Approaches to Retirement Security in the United States
This report was produced by the Advisory Council on Employee Welfare and Pension Benefit Plans, usually referred to as the ERISA Advisory Council (the "Council"). This report examines the Approaches to Retirement Security in the United States. The ERISA Advisory Council was created by ERISA to provide advice to the Secretary of Labor. The contents of this report do not represent the position of the Department of Labor (DOL).
The Council's recommendations address:
After much discussion and debate concerning the issues presented, the Council submits the following recommendations to the Secretary of Labor for consideration.
Recommendation 1: The DOL should support the creation of a Presidential Commission to define a National Retirement Policy and develop new structures for lifetime retirement security.
Recommendation 2: The DOL should take leadership in developing workers who are financially literate by facilitating, coordinating and collaborating with other government agencies, interagency councils, the private sector, professional organizations and academia to leverage all available support for the need to address financial literacy including promoting financial literacy as part of elementary education.
Recommendation 3: In her capacity as PBGC Board Chair, the Secretary should champion the maintenance and expansion of the defined benefit system by convening an inter-agency task force to review and revise the current burdensome regulatory regime and by charging the PBGC to develop initiatives to encourage the continuation, maintenance, and expansion of voluntary private defined benefit pension plans.
Recommendation 4: The DOL should support measures to enhance retirement security for Defined Contribution (DC) plan participants by increasing participation and contributions, and by preventing leakage, when necessary. DOL should develop approaches to address participation disparities across racial, gender and ethnic groups. It should examine the role of race, gender and ethnicity on participation in voluntary plans to determine the best methods to ensure that diverse groups have equal opportunities to achieve retirement security.
Recommendation 5: DOL immediately should amend Interpretive Bulletin 96-1 to expand its scope to the decumulation phase of retirement planning.
The Council is to evaluate the adequacy and structure of the current U.S. voluntary retirement plans to assess whether structural aspects of these plans contribute to retirement security. Recent economic conditions, combined with the use of defined contribution plans as primary retirement plans and an aging U.S. workforce, have exposed issues with the current retirement system. This voluntary retirement system is being challenged as not meeting the needs of U.S. workers. Many of its stakeholders (employers, employees, ERISA fiduciaries, Congress, labor organizations, consumer groups) and the media assert that the system is failing to meet the retirement security necessary for U.S. workers.
The Council will study (i) the structure of currently available employment-based retirement programs in the U.S. and internationally, (ii) the benefits and risks presented to employees and employers in the current system, (iii) issues relative to employee literacy, employee communication and disclosure, plan sponsor and fiduciary risk, the expense of such benefits, contributions and funding requirements; as well as issues involving participant directed plans (iv) potential changes to the current system that could optimize benefits and mitigate risk, (v) the manner in which the DOL can best facilitate system improvements and (vi) whether ERISA and/or the Internal Revenue Code may need to be amended to allow for the necessary structural changes to U.S. voluntary retirement system.
The Council will take testimony to determine how the Secretary might recommend these necessary regulatory changes or, recommend enactment of new legislation that would permit either (i) hybrids of the existing plan types or (ii) new types of plans, to facilitate plan designs that will appeal to both employers and employees; thus promoting a more adequate and secure private retirement income system for all workers.
The Council explored each of the preceding topics, but it did not make findings on all the topics because the Council failed to reach consensus or because the Council felt the record was not adequate.
July 21, 2009
James Delaplane, American Benefits Council
September 16, 2009
Steve Utkus, Vanguard
The Council evaluated the adequacy and structure of U.S. voluntary retirement system to assess whether structural aspects of these plans provide retirement security. Recent economic conditions, and an aging U.S. workforce, combined with increased reliance on defined contribution plans as primary retirement plans, have cast large doubts about retirement security within the current system. Many stakeholders (employers, employees, fiduciaries, Congress, labor organizations, consumer groups) as well as the media, assert that the system is failing to meet the retirement security necessary for U.S. workers.
The Council specifically focused on:
The body of this report presents the Council's findings, including witness observations, regarding the current state of defined benefit pension system, the defined contribution system and overall financial literacy.
ERISA Section 512(b) directs the Council to provide advice or recommendations to the Secretary to fulfill her duties under law.
Three ERISA provisions explicitly address the Secretary's duties under law. First, ERISA section 516(a) directs the Secretary to make outreach efforts to promote retirement income savings. Thus, the Council has addressed financial literacy in this report and in its separate report, Promoting Retirement Literacy and Security by Streamlining Disclosures to Participants and Beneficiaries, as well as reports of prior Councils.
Second, under ERISA Section 4002(d), the Secretary serves as the Chair of the Board of Directors of the Pension Benefit Guaranty Corporation (PBGC). PBGC's statutory mission includes, in pertinent part, the following in Section 4002:
Finally, ERISA Section 513(b) provides:
This topic's scope includes possible amendments to ERISA and/or the Internal Revenue Code to facilitate fundamental structural changes to the U.S. retirement system. Obviously, the Secretary has no legislative power, but she is directed to make recommendations for further legislation. The Council submits that the Secretary's statutory duty to make recommendations for further legislation complements her position as PBGC Chair, i.e., to encourage the continuation and maintenance of DB plans.
The Council solicited testimony to formulate recommendations to the Secretary by which she could effectuate or promote necessary regulatory changes or, recommend new legislation that would permit either (i) hybrids of the existing plan types or (ii) new types of plans that will appeal to both employers and employees; thus promoting a more adequate and secure private retirement income system for all workers.
With respect to the existing system - be it, Defined Benefit programs or Defined Contribution programs - most witnesses believe the system is not completely broken, but they clearly assert that many U.S. workers lack adequate retirement security even when they participate in employer retirement plans. Several witnesses testified that many working Americans are unprepared for retirement. The Institute for Retirement Security states that 83% of Americans seriously worry about retirement. Steve Utkus indicates that anywhere from 13% to 34% are not prepared for retirement. Many witnesses caution that it is difficult to estimate the extent of the problem as it is contingent on many assumptions, but the overwhelming sense is that there is a looming problem. Opinions diverge on how to address coverage and income adequacy.
Witnesses representing most constituencies involved in retirement issues appeared before the Committee. They identified various causes for the current system's ills. In most instances, they recommended both short-term and long-term fixes. No one common approach or "fix" was offered. It was this variety of views and ideas that has moved the Council to recommend the establishment of a Presidential Commission to formulate a National Retirement Policy.
This National Retirement Policy will need to consider the existing retirement structures offered by Social Security, employer provided benefits and retail (e.g., IRA) retirement vehicles as well as other economic factors that contribute directly to income security in retirement (e.g. retiree health care). The Policy also will need to focus on short-term and long-term objectives to achieve worker security. The Commission formulating the Policy also should review the retirement structures employed in the other countries.
The Policy will need to address each phase of retirement planning: the accumulation phase, the ongoing asset management or asset preservation phase and the decumulation or distribution phase. Each of these phases taken individually, and then in the aggregate, must be considered to truly prepare all the stakeholders involved in retirement security. The Presidential Commission must engage small, medium and large employers to encourage all employers to promote retirement security for their workers through all these phases. The Policy needs to identify all available means, including when possible, increased use of electronic media, to encourage individual workers to understand and participate in retirement planning and security.
In addition to the items discussed above and herein, the Policy needs to consider the financial literacy of the workforce. The Council's second recommendation urges the Secretary to direct the Department of Labor to take a leadership role in increasing financial literacy.
Hopefully, greater literacy, particular on decumulation, will help effectuate the fourth recommendation, that the DOL should support measures to increase participation and contributions into DC plans and to prevent leakage. The fifth recommendation, expanding Interpretive Bulletin 96-1, is a specific step DOL can take to improve financial literacy.
Furthermore, staying with the broader recommendation of financial literacy, DOL should pay special attention to how financial literary might be improved to correct disparities across racial, gender and ethnic groups and the cultural differences that impact retirement planning.
Presidential Commission and Consideration of a National Retirement Policy
Many witnesses offered visions of new retirement plans. Professor Alicia Munnell suggests a mandatory DB system, on top of Social Security. Don Fuerst advocates a mandatory minimum contribution into a pooled pension plan (similar to Swiss and Dutch plans), professionally managed under the direction of an independent trustee and open to all employers.(1) The Council does not advocate any particular approach. It has considered and does endorse Michael Sullivan's call for a Presidential Commission to facilitate the creation of a national policy. Secretary Solis' recent remarks make it clear that the country is at a crossroads and it time to take a comprehensive look at national retirement policy --
To improve security for the largest number of workers, a Presidential Commission consisting of a broad cross-section of experts must assemble to develop a National Retirement Policy and new retirement plan models
The Council believes this Commission and the resulting National Policy will be an extremely valuable tool to focus all stakeholders on the issues attendant to retirement security. This Commission should not focus just on DB plans by private employers, as it is equally important to look at DC plans, foreign plans and governmental plans. Do the delivery vehicles provide individuals with tools-such as better financial literacy though financial education and electronic media, auto options in the case of DC, access to annuities, etc.-to help them individually prepare financially for retirement; or should it provide that all stakeholders do all that they can, to ensure that all American workers have secure and adequate financial resources when they leave the workforce? This Policy should also consider the impact of the role of Social Security as well as the impact of retiree health care on the decisions made by employees under DB and DC plans. The Council believes that the DOL take a leading role on the Commission in developing the Policy so that it will consider all possible means to achieve retirement security for U.S. workers.
