Just Like Social Security, the Pension System Needs Fixing

As Congress gets ready to grapple with Social Security, let’s not ignore issues with private pensions.

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Returning Social Security to financial solvency is essential to restoring retirement security to millions of current and future retirees. But it's only part of the retirement equation. In many ways, Social Security is better off than the nation's private pension system. Fixing one without the other makes no sense.

The plight of traditional pensions—government and private defined benefit plans—has been extensively reported. Even before the market plunge in 2007 and 2008, many pension programs were projected to fall short of honoring their payment promises to retirees.

[See 10 Ways to Boost Your Social Security Checks.]

Corporations had been abandoning or freezing plans for years. Even with greatly relaxed rules that will give private plans additional years to regain funding adequacy, the federal Pension Benefit Guaranty Corp. is expected to get hit with additional plan terminations. It thus will assume the responsibility for making good on some portion of the payout obligations of terminated plans. No wonder the Obama administration has just asked Congress for permission to raise the insurance premiums that pension plans must pay to the PBGC.

Public plans also have taken an extended pounding because of the recession and prolonged weakness in government revenues. States and localities are being forced, at a minimum, to lower retirement benefits for new employees. Others are boosting employee contributions. The worst-off plans may be required to renege on some of the promises they've made to existing employees. The money is just not there.

Meanwhile, defined contribution plans—most commonly 401(k)s—have become the dominant private retirement program. Begun in the 1980s to replace traditional pensions, 401(k)s flew under the radar during the nation's bullish economic growth periods of the 1980s and 1990s. But in the decade that just ended, 401(k)s came under increasing scrutiny. Too few workers were using them, too few dollars were being set aside for retirement, and employee investment decisions were often not suited to the long-term retirement goals of the program. When people shifted jobs, they often cashed in their 401(k)s and spent the money.

[See 10 Retirement Issues That Are Here to Stay.]

Laws were passed several years ago to boost employee participation and improve investment decisions, and there is solid evidence that this is happening. But even with major tax breaks (Uncle Sam forgoes income taxes on earnings placed in 401(k)s and IRAs) it's become very clear that as many as half of all U.S. workers either don't have access to such plans at their companies, or simply can't afford to set aside funds in them.

Edward N. Wolff, an economist at New York University, recently studied private pension plans. He found that even before the market downturn, the amount of Americans' pension wealth had stagnated, especially among the older-age households that should have been doing the best job of preparing for retirement. Not surprisingly, pension wealth actually declined during the 2007-2009 period, Wolff found.

By the time the decade had ended, Americans had not increased their pension wealth or net worth at all. Lower-income households actually lost ground. "All in all, the decade of the 2000s (from 2001 to 2009) appears to have been a 'lost decade' in terms of household wealth," his research concludes.

Meanwhile, a recent Government Accountability Office study of private retirement accounts found that their benefits were skewed to higher-income households. They were much more likely to have 401(k)s and also put a lot more money into them. This is hardly surprising. The sustained stagnation in middle-class income has sapped the ability of many households to set aside retirement funds.

[See Public in Denial About Cost of Fiscal Fix.]

However, the public pays a high price for a defined contribution program in which only about half of all private employees participate—usually the higher-paid half. "Pension tax incentives are the second largest tax expenditure [in the federal budget]," the GAO report said, "and the associated income tax revenue losses are estimated to amount to approximately $105.1 billion in fiscal year 2011 and a total of $602.2 billion from fiscal years 2012 to 2016."

"A disproportionate share of these tax incentives accrues to higher income earnings," the report added. "While 72 percent of those who make tax-deferred contributions at the maximum limit [permitted by 401(k) rules] earned more than $126,000 annually in 2007, less than 1 percent of those who earned less than $52,000 annually were able to do so."

Despite the well-documented shortcomings of defined contribution retirement programs, they have succeeded in establishing themselves as the only affordable private retirement system.

The GAO reviewed a list of expert recommendations to boost retirement savings among lower-paid workers. Most would use the tax code to sweeten the appeal of retirement savings. For lower-income workers who don't pay much income tax in the first place, the most logical carrot would be tax credits.

Another approach would be to create a new layer of guaranteed retirement income in additional to Social Security. It would be funded by employee and government funds but, at the lower earnings levels, would likely need to rely extensively on government payments or tax breaks.

Support in Congress for another incomes-based spending program is non-existent, particularly when cutting the deficit has taken center stage. If deficit reduction measures do include major changes in the tax code, it's possible—but not very likely—that they would include retirement-income enhancements for lower-income American workers.

Twitter: @PhilMoeller