the correlation between defined benefit coverage
    growth rates and pension coverage growth rates was 79%, while the
    correlation between defined contribution and pension coverage growth
    rates was a negative 10%. Ghilarducci. Teresa. 2006. "Future
    Retirement Income Security Needs Defined Benefit Pensions." Center
    for American Progress.
    [www.americanprogress.org/kf/defined_benefit_layout.pdf](http://www.americanprogress.org/kf/defined_benefit_layout.pdf)

    Back in 1981, Congress rejected President Carter's Pension
    Commission's call to reconsider the social value of these tax breaks
    and create a mandatory universal pension system (MUPS). Because they
    are designed to meet a social goal there were always conditions on
    these tax breaks. When the federal income tax was implemented in
    1913, employer pension contributions were given special tax
    treatment only if the managerial plans included most of the rank and
    file. This is in direct acknowledgement that the tax breaks were
    targeted to the wealthy. The wrangling \-- over how many tax breaks
    that higher income employees get in exchange for how many lower paid
    workers are in employer pension plans \-- continues to this day and
    is part of a healthy process of assessing if the federal government
    tax breaks have the intended effects. Instead, in that same year,
    Congress satisfied the lobbyists for executives and made way for
    401(k) plans by creating a section of the tax code which allowed
    workers to save, pre tax, in plans at work. After Wall Street firms
    and consultants successfully marketed 401(k) plans, the rest \-- to
    use a shop-worn phrase \-- is a history we all know: 401(k)-type
    plans replaced traditional defined benefit (DBs) pensions.\-- over
    63% of pensions are DC plans; whereas, in 1975, most pensions were
    DBs.

[^15]: Employee Benefit Research Institute. 2008. "Facts From EBRI: Tax
    Expenditures and Employee Benefits: Estimates from the FY 2009
    Budget." EBRI, 1100 13th St. NW #878, Washington, DC 20005. February

[^16]: See Bell, Elizabeth Adam Carasso and C. Eugene Steuerle,
    "Retirement Savings Incentives and Personal Savings,"[Tax
    Notes]{.underline}, December 20, 2004.for this provocative insight.

[^17]: A good paper on the distributional effects of the tax
    expenditures for DC plans: Burman, Leonard E.,William G.
    Gale,Matthew Hall, and Peter R. Orszag. 2004. "Distributional
    Effects of Defined Contribution Plans and Individual Retirement
    Accounts."Washington, D.C.: Urban-Brookings Tax Policy Center.

[^18]: Employee Benefit Research Institute. 2008. "Facts From EBRI: Tax
    Expenditures and Employee Benefits: Estimates from the FY 2009
    Budget." EBRI, 1100 13th St. NW #878, Washington, DC 20005. February

[^19]: Ghilarducci and Sun 2006. How **Defined** Contribution Plans and
    401(k)s Affect Employer **Pension** Costs: 1981-1998." With Wei
    **Sun**. Journal of **Pension** Economics and Finance, 5(2): 175-196

[^20]: I used information from Munnell and Sundén. 2004. Munnell,
    Alicia, and Annika Sundén. 2004. *Coming Up Short: The Challenge of
    401(k) Plans.* Washington, DC: Brookings Institution Press to get
    participation rates, average contribution levels by earnings, the
    distribution of employees by earnings (Calculated from the CPS
    (2003) to make the three billion dollar estimate. The average
    savings per worker is \$156, calculated for their sample of over 800
    employees in one firm that the employer saved over \$250 per older
    worker who did not participate in the 40(k) even when they were
    eligible. Choi, James J., Laibson, David I. and Madrian, Brigitte
    C.,\$100 Bills on the Sidewalk: Suboptimal Investment in 401(K)
    Plans(August 2005). NBER Working Paper No. W11554. Fidelity's (2004)
    annual report documents employers' match behavior.

[^21]: There are \$2.7 trillion in 401(k) assets Employee Benefit
    Research Institute. 2007. "401(k) Plan Asset Allocation, Account
    Balances, and Loan Activity" An Information Sheet from the Employee
    Benefit Research Institute (EBRI).
    www.ebri.org/pdf/InfSheet.QDIA.23Oct07.Final.pdf. The average fee is
    over \$700 per year and average fees are 1.5% of assets which equals
    \$40.5 billion.

[^22]: Ambachtsheer, Keith, Bauer, Rob. 2007. "Losing Ground." *Canadian
    Investment Review*; Spring, Vol. 20 Issue 1, p8-14.

[^23]: My report for the Economic Policy Institute explains the GRA plan
    in depth Ghilarducci, Teresa 2007. "Guaranteed Retirement Accounts
    Toward Retirement Income Security" Economic Policy Institute, 1333 H
    Street, NW Suite 300, East Tower Washington, DC 20005-4707 (202)
    775-8810, Economic Policy Briefing Paper #204, November 20.