One key feature of a future policy, as James Delaplane's (American Benefits Council) testimony provides, is that the retirement system needs to address coverage for all American workers. The American Benefits Council's perspective regarding coverage could be formally incorporated into such a National Policy. It provides that the system should offer a range of retirement plan designs -- from simple arrangements with low contribution limits and relatively modest compliance requirements to more complex designs with higher contribution limits and rigorous compliance requirements. Much of the testimony delivered to the Council, including the direct testimony of the American Benefits Council, offered a range of recommended reforms that attempted to speak to the differing issues that impede plan sponsorship by employers -- and plan or IRA participation by workers. Our Council recommends that the Department of Labor should review these proposed reforms to help initiate the elements of a National Policy.
Another area which the Policy needs to address is fiduciary exposure. Many witnesses expressed concern over potential fiduciary liability. Testimony highlighted the anxiety of small and large plan sponsors. These sponsors are extremely aware of the increasing prevalence and risk of fiduciary litigation which drains time and resources. Moreover, the Council received testimony that this understandable fiduciary anxiety eventually may weaken the commitment of both small and large employers to provide or continue plans. In particular, concerns about the complexity and burden of fiduciary obligations and about the risk of litigation are major deterrents to plan creation among small businesses. Until these fiduciary concerns are addressed, witness suggested that employers will seek to shift the financial risk to workers. These plan participants are not equipped or ill-equipped to initially invest. In addition, they generally do not have the financial skills to make the requisite investment decisions to allocate, maintain and preserve their investment accounts to ensure retirement security.
One final thought -- as part of the National Retirement Policy, there should be focused effort to capture the attention of the American public through targeted communications that is coordinated among agencies to ensure the maximum impact. The SEC and Treasury are launching new efforts addressing financial literacy issues as noted.
The Advisory Council recommends that the Secretary should collaborate with these other agencies and leverage their available support to address the retirement security issue. Because of the need for expertise and the necessity of addressing thorny political and social issues, the normal legislative process might not be up to the challenge of wholesale pension reform. As the 2007 Council's recommended in its Report relative to literacy, and more importantly, in this Report, the Council recommends that there be significant coordination and collaboration among government agencies, the private sector, professional organizations and academia when addressing financial security. A Presidential Commission of experts on retirement security, in general, will benefit from the input of all stakeholders, and to a reasonable extent, must be insulated from political forces. This Commission, at the behest of President, must be formed to deal with all retirement issues and form the National Retirement Policy and do so on a nonpartisan basis.
Promotion of Financial Literacy
An ominous cloud over American workers' retirement security is Financial Literacy, or perhaps more accurately referred to as Financial Illiteracy. There have been many studies done on this severe problem that affects not only retirement security but is an inhibitor for the overall economic well being of our society. Even as this 2009 ERISA Advisory Council prepares this report, other government agencies, non-profits, think tanks and professional organizations are tackling the exact same issues.
In a speech on October 22, 2009, SEC Chairman Mary Schapiro announced that the SEC is enhancing their financial literacy efforts and launching a new website - investor.gov. Ms. Schapiro stated that according to one survey 44% of workers or their spouses have not taken the time to estimate their retirement income needs and nearly 50% leave the workforce before planned.
The University of Michigan Retirement Research Center recently released a report on "Retirement Well Being and Social Security," stating that there is lack of basic knowledge about the rules to obtain Social Security and suggested awareness could be increased by targeted messages based on age or income level. Another University of Michigan report on "Financial Literacy Among the Young" showed that less than one-third of young adults possess basic knowledge of interest rates, inflation, and risk diversification.
It is time to set a goal of developing a generation of workers that are financially literate and to help in every way we can those that are currently struggling. As with retirement security in general, good ideas and strong proponents share this fight. Notably, the President's Advisory Council on Financial Literacy was created in January 2008 by Executive Order. Its purpose is to help support American competitiveness and assist the American people in understanding and addressing financial matters. The Executive Order creating the Council established, for the first time, that it is "the policy of the federal government to encourage financial literacy among the American people." The President and the Secretary of the Treasury tasked the Financial Literacy Council to work with the public and private sectors to help increase financial education efforts for youth in school and for adults in the workplace, increase access to financial services, establish measures of national financial literacy, conduct research on financial knowledge and help strengthen public and private sector financial education programs. The President's Advisory Council on Financial Literacy's initial high level recommendations include:
These recommendations echo the ERISA Advisory Council's 2007 Report on Financial Literacy of Plan Participants and the Role of the Employer. Because our findings and the testimony received mirrors that found by the 2007 Council, this Council did not feel it necessary to repeat and replay all the testimony of the 2007 and the 2009 witnesses. This years Council determined that the testimony received evidences that such increased financial literacy is critical in each phase of the retirement process whether in addressing planning for social security, defined benefit plans, defined contribution plans or post retirement welfare needs. Consequently, this ERISA Advisory Council wholeheartedly endorses all the 2007 recommendations (please see the 2007 report for details and background on the recommendations, at http://www.dol.gov/ebsa/publications/AC-1107a.html).
Secretary's Role in Maintaining and Preserving Defined Benefit Pension Plans
As discussed above, ERISA Section 512(b) directs the Council to provide advice or recommendations to the Secretary to fulfill her duties under law. This section of the report summarizes some of the major impediments to the continuation and maintenance of DB plans, as well as some ways to address those impediments. Pre-PPA laws had already proved inadequate. Changing economic and social conditions, including longevity, make old legislative models obsolete. The Council hopes that the benefits community, including the Secretary and the DOL, develop new forms of lifetime retirement security or risk revisiting today's economic woes on future generations.
Defined Benefit Plan Issues
It is common knowledge, as expressed by many witnesses, that both single and multiemployer DB plans continue to terminate for many reasons, including but not limited to, real and perceived excessive volatility and employer risk in funding DB plans, complex and conflicting regulatory regimes and worker mobility. The Council notes that the funding rules for single and multiemployer defined benefit pension plans(2) differ dramatically; however, there are enough similarities that the Council does not belabor distinctions between the plans.
Because of the sudden and substantial decline in the value of investments in the United States and virtually around the world, the funded status of defined benefit pension plans dropped precipitously during 2008. Additionally, many plan sponsors are required to account for their plans under the rules prescribed by the Financial Accounting Standards Board - for these organizations the rules require that plan liabilities and assets be marked-to-market every year. The corporate income statement/balance sheet volatility has led to many sponsors discontinuing pension plans.
Secretary Solis recently summed up major contributors to the current state of DB plans:
From an employer's standpoint, it is simply easier to run a 401(k) plan than a DB plan: there is less administrative complexity and significantly less financial liability.
Some witnesses conclude, with recent history as a guide, that it is highly unlikely that there will be a resurgence of DB plans under current law. Alison Borland reported that 25% of Fortune 500 plans are frozen. Stephen Utkus and Jack VanDerhei asserted that DC plan participants will be better prepared for retirement than participants in [single employer] DB plan because frequent job changes will not provide adequate DB benefits (Mr. VanDerhei noted that the average 2007 401(k) balance was $65,000, but he believes that by 2030, balances will be much larger). Still, DB plans cover some 40 million American workers.(4) All things considered, the Council concludes that DB plans offer benefits not easily duplicated(5) and that it is appropriate to preserve existing plans and encourage the formation of new plans. The challenge is daunting, as the Secretary has noted --
Note, however, witness testimony was not unanimous in the need for wholesale reform to the retirement system.(7) Anna Rappaport suggested that the overall system is sound but needs tweaking. Ms. Rappaport also encourages DOL to support the development of a National Retirement Policy. David Wray said the current retirement system(8) should be nurtured, not redesigned. Mr. Delaplane described the employer-based system as "successful." Many witnesses viewed 401(k) plans as an inadequate means of retirement security. Mr. Sullivan argued that a wholesale rewrite of ERISA is necessary to protect existing DB Plans and promote the formation of new ones with new features and funding requirements. Professor Munnell suggested a new DB Plan model, with mandatory participation and contributions. Mr. Fuerst suggested a new multiemployer model that would be pool investment and longevity risk under the management of an independent trustee.
Matthew Scanlan and Carter Lyons testified that DB plans are more helpful for retirement security because of professional asset management, access to more diverse investments, lower costs for pooled assets, diversification of longevity risk and reduction of intergenerational strife. Beth Almeida, referring to survey data, notes that DB Plans achieve better net investment returns of 1% to 1.8% which means that over 25 years, a DB investment will exceed a DC investment by 33%. Emily Kessler noted that annuitization out of a DC plan cannot provide the same benefits as efficiently and at the cost that a DB plan provides a lifetime income. Jason Tyler provided data that demonstrates that minorities under-utilize 401k plans. Mr. Sullivan cited a recent study that shows that poverty rates for older households lacking pension income were about six times greater than those with such income.(9) This study also finds that pensions reduce, and in some cases eliminate, the risk of poverty and public assistance that women and minority populations otherwise would face.
