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Financial Crisis Sparks New Debate on Retirement Benefits

By Bill Leonard  10/10/2008
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The U.S. financial crisis has hit participants of defined contribution plans hard—to the tune of $2 trillion in losses in the months preceding October 2008, according to some estimates. The impact has been so severe that polls show many workers who are 45 and older now believe they will have to delay their retirement plans for several years.

The crisis has renewed debate on Capitol Hill on how to ensure U.S. workers are saving enough for retirement, and how to guarantee that they have enough money to retire comfortably. The full House Education and Labor Committee met on Oct. 7, 2008, to examine the security of retirement savings and pension plans following passage of the massive $700 billion mortgage bailout and economic recovery bill.

The committee meeting was one in a series of oversight hearings requested by House Speaker Nancy Pelosi, D-Cailf., to investigate the causes and impact of the ongoing financial crisis.

“Unlike Wall Street executives, American families don’t have a golden parachute to fall back on,” said Committee Chair Rep. George Miller, D-Cailf. “It’s apparent that Americans’ retirement security may be one of the greatest casualties of this financial crisis.”

The average participant in an employer-sponsored 401(k) or other defined contribution plan has seen 20 percent of the value of their account balances evaporate since mid-2007, according to testimony from Peter Orszag, director of the Congressional Budget Office. The individual account losses have helped erode the confidence of workers that they will be able to pay for basic necessities like food, health care and housing when they retire. These losses could continue to reverberate through the economy and make an already bad situation worse, Orszag told the committee.

Delayed Retirements

“To the extent households view balances in defined contribution plans as part of their overall portfolio of wealth, a decline in those balances could lead people to reduce or delay purchases of goods and services,” Orszag said. “The current problems could also lead some workers to delay their retirement.”

An AARP survey released the same day as the hearing supported Orszag’s assertions. The survey examined the retirement plans and situations of U.S. workers 45 and older, and the AARP researchers found that:

  • One-third of the respondents said they would now have to delay their retirement by at least three years.
  • One-fifth reported that to help make ends meet they had stopped contributing to their retirement savings accounts.

Frightened Participants

While defined contribution plans have worked well in getting workers to start saving for retirement, the stock market's downturn and the investment risks associated with 401(k) plans has frightened many plan participants.

“Given that most 401(k) participants are not investment experts, there is a danger that many of them will overreact to this market downturn—I want to caution against this,” said Jerry Bramlett, president and CEO of BenefitStreet Inc, a retirement benefits consulting group. “For participants with still many years to retirement, a drastic abandonment of equity positions in their retirement account will only serve to lock-in as of yet unrealized losses.”

The hardest hit by the downturn are older workers who are just five years or less away from retirement, he said. Bramlett and others testifying at the hearing told the committee members that it could take at least three years and maybe even five to recover the recent losses in the average 401(k) accounts.

“It could take three years to recover but that’s assuming the market stabilizes soon and there aren’t further declines,” Bramlett said. “Further drops in the market will add more time for a recovery.”

Wanted: Better Advice

The lack of financial advice available to participants only has served to exacerbate the situation. For example, instead of diversifying their retirement portfolios, when stocks were surging many 401(k) participants allocated the majority of their account balances into higher risk stocks, according to Orszag.

Even worse, “Research has found that one in 15 workers with 401(k) plans have 90 percent or more of their 401(k) investments in their own employers’ corporate stock,” Orszag said.

The witnesses testifying at the hearing agreed that many 401(k) participants did not understand investment options and were not receiving information or investment guidance that they need.

Rep. Rob Andrews, D-N.J., said workers were clearly at a loss at what to do and did not know where to turn. He also felt that employers had not lived up to their fiduciary duty in providing retirement savings plan participants with the investment advice and information that they needed.

“This is not a blip but a fundamental change in our financial system, and Congress must be prepared to help American workers save for their retirement years,” Andrews said. “It is clear to me that the wild, wild, west of investing in defined contribution plans is not working and must change.”

Alternative Approaches

Teresa Ghilarducci, a professor of economic policy at the New School for Social Research, agreed with Rep. Andrews and said alternatives to defined contribution plans are needed now. She argued that retirement accounts providing participants a guaranteed rate of return would be preferable and more stable than current savings vehicles.

"As Congress reacts to the modern financial order changing forever, we should also realize that individual retirement plans based on that financial order have also changed forever,” Ghilarducci said. She made a bold proposal, asking that Congress pass legislation creating retirement accounts that are comprised of government bonds and guaranteed to earn 3 percent return—which would be adjusted for inflation. (In comparison, over long-term periods of 10 years or more, stock investments—despite their ups and downs—have historically averaged around 7 percent annualized returns.)

“The guaranteed retirement accounts would also end fruitless discussions with brokers and financial sales agents, who are also desperate for more fees and are often wrong about markets,” Ghilarducci contended.

While no one on the committee appeared eager to adopt Ghilarducci’s proposal, several committee members and hearing witnesses did agree that retirement plans needed to offer broad-based coverage for all workers and provide secure sources of income for retirement.

“It’s important to realize that there are already retirement plans in the United States that meet most of these criteria. In particular, defined benefit plans that provide retirement benefits to employees of state and local governments typically meet most criteria for a model retirement system,” said Christian Weller, an associate professor of public policy with the University of Massachusetts Boston.

More Oversight

Weller told the committee that better or professional management of assets for retirement plan participants, lower cost fees and more transparency were needed to reform the system and ensure the retirement security of all U.S. workers. Committee Chair Miller agreed and announced that the committee would be holding more hearings in the future.

“I’m here to say right now, those days [of loose government regulation] are over,” Miller said. “We must have more transparency and better oversight in 401(k) investment practices. The Wall Street veil of secrecy must end.”

Bill Leonard is senior writer for SHRM Online.

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