“The Wobbly Stool: Retirement Insecurity in America” by Ross Eisenbrey

Reference: Economic Policy Institute

October 7, 2010

Good morning, Chairman Harkin. I am Ross Eisenbrey, Vice President of the Economic Policy Institute. EPI is a non-partisan think tank with a long history of analyzing trends in employment, compensation, and income, as well as advocating for policies to ensure shared prosperity. We are founding members of two important coalitions: Retirement USA—28 organizations advocating for a retirement system that delivers universal, secure, and adequate retirement income—and Strengthen Social Security—a coalition of more than 150 organizations who feel strongly that Social Security benefits should not be cut and the retirement age should not be raised. Today, however, I speak only for myself.

Polls show that Americans are scared about their retirement. In a recent Gallup poll of people ages 44 to 75, more than 90% said we are facing a retirement crisis, and 61% said they fear depleting their assets more than they fear dying. Unfortunately, they have good reason to be scared.

According to the Center for Retirement Research, American households ages 32 to 64 currently have a retirement income deficit of $6.6 trillion, a figure that dwarfs the federal deficit and casts a pall over hopes of them retiring in any kind of comfort. That is how far behind they are in building sufficient pensions and private savings to maintain their standard of living in retirement. This sum comes to $90,000 per household, on average, which means these households have about half of what they need in retirement savings.

I have three main points to make in this testimony today:

1. Congress has made matters worse by focusing retirement policy on high-income households and neglecting low-income workers;

2. Congress and the Obama Administration will make matters even worse if they raise the Social Security retirement age; and

3. There are potential solutions to the retirement crisis, but tweaks and small changes at the margins won’t be enough.


1. Congress has made matters worse by focusing retirement policy on high income households and neglecting low-income workers.

The median household income of seniors in 2008 was less than $30,000, about half that of households under 65.

While nothing to tout, the financial situation of seniors today might be as good as it will ever get for the typical American. Between declining pension coverage and Social Security cuts, it is possible that the next generation to retire will be the first to be worse off than its predecessor.

The surest vehicle for retirement savings (other than Social Security) has been the traditional defined-benefit pension, which is disappearing. Almost from the day in 1978 that Congress created an alternative savings vehicle, the 401(k) plan, employers have been shifting employees out of pension plans and into these accounts that put all of the risk and more of the cost onto the backs of individual workers. Only about one private sector employee in five is still covered by a real pension plan.

Traditional pension plans are pooled investments, managed by professionals, and spread risks over many years (even generations), while 401(k) participants must make their own investment decisions and bear the risk of adverse investment performance. But most 401(k) participants do not have the financial expertise to manage their investments. Many fail to diversify sufficiently and often make poor investment decisions. They tend to have an all-or-nothing approach to risk, and despite the lessons of Enron, many still have funds invested in employer stock.

Luck plays an oversized role in whether retirement savings in personal accounts will be adequate. Even 401(k) participants who make relatively conservative investment allocation decisions over a long time horizon are subject to unacceptable risks. Gary Burtless of the Brookings Institution has estimated that 401(k) participants who contributed 4% of her wages over 40 years and invested the funds in a portfolio split equally between long-term government bonds and stocks would be able to replace a quarter of their pre-retirement earnings if they retired in 2008. This replacement rate is only half as much as a similar worker who retired in 1999, but much better than a worker who retired in 1974, who would have a dismal replacement rate of only 18%.

Another key risk—one the Gallup survey identified—is longevity. A real pension guarantees a monthly payment for a lifetime, whereas retirees can and do outlive their 401(k) assets.

And finally, the fees associated with 401(k) plans can decimate long-term returns. The Center for Retirement Research estimates that net investment returns were a full percentage point higher for defined-benefit pension plans than for 401(k)-type defined-contribution plans between 1988 and 2004, despite a lower concentration of funds invested in equities. With compounding of the returns on the investment, this small-sounding difference can translate into a 30% larger nest egg at retirement.

The end result of the shift from secure pensions to insecure 401(k)s and Social Security cuts can be seen in the following chart, which presents the likelihood of inadequate retirement income for three successive generations, each with a smaller share of pension coverage than the generation before.

I hope this committee will recognize that the retirement income deficit we are leaving for the Gen Xers is at least as serious as the “burden of debt for our grandchildren” that gets so much attention in the media and in political debate.

How can it be that after 32 years and trillions in tax subsidies, 401(k)s have worsened—rather than improved—retirement security? First and foremost, the design of the 401(k) ensures that its tax subsidies go disproportionately to high-income earners who least need the government’s help in saving, while providing little or nothing to low-income earners, many of whom struggle to meet their daily expenses, let alone save for a distant retirement.

The Urban-Brookings Tax Policy Center estimates that 80% of the tax subsidies for retirement savings go to the top 20% of earners. This is government welfare stood on its head. There is no rationale for providing a larger tax break to a millionaire than to a Wal-Mart cashier for the same dollar contribution to a 401(k) plan (and nothing at all if the cashier owes payroll but not income tax). Similarly, high earners receive more help from employers, who contribute 5% of earnings, on average, to the retirement accounts of households in the 75th percentile, compared with less than 2% for those at the 25th percentile, according to the Congressional Research Service.

Rather than continue to make this situation worse by increasing the 401(k) contribution limits, which benefits only the highest earners, Congress should re-structure the tax subsidies to ensure that they help everyone save for retirement and provide no greater aid to the upper class than to the working class. One common sense improvement would be to change the current system of deductions into tax credits and make them refundable. But bolder steps are called for.

The system of relying on tax subsidies to expand the employer-based retirement system has proven a failure. Only about half of all private sector workers in the United States between the ages of 25 and 64 participate in a retirement plan—and participation is much lower for blacks and Hispanics. Despite rising enroll ment in 401(k)s, this figure has remained essentially unchanged for 30 years because employers have simply replaced traditional pensions with 401(k) plans.

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Ross Eisenbrey

Vice-President, Economic Policy Institute