Steve Albrecht noted that lower wage workers lack the wages necessary to defer income, so that DB plans are more suitable. The lack of a secured lifetime income stream depresses current spending, as Sullivan testified --
Secretary Solis notes:
The Council and witnesses also view retirement security as both a jobs issue and a social issue. As Mr. Sullivan testified, "If worker separate accounts are decimated, they cannot retire." The specter of intergenerational conflict should not be ignored nor should adverse impacts on succession planning. Older workers that hang on past their prime or perhaps their desire limit job prospects and advancement for younger workers. Employers who offer DB plans are better able to predict retirement dates and plan accordingly.
The American Benefits Council (ABC) recently issued a report which discusses the effect that funding challenges are likely to have on the economic recovery and job creation.(11) The report begins by noting DB plan participants were historically insulated from the losses attributable to the financial meltdowns because their employers bore the risks of investment losses. However, employers sponsoring defined benefit plans must make up any shortfalls in plan funding with additional contributions and under the Pension Protection Act, significant changes in benefits for active workers are possible if the funding situation requires it. This ABC report notes:
Professor Munnell and the ABC report cite a 2008 Center for Retirement Research paper that concludes that "funding requirements that compel companies to increase their contributions dramatically during a recession increase the likelihood of layoffs and terminations."(12)
Longevity risk for the person and the taxpayers has to be recognized, in part for a reexamination of when persons should stop working. The current defined benefit environment is predicated on "age 65" retirement. Many witnesses agreed that the current retirement age is outdated as life expectancy increases. The ERISA rules regarding normal retirement, as well as Social Security retirement ages (including the "new" 66/67) were established when life expectancy, at age 65, was 50% lower than it is currently. This increase in life expectancy, combined with outdated definitions of normal retirement is contributing to an increased cost of benefits. In many cases, employees can potentially spend more time in retirement than they do on the job.
Additionally, many workers do not anticipate simply stopping work on some arbitrary date. Many witnesses discussed the inability of the current defined benefit system to accommodate flexible (phased) retirement arrangements for workers that are not interested in fully exiting the workforce upon attainment of a given age. In order to support a new retirement paradigm of later retirement ages and flexible approaches to retirement, the current regulatory regime needs to be reviewed to ascertain if defined benefits plans can continue to be a viable benefit for employers to offer. The Council commends to the Department its recommendations addressing these issues in the 2008 Report on Phased Retirement. (See http://www.dol.gov/ebsa/publications/2008ACreport2.html)
Panoply of Proponents' Pension Proposals
Given the issues identified with the DB system in particular, several possible approaches to reforming DB plans and DB plan rules (and some related proposals) follow. The names of proponent witnesses appear in parentheses. Some ideas come from Council members.
The Council would expect the recommended Presidential Commission would explore these issues and more.
Challenges for Defined Contribution Plans
The Council's next focus involves the existing and evolving Defined Contribution models. The testimony centered generally on medium and large employers. It addressed the participation, accumulation and decumulation phases of the Defined Contribution (DC) plans. As addressed by many witness, 401k plans are now the most prevalent and expanding plan structure in the U.S. Although the DC model is growing and is replacing the DB model, as the recent crisis has illuminated with the brightness of an exploding supernova, this does not necessarily mean that workers will receive greater retirement security without greater fiduciary involvement.
The Council received testimony concerning the DC model and how to deal with the basic needs of participants to make investment decisions even though they may not equipped to do so. Specifically, can financial security be promoted in a well-diversified portfolio?
Studies have indicated and witnesses testified that the system suffers from a variety of problems: only about half of all workers have access to any form of employer sponsored retirement program; too few workers who have access to a DC plan enroll in those plans; and those who do defer too little initially and fail to increase the levels of deferral as time goes on; and finally that there are too many opportunities for "leakage." They also indicated that workers do not participate because of their inability to understand how plans work. Moreover, even if they do understand the concepts of tax deferral they do not understand how best to invest the funds which are to be invested. Most studies and most testimony identified a principal cause of the issue to be financial literacy, or as more accurately described, financial illiteracy.
The testimony concerned this fundamental issue - how to manage your money - which is documented in the witness summaries. A significant number of working Americans (28 million) are "unbanked," i.e. have no checking or savings accounts. Yet most retirement plans ask these same people to manage their investments and understand how to project retirement needs; to understand the pitfalls of inadequate contributions or early withdrawals; and to navigate the most effective means of the spend down phase, including the most advantageous way to draw Social Security. Mr. Sullivan observed that as a trustee of a large defined benefit plan, he would not think of investing the plan's assets directly. Instead, board members would take advantage of their discretionary authority under ERISA to retain qualified professional asset managers (QPAMs) to make these investments, and they retain investment consultants to monitor the performance of these QPAMs, who, in turn replace managers who fail to perform. Yet the DC system requires employees who receive limited, infrequent education, to take personal responsibility for these functions on their retirement accounts and if they fail to perform, their punishment is not that they are simply replaced as their own portfolio manager, but that they suffer "the retirement equivalent of capital punishment."
As addressed by the 2007 Council, the issue of financial illiteracy in the DC model was and remains as significant an issue whether in the accumulation; maintenance or decumulation phase.
There were several areas where testimony identified the need for interventions, both short and long term, for defined contribution plans:
Expand and Amend Interpretive Bulletin 96-1 for the Decumulation Phase
In particular, this Council recommends the immediate expansion and amendment of Interpretive Bulletin (IB) 96-1 to address the decumulation stage and to allow for innovations in the marketplace. This same recommendation was made by the 2007 Council that studied Financial Literacy and the 2008 Council that studied the Spend Down of Defined Contribution Assets at Retirement.
There continues to exist confusion at the plan sponsor level concerning the applicability of fiduciary liability for tools or information provided to assist plan participants on plan distributions. Clarity is needed for corporate plan sponsors and multi-employer plans alike.
Consequently, the Council again recommends that the Department of Labor expand the reach of IB 96-1 to the decumulation phase to further retirement security. As innovation continues in the financial marketplace and greater numbers of retirees rely on DC plans as their primary retirement vehicle, fiduciaries need to know how to address issues not necessarily addressed in IB 96-1 concerning education and advice for the decumulation phase of retirement plan assets (distribution options, in-plan vs. out of plan payments). Plan sponsors need clear guidance about the type of information, programs and education they may provide to participants, without being concerned that they are acting as a fiduciary providing investment advice or that they may be exposed to liability for breach of their fiduciary duty.
James Delaplane, Davis & Harman LLP, on behalf of the American Benefits Council
Mr. Delaplane's testimony focused on the adequacy and structure of employer sponsored retirement plans. He said the recent focus on the current system has been triggered by economic conditions and has created an environment in which an examination is taking place of what's working, what's not working and what we can do to improve outcomes.
Mr. Delaplane pointed out that some things employers currently are doing are counter-productive from a retirement security perspective but necessary at this time to ensure the viability of their firms or preserve jobs, e.g. cutting back on employer matching contributions. So, while employers are taking necessary steps in light of economic conditions, they remain committed to employer-sponsored retirement plans as the foundation of the private retirement system. Employers are asking for patience to weather the storm before implementing the innovations of the future.
According to Mr. Delaplane, there is great value brought to the table by the private employer system which has been a great success. The defined contribution system should not be judged on the economic conditions of the last 12 months. What has taken place is a once in a lifetime event. But, there is no need for radical structural reform or wholesale restructuring. Rather he recommended several steps to improve the system by enabling greater participation in system by employers and employees.
To improve and grow existing system, he said we must avoid undermining the current system. Also, we must recognize that no single policy response or mandate would speak to all the reasons why some employers have shied away from plan sponsorship. Mr. Delaplane also cautioned against creation of a new governmental system or structure to provide retirement plans or investments which he said could create unwise governmental liabilities and supplant private-sector activity.
More specifically, Mr. Delaplane indicated that the American Benefits Council believes that proposals to increase coverage could best be accomplished by offering a range of retirement plan designs - from simple arrangements with low contribution limits and relatively modest compliance requirements to more complex designs with higher contributions limits and rigorous compliance requirements.
Mr. Delaplane further pointed out that employers have high anxiety about fiduciary liability. The recent spate of litigation, coupled with current market conditions, dominates the concerns of plan sponsors. To address these concerns, Mr. Delaplane recommended that safe harbors be instituted to give sponsors a road map for how to satisfy their fiduciary responsibilities and offer protection if litigation arises. Some recent examples of helpful safe harbors are the QDIA and 404(c) regulatory safe harbors that the Department of Labor has issued. He recommended and suggested that the fee disclosure legislation that Congress is currently considering include safe harbors. For example, plan sponsors should be able to rely on the fee disclosures they receive from service providers without fear of being held accountable if the information included in that disclosure is erroneous. Also, safe harbors should be available that address the obligations fiduciaries have with respect to reviewing unbundled service pricing. Increasing fiduciary risk could weaken commitments of plan sponsors to maintain plans and serve as an impediment to plan formation. Finally, in response to an inquiry regarding the effectiveness of safe harbors and whether they could potentially backfire and increase litigation risk, Mr. Delaplane responded that while some safe harbors could potentially increase litigation risk by serving as a roadmap for plaintiffs lawyers, the benefit of having these in place outweighs the risk.
