Should Feds Rescue Retirement System, Too?

Shrinking private savings plans and shaky pensions equal tougher future for millions.

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Even before the recent collapse of investment values, the paltry sums in private retirement accounts caused concern if not alarm among pension and retirement experts. Now, the wolf is not only at the door but in the room, and is devouring what little remains of the financial future of millions of Americans.

Pretty much all of Washington is shoveling hundreds of billions of dollars to shore up the nation's financial system and restore liquidity to the global credit system. And there is growing if belated support for providing direct aid to millions of homeowners who otherwise can't afford to stay in their homes.

But while these concerns are front and center, there's been little but hand-wringing when it comes to the huge losses suffered by individual retirement accounts, what's left of traditional private defined benefit pensions, and state and local retirement programs.

The scale of the problem is illustrated by two sets of some pretty scary numbers.

A briefing paper put out recently by the Center for Retirement Research at Boston College estimates the declines in the nation's private investment holdings from the peak of the stock market in October of 2007 to its low point a year later.

Using the Wilshire 5000 index, a broad measure of the stock market, the Center applied its steep 42-percent drop across the various categories of retirement accounts and concluded that we have lost nearly $10 trillion in the past year—to $13.6 trillion from $23.5 trillion.

IRAs and 401(k) plans went to $2.7 trillion from $4.7 trillion. Defined benefit plans (remember them—the "safe" harbor of retirement income?) went to $2.6 trillion from $4.4 trillion. Household investments in the market went to $5 trillion from $8.5 trillion and corporate equities owned by other institutions and foreign residents fell to $3.4 trillion from $5.8 trillion.

Some pension plans are worried about being forced to sell part of their holdings for huge losses in order to have enough cash on hand. State and local pensions, already short of being fully funded, have fallen much further from self-sufficiency. They are or will be seeking higher contributions from governments that are already making deep budget cuts because of the recession.

While market values will recover over time, people who need access to their retirement funds in the near future do not have that time.

Alicia Munnell, director of the center, says in an interview that "people are really alarmed at the amount that has been lost" and questions the fundamental role of self-directed retirement investments. "It's so clear that the 401(k) system doesn't work," she says. "You just can't expect people to run their own retirement system."

Many other experts agree, pointing to overwhelming evidence that people invariably don't take full advantage of the plans, make inappropriate investment choices and then, when times are tough such as today, tend to panic and sell at or near the bottom of the market.

The second set of numbers, which you can see below, shows the sources of retirement income relied upon by people 65 and older. It's compiled from annual projections by the Employee Benefit Research Institute. Social Security provides roughly 40 percent of retirees' income, which is scary in its own right, but a truer state of our retirement system appears when you look at these numbers by income level, which EBRI does.

Sources of Retirement Income People Aged 65+ (Percentages)
  Total Bottom
Social Security 38.6 88.7 88.7 75.3 46.3 17.2
Pensions and Annuities 18.6 2.6 3.5 10.6 25.8 21.0
Income from Assets 15.6 4.4 4.5 7.2 10.3 21.8
Earnings 25.3 1.8 2.4 5.7 15.1 38.1
Other 1.8 2.6 1.0 1.3 2.4 1.8
Source: Employee Benefit Research Institute estimates of data from Current Population Survey, U.S. Census

Social Security, it turns out, provides more than 75 percent of retirement incomes for 60 percent of Americans, and more than 88 percent for the bottom two fifths of retired people.

"Social Security is going to have to go back to its origins," says Gail Buckner, financial planning spokesperson for Franklin Templeton Investments. "It was never meant to provide 40 percent of someone's income" let alone nearly 90 percent.

Of course, that $10 trillion drop in equity values will further increase at least proportional reliance on Social Security in the short run. Wealthier Americans—the folks in the top two tiers of the EBRI income table—are the main victims of the market decline.

"We need a retirement system that is automatic and mandatory," Munnell says, and this will require a "new and additional tier" of retirement savings, probably with heavy government support and mandates.

"Before this crisis, my thinking was that we were going to need a large group of people to suffer in retirement" to generate support for such changes. "Unfortunately, I think this crisis will really accelerate the process."

I will be writing a lot about these issues so please weigh in with your own concerns and recommendations.