Is the U.S. Saving Enough for Retirement?

by George F. McClure

Historically, retirement income has been described as a three-legged stool — the three parts being a drawdown of personal savings and investments (which may include IRA assets and rollovers from defined contribution (DC) plans such as 401k and 403b plans), a corporate pension, and Social Security. For most people with pensions, Social Security is the least of these, but there is more talk about the three-legged stool recently, as a result of the president’s push for personal savings accounts as a future component of Social Security for younger workers.

With the decline in the number of traditional employer-maintained defined benefit (DB) pension plans, more workers will be largely dependent on personal savings for the major part of their retirement income. There were 19 percent fewer DB plans in operation in 2002 than in 1999 [www.mercerhr.ca].

Defined benefit pension plans — the gold standard

Since 1985, the number of DB plans insured by the U.S. Pension Benefit Guaranty Corporation (PBGC) has declined from 114,500 to less than 32,000, a 72 percent drop [www.mmc.com]. The number of retirees drawing a corporate pension now is about 44 million. The advantage of a lifetime pension is that you can’t outlive it. The disadvantage is that it is based on your income level while working (either final average pay for traditional defined benefit plans, or career average pay for the cash balance plans increasingly being adopted in their place) [www.pueblo.gsa.gov/]. Very few corporate DB plans have any upward cost of living adjustment in retirement, although many government pensions and Social Security benefits increase with the cost of living.

The sharply rising cost of health care, not foreseen a decade ago, also impacts family budgets, especially for retirees not yet eligible for Medicare where the recipient pays only a quarter of the cost, through the Part B premiums. To be prepared for this in retirement, a higher rate of personal savings would seem to be prudent. Yet, the U.S. personal savings rate had fallen in November 2004 to only 0.3 percent of disposable household personal income [The historical average is eight to 10 percent www.bea.doc.gov].

United States at the bottom in savings rate

Long-term comparisons of the household savings rate of the euro area, Japan, and the United States reveal that, although all three have been trending downward, the savings rate in Japan is double that for the United States, while Europe saves four times as much as the United States [Chart 3 at www.oecd.org].

Critics of the calculated savings rate, obtained by subtracting consumption from disposable income, point out that growth in value of owned assets, including retirement accounts and housing, is ignored in this statistic, as are employer contributions to retirement savings. The argument is that downsizing housing in retirement would free up the buildup in value of the larger home, upon sale, to add to other retirement assets. The counter argument is that the sharp rise in real estate prices in the past decade cannot be sustained, as interest rates rise, and that this level, as well as the returns from equities, that had averaged 14 percent before the last recession, will not be sustained in the next decade.

The increase in spending during the economic recovery, since the trough of November 2001, has been at triple the rate of increase in private-sector wages and salaries. This spending may have been financed in part by taking out home equity in refinancing or new loans, thereby reducing the net value of the asset available to cash-in during retirement.

Wages and salaries in the United States as a percentage of the Gross Domestic Product are currently at their lowest level in decades, yet consumer spending relative to GDP is at a record high, according to The Economist. [www.economist.com] Rising home prices are a wealth illusion, since they do not increase the economy’s productive potential, or raise expectation of future higher profits. Some worry that if all the baby boomers start selling their big houses and trading down, the glut of big houses on the market could depress prices and cut into the net assets gained for the retirement nest egg.

Incentives to increase saving

The lowest income workers have the hardest time accumulating retirement savings, and those workers are least likely to be participating in DC plans. Some are covered under DB plans under union contracts. One incentive that the Democrats proposed during the 2000 presidential election campaign was a matching program, where the government would use tax revenues to match worker contributions to a 401k-type retirement account up to three dollars for every dollar of worker contribution [www.cato.org].

Gene Sperling, of the Center for American Progress and a former Clinton economic adviser, recently offered another savings incentive for low-income workers. He calls his plan a flat tax incentive for retirement savings based on a portable and continuous “Universal 401k Plan." He would have a two-to-one match for those in the 15 percent tax bracket, so that they would be credited with a $2,000 contribution by contributing $667 of their own money. Some higher-income savers would get a one-to-one match and everyone would get a 30 percent refundable credit for retirement saving. He figures this would get 50 million more people saving for retirement. He would pay for it with a 3 percent surcharge on taxes on estates above $5 million to $7 million. Each year, Sperling says, there would be about ten thousand estates facing this tax, and each would fund matching incentives for about five thousand new savers. [Video, after Dean Baker, or click on Gene Sperling at www.americanprogress.org or go to www.cepr.net/ and click on “Dean Baker on C-SPAN”.]

Employer incentives proposed

What else could be done legislatively to improve the outlook for retirement savings? Testimony before the House Committee on Education and the Workforce in February 2004 by the CEO of Mercer Human Resource Consulting included the following recommendations to improve incentives for employer-provided pensions plans:

• Provide a 50 percent tax exclusion on DB plan retirement benefits taken as lifetime annuities, to discourage lump-sum payouts. 401k and other DC plan proceeds transferred to DB plans and paid out as annuities would also qualify for this tax exclusion.

• For overfunded DB plans, permit employers to use a portion of the excess assets without penalty to fund retiree health benefits and required employer contributions to DC plans.

• Increase the ratio on the annual dollar limit to benefits under a DB plan and the limit on contributions under DC plans. The ratio has been four-to-one since 1987. A ratio of five-to-one or six-to-one would provide added incentive to employers and their senior executives to maintain DB plans.

• Provide income or employment tax relief to employers that maintain DB plans that go beyond current law in providing additional benefits. Mercer maintains that this would reduce the pressure on Social Security and other government programs [visit www.mercerhr.dk and click on McCaw for a PDF of testimony].

Are you saving enough personally?

How does your own retirement saving program stack up? Various Web sites provide calculators that enable you to compute both the savings rate you need to afford a comfortable retirement and the prospect, given a specific nest egg in retirement, that you will outlive your assets. For examples, see:

• www.kiplinger.com/columns/ask/archive/2004/q0730.htm
• www.smartmoney.com/retirement/planning/index.cfm?story=intro
• http://planning.yahoo.com/?quicken=2
• http://www3.troweprice.com/ric/RIC/?scn-%22How_Much_to_Sa$rfpgid-7391

A retirement planning briefing found at www.unf.edu/~cfrohlic/Community.htm provides useful information, but you will note that IRA contribution limits have increased since it was prepared.

George McClure is chair IEEE-USA's Communications Committee, a member of the IEEE-USA Career & Workforce Policy Committee, and technology policy editor for IEEE-USA Today’s Engineer. Comments may be submitted to todaysengineer@ieee.org. Opinions expressed are the author's.