Mr. Delaplane made several other recommendations in his testimony. These included:
Alicia Munnell, Ph.D., Boston College Carroll School of Management
Dr. Munnell opened her remarks by observing that the US needs a bigger more robust retirement system. In her opinion, the case for revising our retirement system is based in several areas:
Turning her attention to the private sector, Dr. Munnell noted that less than half of all employees are covered by a private retirement plan. This number has not moved in decades. During that time, there has been a marked shift from defined benefit to defined contribution plans, mainly the 401(k) plan structure, which still operates under the old roles, allowing great discretion on the part of the participant with respect to participation, amounts of deferral, and withdrawals from the plans. She observed that this model has not been particularly successful, noting the average account balance in 401(k) plans was recently estimated at approximately $60,000.
As the retirement system is contracting and is being strained by increasing life expectancies, the period of time that these assets must support retirement translates into lower long-term income. She referenced a recent analysis that showed an increasing trend toward households that are "at risk" in retirement. 44% of households will not be able to maintain their standard of living (within 10%).
How we get from where we are to where we need to be:
Another aspect of retirement income security is the individual's home as an asset. She commented that the designs of current product offerings including home equity, lines of credit and reverse mortgages appear to be too restrictive to be truly helpful.
Dr. Munnell stated that we must be careful to not undermine the benefits provided by Social Security as the backbone of retirement security for most Americans. She cautioned that we should resist the temptation to reduce future benefits to meet tax shortfalls. Finally, Dr. Munnell noted the need for an additional tier to the retirement security pillars. She expressed disappointment that the Defined Contribution system has evolved into something that it was never intended to be - the primary source of retirement income. She stated that she believes the new tier should be sponsored by the private sector. She also observed that it appeared to be inappropriate to build in guarantees for the defined contribution systems, noting that such guarantees carry with them intergenerational shifts in responsibility for funding when assets are invested in risky asset classes. She did, however, note that there is a need for risky assets in order to deliver the required benefit, but stated that the Social Security system is perhaps, the place for such assets.
Dr. Munnell concluded that there is just too little retirement income and that we need "more" if we are to meet the needs of older Americans.
Issue Chair McCaffrey asked Dr. Munnell whether she believed that 401(k) plans should be mandatory. She noted that her proposal would include a plan that would provide about 15% of the employees' replacement income. Whether this should be employer sponsored, employee funded or some combination of the two was not a matter she was prepared to address. With specific respect to the 401(k), however, she said "that these poor things should be left alone" for those people for whom they were originally intended (as a source of supplemental income).
Council Chair Dill asked Dr. Munnell whether she believed that the retirement age of 65 continues to be appropriate. She noted that in a book she had recently published, the conclusion reached was that people should be encouraged to work longer. She stated, however, that as long as the government has a standard retirement age of 62, getting employees to work longer is a very difficult hurdle to overcome, philosophically and economically.
Issue Chair McCaffrey asked whether there are other models internationally that should be considered. Dr. Munnell noted that Australia, Canada, and, to some degree, the Netherlands have brought equities into the public system and that some variation of those systems could be devised for the American system.
Council Member Billings asked Dr. Munnell to comment on phased retirement. She noted that employers hate flexible retirement arrangements and they tend to be disruptive to the smooth functioning of the enterprise.
Council Member Koeppel asked Dr. Munnell to comment on whether she believed that the addition of the new "tier" to the retirement system would result in a reduction in deferrals to current plans. She stated that the adoption of a (preferably) mandatory additional tier, may result in the reduction of contributions to existing 401(k) plans (and noted parenthetically that that may allow these plans to return to their intended purpose of providing supplemental income to the more highly paid). Overall, she said that she believe that through the implementation of such a system, the rate of overall savings for retirement will increase by covering the 50% of people who currently have no retirement savings programs.
Carter Lyons, Barclays Global Investors (BGI) and Matthew Scanlan, Renaissance Institutional Management
BGI is one of the largest investment managers in the world, has been managing DB assets for 30+ years and DC assets for 20+ years. Renaissance Institutional Management is a leader in quantitative investment management and has provided quantitative portfolio management for 25+years. Both speakers have worked with hundreds of DB & DC plan sponsors on plan design, implementation, and ongoing management of retirement plans. Mr. Lyons is a Managing Director at BGI and Mr. Scanlan is CEO and President of Renaissance Institutional Management. Mr. Scanlan spoke first about DB plans and Mr. Lyons spoke about DC plans and education.
Mssrs. Lyons and Scanlan believe that for DB Plans:
That being said, there are still paths to better manage the overall health of the DB system:
Mssrs. Lyons and Scanlan believe that for DC Plans:
They have three recommendations for structuring better DC plans:
Mssrs. Lyons and Scanlan recommend that in order to best educate participants, sponsors should have short and focused materials that include action items.
Joseph Piacentini, Employee Benefits Security Administration (EBSA)
Mr. Piacentini is EBSA's Chief Economist and Director of Policy and Research. His opening remarks focused on risk and adequacy, explaining risk includes variability and uncertainty in investment returns, consumer price inflation, and longevity. Adequacy is a question of what resources are devoted and how they are distributed. Mr. Piacentini described the U.S. retirement system's three pillars: Social Security, job-based pensions and individual savings. He believes the second and third pillars have blurred, due to the profound shift from defined benefit (DB) to defined contribution (DC) plans.
Risk: There is investment risk associated with exposure to equity in DC and DB plans. Between 2007 and 2008, the assets of both DC and DB plans fell 28 percent. Regarding target-date funds, Mr. Piacentini confirmed that funds targeted at near retirees and exposed them to substantial equity investment risk. Mr. Piacentini drew attention to a longer existing problem though, involving high equity exposure among older DC plan participants. EBSA estimates that young workers today will accumulate enough job-based pension (mostly in the form of 401(k) savings) to replace one-third of their pay. This estimate could vary to more than one-half or less than one-quarter of lifetime career pay, estimated to be a 10 percent chance respectively. With regard to DB plans, stress falls on plan sponsors, who contribute to overcome shortfalls, and trickles down to prospective benefit cuts or plan freezes. Plan insolvencies stress the Pension Benefit Guaranty Corporation (PBGC), remaining plan sponsors and participants who can lose benefits in excess of PBGC guarantees.
Mr. Piacentini then discussed longevity risk, regarding life expectancy for men and women after age 65 and its financial implications. Given that 10 percent of men and women will survive almost 11 years past their gender's respective life expectancy, it is expensive to self-insure against longevity. If longevity risk is pooled, these resources in aggregate would provide lifetime income for the entire population. Mr. Piacentini noted inflation risk is also substantial considering cost of living increases.
Adequacy: Threats to adequacy come from fiscal and demographic pressure on the Social Security program, gaps in pension offers to lower-paid workers and inadequate savings contributions from some workers. In a growing DC pension system, contribution rates are critical for adequacy. Current retirees' average replacement rates appear to be 50 percent or higher. Projections suggest that today's young workers' earnings replacement from pensions and Social Security will be nearly 70 percent. 2003 CBO and GAO reports on baby boomer retirement preparedness conclude boomers on average are better off than their parents' generation. Mr. Piacentini cautions certain caveats, however, including longevity, inflation and investment risks. Moreover, boomers' personal expectations for income are higher. The GAO report concludes retirement prospects for gen-X extend and amplify boomer trends.
Mr. Piacentini made a few international comparisons, noting the U.S. retirement income system relies more on private pensions and exposes individuals to more financial market risk. In most other countries, DB and DC funds invest more in fixed income instruments. The U.S. falls toward the low end in expected replacement and the high end in reliance on financial wealth. Mr. Piacentini made no policy recommendations. He concluded suggesting the U.S. is addressing the complexion of the retirement system's second pillar which could emerge with government help to meet the current threats to risk and adequacy.
Emily Kessler, Society of Actuaries
Ms. Kessler is a senior fellow, Intellectual Capital of the Society of Actuaries. The SOA launched the "Retirement 2020 Initiative" in 2006. Retirement 2020 is an initiative to review retirement systems in their totality. Ms. Kessler joined the SOA in 2003 as a retirement staff fellow, where she worked with SOA members on research and education issues whose primary practice is pension.
Ms. Kessler testified about whether there is a need for insurance within the retirement system. In her view, a DB plan is an insurance arrangement to protect against a retiree outliving his or her assets. A DC plan accumulates wealth but is not designed as insurance. In "Retirement 2020" part of the discussion focuses on whether it is important for individuals, for society, and future taxpayers to have insurance in the system. Ms. Kessler said in a DC plan, some do well and others do not.
Some individuals look at retirement plans as wealth accumulation and not retirement income insurance. If they consider it to be wealth, they are less likely to annuitize the assets. She feels that some form of insurance - guaranteed lifetime retirement income - is very important to stakeholders in the system.
