Increased longevity, the lingering effects of the recent recession and inadequate savings all contribute to this funding gap, which is the difference between what people have saved and what they will need for retirement.
Everyone from policymakers and financial institutions to employers and savers must rethink today’s accepted model of the U.S. retirement system, said Barbara Novick, vice chairman and co-founder of BlackRock. “There has to be an adequate retirement system in some form,” she said. Recent discussions and proposals have been too narrowly focused, she said. “People need to think outside the box.”
Timing is one of the issues making retirement such a critical discussion. According to research from the Pew Research Center, about 10,000 Baby Boomers reach retirement age every day. Novick cited employer-sponsored defined contribution (DC) plans as one of the three main pieces of the country’s “patchwork retirement system,” along with defined benefit (DB) plans. Social Security and personal assets, accumulated in individual retirement accounts (IRAs) and personal savings, are the other two components.
Each of the three has some structural weakness. “Everyone is covered by something different, and some people are not covered at all,” Novick said. A large percentage of the country does not work for a big company with a sturdy DC plan. People commonly think that Social Security is a fallback for most people, but in some extreme cases, such as firefighters and police in Detroit, some workers may not even have that.
Novick proposed that Social Security be used as a safety net for the neediest instead of a component of an individual’s retirement plan. She cited California’s proposal to allow smaller companies to participate in government pension plans as an example of a successful way for public and private entities to form partnerships that address retirement (see “Calif. Senate Approves Government-Run Private Worker Retirement Plan”).
Some of the ideas from California could be useful, such as an employer mandate to deduct a percentage of employee salary as a contribution, said Joanne Medero, managing director of government relations at BlackRock. “It can be simple and cost-effective for employers,” she said, “and a lot of employers would like to do it—but not if it is subject to the compliance burdens of ERISA [Employee Retirement Income Security Act]. We’ve created a lot of disincentives for people to offer plans.”
Two other proposals—one each by Sen. Tom Harkin, D-Iowa, and Sen. Orrin Hatch, R-Utah—deserve consideration, Medero said (see “Retirement Plan Would be a Win-Win for Working Families, Employers” and “Bill Would Overhaul Public Pension System”). Neither has gained much traction, but because both men are members of the Finance Committee, next year could see some movement.
Legislation is just one way to address retirement. Plan sponsors can make use of plan design and features such as auto-enrollment to change participant behaviors, said Ann Marie Petach, senior managing director and co-head of client solutions.
“People are not proactive, and very few participants opt out,” Petach said. “Inertia keeps people from turning it off.” Plan sponsors can also change outcomes by other practices, such as changing the employer match. “People will save more if they’re defaulted into or if they are incentivized to do it,” she said.
The trend away from having participants make their own investment choices is positive, Petach said. Plans will increasingly use target-date funds (TDFs) as a way of automating the investment process, and the financial services industry will need to keep offering products that help plan sponsors and plan participants. “As investment managers, we have to move toward giving people the results they need and tools to give them strength.”
The panel made a number of recommendations for the main components of the retirement system, including:
- Improve the fiscal health of existing defined benefit plans, and restore funding levels;
- Review incentives and disincentives for employers to offer retirement plans;
- Review compliance burdens;
- Address decumulation/income distribution with clear guidance;
- Encourage public-private partnerships that have the potential to increase overall participation;
- Establish savings targets and allow individuals to use a combination of employer-sponsored and individual savings to meet them;
- Mandate personal retirement savings (similar to Australia’s superannuation system);
- Offer tax deferral and other incentives to encourage participation;
- Provide savers with the option to direct their own investments or participate in government-sponsored pools;
- Re-establish Social Security as a safety net and not the primary source of retirement savings;
- Consider increasing the retirement age to account for increased longevity;
- Alter COLA calculations, as proposed in the Obama budget;
- Consider means testing or a benefits cap where other large sources of retirement income exist; and
- Invest Social Security funds in a wider range of assets to maximize trust values.
“You need to look at this problem holistically, and then you get very different solutions, rather than looking at it piecemeal,” Novick said. If people think of these pieces as having different roles, then they can be addressed and used differently. “Otherwise, you are not really addressing the problem.”