Retirement 2020 also is considering the role of employers. Now employers can offer retirement plans (DB or DC) or not. Retirement 2020 would like to offer other roles. Employers could play an education role where they provide employees access into the system without sponsoring a plan, such as with TIAA/CREF.
Retirement 2020 also advocates using markets wisely. Individuals don't use markets well. They don't know how to invest and don't have access to special purpose investments. They don't have a sophisticated agent acting on their behalf. These are all things that would enable individuals to take advantage of the power of the markets to help their retirement assets grow.
Retirement 2020 has considered the role of equities in the retirement system. It has reached no firm conclusions yet, but she said anyone thinking about a true life cycle concept needs to be hedging against these retirement risks. Insurers have to make very conservative estimates because there is no way to lay that risk off on the capital markets.
Another lesson that Retirement 2020 has learned is the role of defaults and signals. With insurance arrangements, choice adds cost. People have a few choices when they retire regarding the distribution of their retirement assets from their plans, while they do not have a lot of choice in their Social Security benefit and that really drives costs down. With Social Security, everyone stays in the system and the pooling is at its most efficient. So there is a tradeoff to be made. As soon choice becomes part of the system, it increases the cost of the system.
Ms. Kessler said it will be very difficult to turn a lump sum from a DC plan into insurance. The account balance signals we're sending are strong that this is private wealth and private ownership. It will be difficult to change the system back to the insurance mode that is needed by society and by individuals.
One possibility is to allow employers to participate in a TIAA/CREF model. All employers in a given industry can participate in a plan without fiscal responsibility for retirement income, but they can make contributions to the plan.
Beth Almeida, National Institute on Retirement Security
Ms. Almeida is Executive Director of the National Institute on Retirement Security, a nonprofit, nonpartisan research and education organization. Ms. Almeida's testimony focused mostly on the beneficial characteristics of DB plans. She opened by describing some opinion research conducted by the NIRS in November 2008 with a sample of 801 people. The poll found that 83 percent were concerned about their ability to retire in light of economic conditions, and that 71 percent think it is harder to prepare for retirement today compared with previous generations. The poll also found that a majority without a DB plan think that they would be more secure if they had one.
Ms. Almeida stated that two leading risks that Americans face in preparing for retirement are first, the risk of not accumulating sufficient assets to finance a retirement and, two, the risk of outliving those assets in old age. These problems are mitigated by DB plans because of their pooling characteristics.
Ms. Almeida further emphasized that professional investment management drives significant economies in DB plans, making it a very efficient system. According to NIRS calculations, a typical DB plan can provide the same level of target retirement income as a typical DC plan at about half the cost in terms of the contribution required over a career.
Thus, the decline of DB plans in the private sector should be a concern for policymakers because fewer Americans will have a chance to achieve a secure retirement and because we will have a generally less efficient system of preparing Americans for retirement.
Ms Almeida suggested a 2 track strategy:
In answering questions, Ms. Almeida described a case in West Virginia in 1991 where some employees were given the option of DB or DC and three-quarters of those under age 40 opted for the DB plan.
Don Fuerst, Mercer
Don Fuerst began his testimony by providing background on the evolution of US retirement system. He noted that the growth in DB plans was replaced by growth in DC plans in the late 20th century. With respect to defined benefit pensions, he pointed out that some of the practices that produced stable costs contributed to plan insolvency. The growth of DC plan assets coincided with a long bull market. Capital market volatility is now a factor for both participants and employers.
In today's environment, a logical, rational individual may have enough retirement income by:
However, people are often not rational - there are competing financial challenges facing many Americans. Additionally, some employers do not offer plans, due to the cost / complexity of the current voluntary system. The current system has many key deficiencies that make it unsustainable and incapable of providing widespread financial security for retirees.
Mr. Fuerst provided a proposal for a future retirement system:
In both tiers, the structure would move from employer-based system to one that places the mandate on employees / self-employed individuals - similar to FICA taxes. An employer's responsibility would be limited to providing choice of plans.
Mr. Fuerst acknowledged this type of system would require significant enabling legislation. The benefits are:
David Wray, Profit Sharing / 401(k) Council of America
Mr. Wray suggests that the Council look at the questions of retirement security in a different way, noting that the United States already has a mandatory defined benefit system, namely Social Security. It provides a progressively structured joint survivor annuity indexed to inflation. The question then, is what to do in addition to Social Security. He suggests that the future of retirement security is a combination of Social Security (a government promise and program) and some prefunded accumulation approach in the private sector. Various income replacement studies show that it is indeed very possible for an employee to have sufficient retirement income with modest contributions and returns over time, but the key is getting the employee to participate in an employer sponsored plan or save on their own, which is less likely to happen.
In Mr. Wray's view, prefunded systems require some kind of trusted intermediary such as an employer or other entity to be successful, as people are not saving sufficiently for retirement on their own. The employer system should be nurtured and encouraged because that is what it going to be successful; it will not happen on a voluntary basis. It should not be a "mandatory" system -- Social Security already provides a mandatory solution. Employers make the best fiduciaries in this scenario due to a natural alignment of their interests with the employees, particularly since the largest account holders tend to be senior managers of the employer. Employers also benefit from the opportunity to use plans as a means of fostering good employer/employee relations.
Every American worker has access to a retirement plan right now (e.g. Roth, regular IRAs), with government incentives for participation. Plan design at companies is not a casual decision by plan sponsors. They are designing programs that they think that their employees will value. The employer provided defined contribution system has demonstrated that it can provide asset accumulation adequate for a secure retirement for participants at all income levels, but participation by certain ethnic groups and lower paid workers should be increased.
Additionally, small business plan coverage rules need to be simplified and made less onerous to owners to compensate for the costs of providing a plan to their workers. Mr. Wray suggests eliminating the complex top heavy test and mandatory funding for small employers in order to encourage them to offer retirement plans. Many small companies have uncertain cash flows, and a required contribution to a retirement program could jeopardize a company's survival. Unfortunately, ERISA requires that small companies do just that.
In practice nearly all companies with fewer than 50 employees will eventually fail the top-heavy test, even if they are not top-heavy initially. For companies with fewer than 25 employees, it is a virtual certainty. For small businesses, the resources to cover fines and reparations incurred as a result - especially those with 50 or fewer employees - may put the entire company at risk.
Mr. Wray observes that the American work force has overwhelmingly rejected the concept of the joint and survivor annuity option for distributions, so the laws mandating this approach should be repealed before serious conversation can be had about how to deliver guaranteed income solutions from defined contribution plans.
Today's retirement money is managed by professional money managers at a very high level. Consolidation of providers has resulted in economies of scale and increasingly sophisticated employer-sponsored plans at continually decreasing costs, but the costs for smaller employers still remain high. Mr. Wray does not believe that plan providers should be able to market retail products to plan participants. The fiduciary duty may be compromised if there is an implied employer endorsement on cross-marketing by plan providers. Mr. Wray emphasizes that employers should retain a high level of fiduciary responsibility. Employers and plans have to do a better job of getting information to employees and encourage them to obtain advice on their own, not from the employer.
Stephen P. Utkus, Vanguard Center for Retirement Research
Mr. Utkus discussed the divergent views concerning how well prepared Americans are for retirement and reviewed three studies of U.S. Retirement Readiness. Two of the three studies roughly divided the U.S. population into three groups - the prepared, the potentially prepared, and the not prepared. One study divided the population into two groups - the prepared and the not prepared. Mr. Utkus states he did not believe it was helpful to describe retirement readiness in either/or terms. He suggests the best approach for policy development is to imagine three groups:
For the intermediate or "partially prepared", small changes in behavior today can produce meaningful improvements in outcomes. For example, savings shortfalls can potentially be cut in half by delaying retirement three years or increasing savings by 3%. Either retirement readiness inadequacy is 1) rather widespread affecting 4 out of 10 households or 2) the problem is about half this and affects about 2 out of 10 households. The variance depends on the study and the assumptions utilized.
To compare retirement readiness on the national level, we are hampered by important data limitations but what mostly accounts for the different assessments of readiness is the role of assumptions. The most important assumption differentiation is the definition of what constitutes an adequate retirement. In the end, the studies with more realistic results sets lower targets for what constitutes an adequate income. The variance ranges from 13% to 34% of the population is not prepared for retirement.
The heart of the policy question is defining the goal - a minimal level of retirement adequacy or the conventional practitioner's view of replacement of 70% - 80%? Also many studies assume the conversion of all retirement savings to an inflation adjusted annuity and the use of home equity for retirement income, which is not usually the case. The qualified plan system covers approximately half of private sector workers, but private plans represent only one component of wealth accumulation. Therefore any analysis of readiness must consider more than employer retirement plans.
The shift from DB to DC, the aging of the population, the need to slow the growth of SS and Medicare costs, the lack of thrift among the baby boomers, two recent large declines in the global markets and increased longevity all have led to worries about whether retirement readiness is declining. These headwinds will need to be considered in any future national retirement policy.
The three major factors linked to inadequate retirement preparation:
Possible Policy Solutions
Jack VanDerhei, Ph.D., Employee Benefit Research Institute (EBRI)
Dr. VanDerhei reviewed the results of several empirical and simulation studies EBRI has undertaken to analyze retirement readiness in the context of the voluntary retirement system and possible modifications. Retirement income adequacy can be defined in a number of ways. EBRI's approach focuses on the probability of whether retirees will be able to meet certain minimum expenditures, including medical expenditures that are not covered under Medicare and/or Medigap policies.
He states in his introduction that very few (if any) individuals on the verge of retirement have had the opportunity to participate in a 401(k) plan for their entire working careers. Simulations suggest that a significant percentage of 401(k) participants are likely to be able to replace at least 70 - 80 percent of their preretirement income from a combination of 401(k) plans and Social Security as long as they are continuously covered by a 401(k) plan. Simply tabulating average account balances provides an inadequate measure of the wealth accumulations potential of 401(k) plans. He notes that the study was performed prior to the 2008 market crisis.
One study noted that a high income male retiring at age 65 with 100% equity allocation and no annuitization would only need 3.3 final earnings in addition to Social Security to provide a 50% chance of covering basic expenses for the full retirement period. However, moving to 75% (5.0 final earnings) and 90% (11.6 final earnings) levels, investment and longevity risk as well as the possibility of extended stays in a nursing home begin to move the multiple to higher ranges.
To switch from voluntary enrollment to automatic enrollment for all US workers resulted in a majority of individuals being at least as well off with automatic enrollment as they were with voluntary enrollment for all income groups. Automatic escalation has a positive impact with the lowest income quartile experiencing an income replacement rate increase of 11% and the highest income quartile increases by 5%. The lower paid quartile, the second lowest quartile, and the third quartile (through the 75th percentile) will always be at least as well off under automatic enrollment.
The impact of the current market downturn will take years to analyze and outcomes depend on the assumptions made for future markets. Early findings show that at least for the median results, lower paid employees will have shorter recovery times than their high paid counterparts.
Target date fund are often chosen as the default investment strategy for employees who are automatically enrolled in 401(k) plans. Employees are put into asset allocations considered age appropriate. It is likely that these employees (especially young employees) who otherwise would have chosen a relatively low equity allocation would end up with larger 401(k) accumulations at retirement with target date funds opposed to participant directed investments. With an incredible range of asset allocations, target date funds have a large range of different outcomes.
When asked if he would recommend auto enrollment and auto escalation be made mandatory, Dr. VanDerhei replied he thought many employers would not offer a plan at all. His recommendations:
Aliya Wong, U.S. Chamber of Commerce
Ms. Wong opened her remarks with a comment regarding the success of the current employer provided retirement system. However, she cautioned that the recent financial crisis has placed significant strains on the ability of many employers to maintain this system.
She noted several issues that require immediate attention for the system to survive:
Ms. Wong also revisited the subject of decumulation of assets in retirement, a subject on which the Chamber testified last year. She noted the Chamber's concern over the ability of retirees to adequately plan to provide a steady and reliable stream of payments in the post-retirement period. She stressed the need to make education on the need for employees to understand the need for such security, while noting that many of the Chambers' members do not believe that this should be a primary responsibility of the employer. She recommended that Congress approach this topic in a "product-neutral" manner that allows plans to take advantage of product innovations in this important area.
Finally, Ms. Wong noted the companion issues of participants' needs for additional education on the subject of annuities and the need to balance the retirees' need for retirement security with the exposure to which employers who try to assist employees access affordable annuity products may be subject; and the question of whether longevity insurance products that help address the retiree's exposure to longevity risk should be subject to the minimum distribution requirements.
In the question and answer period, Ms. Wong responded to a question from Issue Chair McCaffrey regarding the desirability to encourage employees to leave their account balances in the plans, she noted that her members struggle with the conflicting issues of giving employees access to professional management and lower fees with the administrative and fiduciary concerns of employers who permit employees who do so as they move through the decumulation phase.
Council Chair Dill explored the question of fee disclosure with the panel. She noted, as she had in her written statement, that there is a need to provide additional transparency with the questions of whether participants make decisions based on a limited data set.
In response to a question by Council member Wiggins regarding actions states have been taking to facilitate the development of investment pools that permit IRA participants to access lower fees, Ms. Wong noted the unanswered questions about how such programs would interact with ERISA and noted that this could be an area that the Department of Labor could help to clarify. Council member Haber noted the recent focus on fee disclosure in the 401(k) arena, but noted that no similar focus has been directed to the fees charged to IRA participants. Ms. Wong noted that the Chamber's members, which include investment firms are focused on this issue from that perspective.
Council Vice Chair LeBlanc raised the question of whether the limit on compensation of the current tax code has a negative effect on the continuation of defined benefit plans. Ms. Wong noted that this is clearly a problem, but that the complexity of regulations also has presented barriers to the continuation of defined benefit plans.
David Certner, AARP
David Certner, Legislative Counsel and Legislative Policy Director of AARP, noted that the key trends making attaining adequate retirement income more challenging were: the erosion of employer-sponsored pension plans and the growth of 401(k) plans; the absence of workplace savings plans for those working for small employers; and the low private savings rate resulting in many people approaching retirement with very little in private savings and assets. These trends especially in the current economic crisis highlight the importance of Social Security and its guaranteed benefit to retirement security. While Social Security was not meant to be the only source of retirement income, it is the primary source of income for two-thirds of retirees.
Mr. Certner emphasized that all workers need access to a retirement plan to supplement the foundation Social Security provides. The three central issues in the voluntary pension system since the enactment of ERISA have been: coverage and participation, security and adequacy.
Private sector pension coverage has been near 50 percent since ERISA's passage. Workers who are older, better educated and paid and full time are more likely to be covered than those who are younger, less educated, lower paid and part-time.
He said the adequacy of income from pension plans has been eroding with the decline in private sector defined benefit plans and the dominance of 401(k) plans. The growth of 401(k) plans has shifted the adequacy, investment and longevity risk from employers to employees. The problems that have surfaced with 401(k) plans include low participation, low contribution rates, inappropriate asset allocations, improper assets diversification and pre-retirement cash-outs of accounts. Participants typically have no professional guidance on investment and do not have meaningful information or incentives to annuitize their account balances. Mr. Certner noted that individuals were not yet prepared to handle the responsibility of our complex financial world and more financial literacy is necessary.
Mr. Certner suggested several areas worth exploring to improve retirement security.
AARP generally supports the use of automatic proposals such as automatic enrollment, automatic escalation, and default investment options. However, too few employers have adopted these provisions and they usually apply them only to new employees. Mr. Certner noted that greater regulatory oversight was necessary with automatic proposals because employees will pay less attention. AARP also supports for the auto IRA concept, because of the roughly 75 million workers who do not have access to a retirement savings plan at work.
More explicit disclosures regarding the risk of target date funds could narrow the disconnect between fund managers' recommendations and participant expectations. He also said increased fee disclosure from 401(k) plan service providers should be required to be made to fiduciaries, the first line of defense in assuring that fees are not too high, and participants. Individuals should have the right to receive detailed information upon request.
Mr. Certner urged DOL to issue regulations on investment advice to ensure that participants receive objective, non-conflicted advice.
He also said DOL should have additional resources to enforce ERISA, including meaningful remedies for violations.
On asset preservation, Mr. Certner expressed concern about the tendency of younger and lower paid workers to take distributions rather than annuitize or rollover account balances. He advocated low cost, inflation-protected annuitization options and a better job educating participants about the importance and value of lifetime income streams. Automatic rollovers protect benefits and should be encouraged and there should be tougher restrictions on the distribution of, and access to, employer matching contributions.
Mr. Certner said simplified defined benefit plans can be developed and promoted to provide a guaranteed income to workers. Hybrid plans, such as cash balance and pension equity plans, as well as the different types suggested, should also be used to provide employer paid guaranteed benefits.
In response to a question regarding the inconsistency between ERISA rules on normal retirement age and Social Security retirement age, Mr. Certner noted that any changes should be gradual and that given longer life expectancies, people should be encouraged to work longer. In addition, doing so could lead to greater savings being available at retirement as well as increased Social Security benefits. He also noted that those who were not able to work longer should not be penalized for leaving the workforce.
Answering a question about leakage from pension and retirement plans, Mr. Certner expressed a preference for participants to keep their account balances in the plans or use automatic rollovers. He noted that keeping the account balance in the former employer's plan could be beneficial for the participant due to lower fees and possible professional investment availability, but he acknowledged that employers may not want to retain smaller account balances. One possible approach is to create a collective place for holding account balances so they can be managed more efficiently.
Health care, he noted, was a huge part of retirement and he described the "four pillars of retirement," the alternative to the traditional three-legged stool. The four pillars were: pension and savings, Social Security, continued work and health care.
Sarah Holden, Investment Company Institute
Sarah Holden testified on behalf of the Investment Company Institute (the "ICI") on the role of IRAs in U.S. households' retirement planning, the fees associated with mutual funds held in IRAs, the role of advice for IRA-owning households, what information is provided by employers and IRA providers to plan participants regarding portability and rollovers. Ms. Holden testified that at year-end 2008, IRAs have grown to be the single largest component ($3.6 trillion) of the $14.1 trillion total retirement plan market assets . This places them neck and neck with Defined Contribution plan assets. Defined Benefit plans have $2 trillion in assets. Although initially accumulation accounts played a significant role in IRA growth, more recent growth has resulted from rollovers for employer sponsored plans. Approximately 40% of U.S. households own IRAs and 50% of IRA-owning households indicated that their IRAs included funds that were rolled over from an employer-sponsored plan.
Ms. Holden said that individual choice plays an important role in the decision at job change or retirement to leave money the current employer's plan, roll over to the next employer's plan (if available), roll over to and IRA, buy an annuity, cash out, or do a combination of these options. Moreover, while DC plan participants typically have a lump sum option available for rollover, increasingly DB plan participants have access to accumulated account balances as well. Studies have shown that older participants and those with larger account balances are more likely to preserve accumulated retirement account balances at job change or retirement. As well, an increasing percentage of retirement plan participants are rolling over all of their lump sum distributions at job change.
With respect to fees, Ms. Holden testified that of the $3.6 trillion in IRA assets at year end 2008, 45% were in mutual funds, 9% was invested in annuity products, 11% in bank deposits and 36% was invested in non-mutual fund investment through brokerage accounts. Within mutual funds, stock funds represent the bulk of money in IRAs with 68% of mutual fund assets held in stock funds. While it is not possible to estimate average expenses and fees for all IRAs, Ms. Holden was able to speak about expenses for mutual funds for the variety of expenses that are attributable to IRAs. The Average Expense ratio in 2008 for IRAs invested in stock funds was 0.82%. which is lower than the industry average of 1.44% for all stock funds. With respect to bond funds, IRA bond fund investors incurred an average expense ratio of 0.60% compared with the industry wide 1.06% simple average. Finally, for IRA owners owning money market funds, their average fund expense ratio was 0.46% compared with an industry wide simple average money market fund expense ratio of 0.55%.
Laura Gough, Robert W. Baird, on behalf of SIFMA
Ms. Gough's testimony reinforced the role that employer sponsored retirement plans play in providing retirement security and expressed the view that these are the best way to provide retirement benefits to American workers. She stated that there is a need to enhance our voluntary retirement system to encourage retirement savings. Ms. Gough also expressed the view that IRAs play an important role in preserving assets for retirement.
Expanding pension coverage, particularly among small employers, requires the attention of policymakers. Ms. Gough noted that the SIMPLE IRA responds to the needs of many small employers who are looking for flexibility and are concerned about administrative burdens and liability concerns. She added that some adjustments to SIMPLEs can make them have even more appeal. She suggested increasing the maximum contribution up to elective deferral limit of 401(k) plans. Since employers are required to either match employee contributions or make a non-elective contribution with immediate vesting, the small business owner who offers a SIMPLE is providing employees a plan that could potentially exceed the benefits offered by a business with a 401(k) plan. So, there is no reason for the limits not to be the same.
With respect to IRAs, Ms. Gough testified that IRAs provide many retirement security benefits. They assure portability and provide a way to save for retirement for those without plans. She provided Bureau of Labor Statistics data showing that the average worker's tenure on a job is about 4.1 years. For younger workers the average tenure is shorter. Workers who leave their job have three options regarding their assets in a defined contribution plan. They can leave their money in the plan, roll it over to an new employer's plan or IRA, or take the distribution in cash. The actual decision about how to handle the assets is unique to individual participants. There is no "one size fits all" answer.
According to Ms. Gough, there are benefits to rolling money to IRA vs. maintaining multiple accounts in employer sponsored plans even despite the lower fees in plans. For example, guaranteed lifetime income distribution options might not be available in plans. To help participants deal with these decisions Ms. Gough testified that SIFMA believes that participants should have access to quality information about their options and the best way to deliver this information is by a face to face meeting with a knowledgeable financial expert. She further testified that this is not a common occurrence today and that when this advice is made available, employers carefully choose investment advisors. In these situations, advisors generally view employers as the client and "cross selling" is often not conducted as advisors would not want to risk the losing the employer as a client in order to market the firm's other services.
William Scogland, Jenner & Block LLP
Mr. Scogland focused on describing the limits fiduciaries face in providing information and advice to former employees regarding their investments in qualified plans. Mr. Scogland began by discussing the current disclosures that a plan must make to retiring participants before their money can be distributed or rolled into an IRA. Before a qualified plan can distribute participants' immediately distributable accrued benefits, the plan must provide a notice informing them of their right to defer receipt of distribution. The plan may make a distribution only after the participant consents. Regulations proposed by the IRS would expand these notice requirements, obligating fiduciaries to provide information about the benefits and detriments of keeping balances in the plan. However, the regulations do not permit fiduciaries to make recommendations as to a participant's best courses of action without the risk of potential fiduciary liability.
The Code also requires plans to give participants the option of rolling over their money when they leave employment, including rollovers to IRAs. Under Code Section 402(f), for eligible rollover distributions, the plan administrator must provide the participant with written notice explaining the options available. If proper notice is provided under this section, the plan administrator can create a default plan procedure that will automatically treat the participant as having made a direct rollover election if the participant is eligible for a rollover distribution but fails to make an affirmative election requesting or rejecting the rollover distribution.
Mr. Scogland discussed the limits on a plan fiduciary's ability to treat former employees' accounts differently than active participants' accounts. Treas. Reg. Sec. 1.411(a)-11(c)(2)(i) states that "consent [for purposes of Code Section 411(a)] is not valid if a significant detriment is imposed under the plan on any participant who does not consent to a distribution." In IRS Announcement 95-33, the IRS cited examples of impermissible significant detriments. While there are limited circumstances where plans can treat former employees' accounts less favorably than those of active employees, these examples indicate that it is impermissible to place restrictions on former employees that make it difficult for them to leave balances in the plan.
Mr. Scogland discussed bounds of a fiduciary's ability to advise former employees about post-termination investment options. While there is very little relevant authority in this area, the DOL has provided guidance for determining whether conduct amounts to "investment advice" that may rise to a fiduciary level. In a non-exhaustive list, the DOL determined that distribution of the following types of materials does not amount to investment advice: (1) materials that provide plan information, (2) general financial and investment information, (3) asset allocation models, and (4) interactive investment materials.
This guidance indicates that materials would not qualify as mere educational materials (and would qualify as investment advice) if they provide specific recommendations as to the proper type of investments for retiring participants. Additional authority suggests that the provision of such advice by fiduciaries will likely expose them to fiduciary liability. For example, if a plan administrator recommended that participants leave their money invested in the plan as opposed to taking a distribution, the administrator would likely be engaging in fiduciary activity and be liable as a fiduciary. The same result is likely where the fiduciary's suggestions favor certain types of investment options. While the fiduciary can and should describe risks posed by various options, the fiduciary should avoid suggesting to the retiree which options are best.
Anna Rappaport, Anna Rappaport Consulting
Anna Rappaport is an actuary, consultant, author, speaker, and recognized expert on the impact of change on retirement systems and workforce issues. She previously was at Mercer Human Resources Consulting, where she retired in 2004. Ms. Rappaport emphasized that the employer system is voluntary. The employer system has resulted in retirement benefits and savings for millions of people who would not have anything beyond social security without employer plans. Auto enrollment and default investment options in particular have improved the system. Ms. Rappaport believes that the current voluntary system should not be re-designed completely, but could be improved.
In re-designing the system, the DOL could play a leadership role in development of ideas and promotion of legislation. To unify and rationalize regulations would be important for the long-term to try to make things work more smoothly. To this end, Ms. Rappaport recommends a National Retirement Policy to develop a coherent policy.
She emphasized the need for long-term thinking in focusing on whether the amount plan participants save will be enough. Participants should be encouraged to think about whether a defined contribution account will generate a sufficient annuity amount. Also, about 4 out of 10 Americans retire before they want to retire, so that proper planning doesn't always work.
She believes that 401(k) plans could be re-designed to offer not only guaranteed income products, but also other features such as risk pooling, survivor protection, inflation protection, supplemental health insurance, long term care benefits, or other benefits. Also, minimum distribution rules should be re-considered. She suggested addressing the issue of spousal rights in primary defined contribution plans and individual retirement accounts.
Ms. Rappaport believes that defined benefit plans can be re-designed to be more attractive to employers with a goal of broader coverage. Allowing more employee contributions would help with risk pooling. Plan sponsors should have a choice of offering a guaranteed investment income. One model that would be worth a re-study are participating deferred annuity contracts that guarantee a modest benefit and increase the benefit in the event of good experience. Multiemployer and collective models are also good models.
Ms. Rappaport discussed the importance of the 28 million Americans who are un-banked and the 45 million who are under-banked. Until these people are connected to the mainstream financial system, she said it is unrealistic to expect that they are going to be covered by 401(k) plans, IRAs, or pensions.
Barbara Marder, Mercer
Ms. Barbara Marder is a worldwide partner in the Baltimore office of Mercer. Ms. Marder works with a team of defined contribution consulting specialists across the globe and, as a leader of the International Benefits group, she consults on global benefits issues. Ms. Marder addressed the issue of what we can learn from retirement systems outside of the United States, focusing on the retirement systems of the United Kingdom (UK), Australia, and Switzerland.
Ms. Marder said one of the biggest trends is the introduction of personal account systems. Countries are looking for new and interesting ways to encourage supplementary savings. In response to the financial crisis, some countries relaxed mandatory contributions and others freed up "locked" monies, such as allowing people to use retirement savings for pre-retirement expenses.
A Mercer study found that fewer than one-third of all employers offer defined benefit plans to new employees, while ninety-one percent of the companies that responded offer defined contribution plans to new employees. Globally, she sees heightened interest by governments and employers in providing financial education and advice. Australia offers one-on-one financial planning, whereas in other countries there is less involvement with each participant.
In discussing the UK retirement system, Ms. Marder noted most defined benefit plans are already closed. On the defined contribution side, the United Kingdom has two systems: (1) trust based, similar to employer plans in the U.S., and (2) contract based, which is similar to the U.S. retail market. There are required contributions of about 8 percent of pay and no access to money pre-retirement. The UK mandates annuity purchase with retirement savings by age 75.
Australia recently instituted a 9 percent mandatory retirement savings contribution to complement a very low state retirement income payment. The government is reviewing whether 9 percent is enough. The mandatory contribution has increased coverage significantly, up to 92 percent of workers. Employers in Australia has no meaningful role in the retirement system. Contributions are mandatory and employees have complete choice of where they direct their money, though employers might pick a provider for their DC plan or trust.
Switzerland uses a shared risk model. All the pension funds are separate entities from the employers and are administered by boards that are run by both employers and employees. The law requires some minimum level of benefits. Typically, it is now a cash balance type concept. The government mandates a specific interest rate to be credited to the accounts. They also specify conversion rates of the lump sum to an annuity. The plans typically are funded by both the employer and the employee. It is common to provide some type of profit sharing, so employees actually share an up side risk, gaining distributions of reserve excesses. In down years, the boards reduce benefit accruals to give time for the funding position to recover.
Ms. Marder concluded that the best retirement systems are simple, have predictable costs, and are transparent have a lot of merit. Considerations of individual property rights versus collective ownership should be taken into account. Compulsory savings should be considered, or soft compulsion through auto enrollment features.
Michael Sullivan, Sheet Metal Workers' International Association
Michael J. Sullivan is the General President of the Sheet Metal Workers' International Association and Vice President of the AFL-CIO Executive Council. He directs 157 local unions throughout the U.S., Canada and Puerto Rico with 150,000 members who provide skilled services to sheet metal and air conditioning, kitchen equipment, transportation and other related manufacturing and services industries. Mr. Sullivan has served in union leadership for over thirty five years and during this time, has been a trustee on many pension and welfare plans.
Mr. Sullivan does not believe that defined contribution plans provide retirement security. Instead, it is clear to him that defined benefit pension plans play a critical role in reducing risk of poverty and hardship among older workers. Mr. Sullivan also indicated that retirees can help pay for the economic resources and health care system costs that will add to financial security for American workers, if they, themselves have financial security. His belief is that more retirees equal more tax payers, so legislators need to make sure that workers have some wealth to help create and sustain retirement security.
Mr. Sullivan remarked that crisis begets legislation, especially with respect to pensions, and he does not believe that this type of rulemaking process is effective. He also believes that it is time to overhaul the entire pension system. He further stated that a solution to the nation's pension woes cannot be fixed in the short term by Congressional action. He further stated that the national retirement policy has veered in multiple directions, depending on the crisis at hand, with Congress sometimes simultaneously expanding and contracting benefits.
Instead of short term solutions that will only stand until another legislative effort comes along, Mr. Sullivan proposed that the Department of Labor and/or the President of the United States should convene a panel of experts to marshal research and make recommendations to elected officials. He believes that the problems with the pension system are complex but not insoluble and any solution requires careful thought and analysis, with input from many diverse sectors of the economy.
His proposed DOL or Presidential commissioned panel of experts would:
During the Q&A, Mr. Sullivan remarked that,
Steve Abrecht, Service Employees International Union (SEIU)
Steve spoke on behalf of the Service Employees International Union (SEIU). SEIU covers service workers, including lower wage janitorial and health service workers. DB Plans cover about three-quarters of SEIU members who have retirement coverage. About 60% of DB Plans covering SEIU members are in critical, endangered or at risk status under the PPA. These funding challenges arose despite the fact that the funds followed ERISA's dictates religiously. The risky, unchecked behavior in financial markets is at the root of funding problems. This is intolerable as 70% of benefits paid come from investment returns. No funding reforms will make any difference unless financial markets and financial professionals have integrity and accountability. Financial industry reform and re-regulation is critical to foster sustainable, predictable long-term returns and an end to boom and bust cycles, which make funding impossible.
Given the destruction wrought by financial professionals, many employers and employees conclude that retirement saving is futile if financial markets can erase assets so recklessly. He commends Congress and the Administration for seeking regulatory reform.
He notes that DB consistently outperform DC plans and that low wage workers do not have sufficient pay for DC plans. He supports the principles developed by the Retirement USA Coalition for secure retirement which include:
Jason Tyler, Ariel Investments and Alison Borland, Hewitt
Jason Tyler is a Senior Vice President of Ariel Investments, a 26 year old investment firm based in Chicago. He manages operations for Ariel's research department. Alison Borland is a Retirement Strategy Leader at Hewitt Associates. She serves as spokesperson for Hewitt on retirement issues, primarily defined contribution issues. They testified together on the same panel.
Ms. Borland divided her testimony into two sections, both which include short term actionable recommendations to improve the U.S. retirement system. The first focused on asset leakage in the current system, or taking funds out of retirement savings prematurely for loans, hardship withdrawals, or when changing jobs. She said the number of participants with loans is increasing, more than one-fourth of employees who leave a plan fail to repay their loan, and the risks are even higher for minorities. Ms. Borland recommended (1) making loans portable and encouraging employees to roll over their 401(k) loans to another plan or an IRA and continue loan repayments, (2) extending the "cure period" for loans at termination of employment upon involuntary termination, (3) encouraging plan sponsors to allow loan repayments after termination, and (4) placing restrictions on other in service withdrawals before age 59.5. She urged limiting the availability of hardship withdrawals while providing more flexibility to participants to re-contribute the withdrawal amounts. Ms. Borland called for reforms on administrative fees to reduce the contribution of those fees to leakage. Those reforms could include: (1) mandating complete fee transparency in 401(k) plans, (2) requiring disclosure of rollover opportunities and additional revenue sources, and (3) asking the Department of Labor to provide general education for participants and encouragement to plan sponsors to communicate the potential risks of moving into a retail environment (IRAs) from a qualified plan environment. She also described six recommendations to make defined contribution plans more feasible long term retirement savings vehicles for U.S. workers.
Finally, she indicated that legislators, regulators and plans sponsors have opportunities to make changes to eliminate existing barriers to improving plan utilization and add opportunities for increased savings.
Mr. Tyler described his firm's joint study, in partnership with Hewitt Associates, of 401(k) plan disparities among African-Americans, Asians, Hispanic, and whites. The study examined 401(k) data as of December 2007 for nearly 3 million eligible employees, including race, ethnicity, gender, age, salary, job tenure, and other account information. The study showed race and ethnicity were the dominant factors in determining the outcome of an individual's 401(k), with meaningful differences in African-American and Hispanic participation rates, contribution rates, loans, and early withdrawal statistics compared to their white and Asian counterparts. He attributed the differences to several factors, including knowledge levels, trust of the financial system, and misinformation. Mr. Tyler recommended the following: (1) encourage employers to voluntarily collect and report their 401(k) plan data by race and ethnicity of participants, (2) modify loan terms -- e.g., longer repayment periods and portability of loans -- to decrease the likelihood of default when an employee terminates employment, (3) provide financial education as a mandated part of both public and private school curricula at all levels, (4) implement automatic 401(k) enrollment for all new employees, with default contribution levels that maximize the company match, and (5) provide retirement planning resources that incorporate different cultural perspectives.
Mr. McCaffrey asked for an explanation of the Ariel Community Academy, referred to in the testimony. Mr. Tyler explained it is a small public school in Chicago where the students are provided $20,000 for investments during their time at the school, to teach them financial literacy. He indicated that students learn financial literacy via unique financial curriculum that includes the opportunity to invest real money.
Ms. Dill asked what DOL can do to help plan sponsors communicate to minorities. Ms. Borland said plan sponsors have concerns with sharing data, so the DOL could contribute by removing barriers to getting more data that would help in the development of effective communications. Mr. Wiggins followed by asking if the recommendation is for DOL to collect the data. Ms. Borland said that would make the data comprehensive and consistent. Mr. McCaffrey asked what are the obstacles to allowing rollovers of 401(k) loans. Ms. Borland said clarifying some rules and extending the length of the re-payment period would help. Mr. Koeppel said loans now are re-paid through payroll deductions and that providers are not able to handle re-payment checks.