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The Washington Post: "Looking to Locate The Comfort Zone"

JULY 2005

Looking to Locate The Comfort Zone

Albert B. Crenshaw
Washington Post Staff Writer
1,988 words
24 July 2005
The Washington Post
Copyright 2005, The Washington Post Co. All Rights Reserved

In the late 1970s, the nation appeared to be getting many of the economic problems of old
age under control.

A 1974 revision of federal pension laws required that employers set aside and invest the funds
that would pay for pensions they promise their employees. A few years later, higher
withholding, a tweaking of eventual benefits and other changes seemed adequate to deal with
the Social Security system's problems for the foreseeable future.

Special tax-deferred arrangements were written into the tax laws to encourage workers to
save for themselves, strengthening the third leg of the three-legged stool -- company pension,
Social Security and personal savings -- that was the traditional image of a secure retirement.

None of it worked out the way planners intended, at least not in the long run.

Because of numerous loopholes, tightening the pension rules failed to eliminate underfunding
by many employers. But it did drive a lot of companies to terminate their pensions. In fact,
the special tax-deferred savings arrangements -- yes, those would be your 401(k) plans and
similar retirement accounts -- provided a seemingly painless way for employers to replace the
traditional pension, escaping the new rules and shifting the risks of retirement saving onto
their workers.

However, employees have not participated in their 401(k) and similar plans in the numbers or
at the contribution levels needed to make those plans effective providers of retirement
security.

And now, the problems with Social Security that policymakers deferred are no longer all that
far off.

"There's certainly a lot of gloom and doom to go around," said Olivia S. Mitchell, professor at
the University of Pennsylvania's Wharton School and director of its Pension Research Council.

Today, elected leaders, policymakers and private-sector experts are casting about for ideas
that will enable the coming generation of retirees to live in reasonable comfort but won't cost
so much that they bust the government and/or employers.

Major legislation is in the works to toughen the funding requirements on traditional pension
plans. A bill approved last month by the House Committee on Education and the Workforce is
awaiting action in the Ways and Means Committee, and Chairman Charles E. Grassley (RIowa)
of the Senate Finance Committee unveiled his version Friday.

However, those measures focus primarily on traditional pensions and the financial health of
the government agency that insures those plans. The agency, the Pension Benefit Guaranty
Corp., is facing a huge deficit after taking over a number of large pension plans from failed
companies in the steel and airline industries.

Getting considerably less attention are proposals for providing retirement security in an
environment where traditional pensions and Social Security count for less and less. While
numerous, most of the proposals being floated are variations on the "work longer, save more"
theme that runs through much expert thinking on retirement. And a number seem aimed at
benefiting financial services firms as much as retirees.

This distresses many experts, who note that in any saving program, time is key, and it cannot
be made up.

"Policymakers do not seem to understand that accruing retirement security is a long-term
proposition," said Sylvester J. Schieber of Watson Wyatt Worldwide, a benefits-consulting firm.
"Workers can't do it in the last decade of their working career."

As leaders continue to put off dealing with Social Security, workers retiring in 25 to 30 years,
when the program is forecast to run out of money, are already "pretty well into their career,"
Schieber said, and those affected by "the destruction of employer-based [traditional pension]
plans are much further along. We need to take a look at this and figure how to fix it."

Some experts say the lack of urgency stems from the fact that the retirement system that is
now breaking up performed so well in the past.

"In some ways, this is a golden age of retirement. People entering [retirement] now are fine.
They are not affected by the age increases in Social Security [eligibility]. They have
[traditional] pensions that pay them a regular monthly check. . . . They have also just enjoyed
a big run-up in their house value," said Alicia H. Munnell, director of Boston College's Center
for Retirement Research.

"There's no blood in the streets," she said.

Many experts fear there will be blood, though, in coming decades, if nothing is done. Some
employers are also becoming worried and are starting to do things on their own. But there is
widespread agreement that law and policy changes are needed.

Some of the key actions and proposals on the table are:

* Automated 401(k) plans. These plans differ from traditional pensions not only in that they
shift investment risk to the worker, but also in that they are voluntary.

Employees who go to work for a company with a traditional pension are generally enrolled
automatically and become legally entitled to their benefits after a five- or six-year "vesting"
period. If the company has a 401(k) plan, workers have generally been asked if they want to
sign up. Not all do, especially among the lower-paid.

Those who do sign up are offered a menu of investment choices, which many find daunting. If
they fail to make a choice, employers often have "defaulted" them into a money-market
account, which employers could be certain would not lose value and thus, they reason, would
shield them from possible lawsuits that employees might bring if they were put into an
account that declined.

Recently, some employers have begun turning these decisions around. At these companies,
new workers are automatically enrolled in the 401(k) plan unless they opt out, and unless
they choose otherwise are placed in a "life cycle" mutual fund or similar investment that is
initially weighted heavily toward riskier but potentially higher-yielding assets, such as stocks,
but shifted automatically toward less volatile assets as the workers grow older. Some plans also
call for automatic increases in the worker's annual contribution as he or she gains more
seniority and, presumably, more pay.

This "makes it harder for employees to shoot themselves in the foot" by failing to participate
or by investing too conservatively, said Jack L. VanDerhei, a fellow at the Employee Benefit
Research Institute in Washington.

But a number of employers say they continue to worry about liability suits and are hesitant to
automate their plans. They would like to see Congress enact a "safe harbor" to protect them.

* Annuities. Experts think employers and employees should be encouraged to "annuitize" --
take as a lifetime stream of income -- their 401(k) accumulations at retirement, rather than
taking them as a lump sum. A number of studies show that retirees are spending down their
k-plan balances (or money from traditional pensions they have taken as lump sums) so rapidly
that they are likely to run out of money before they die.

"They are basically trying to keep a standard of living similar to what they had previous to
retirement," which raises the fear that more people will end up "on nothing but Social Security
in the not-too-distant future," VanDerhei said.

Several proposals in Congress would provide special tax credits or exclusions to retirees who
convert a portion of their retirement accounts into annuities. The bills are strongly backed by
life insurance companies, which sell annuities, but the insurance industry says there are sound
policy reasons to support the bills, as well.

"We need to give people an incentive to start thinking about longevity risk, about market risk .
. . to seriously consider locking away some of that money" so they don't outlive it, said Alane
Dent of the American Council of Life Insurers, an industry group.

* Cash-balance plans. Stripped to their essentials, many of the changes being introduced to
401(k) and similar retirement plans are really attempts to make them behave more like
traditional pensions. Oddly, there already exists a hybrid plan that accomplishes many of
these goals. It is called the cash-balance plan, but after years of complaints, lawsuits and
political hyperbole, few politicians and fewer employers want to go near such a plan.

Under a cash-balance plan, each employee is given an account to which the employer credits a
percentage of the worker's pay each year. The account is also credited with interest each year.
In fact, employee accounts work much the way a bank savings account does, except that the
cash-balance accounts are hypothetical. When a worker leaves, she can take her account
balance, which is paid out of the employer's pension fund, and roll it over into another plan or
an individual retirement account. Thus, a cash-balance plan behaves in many ways like a
401(k) or other defined-contribution plan, but is legally a defined-benefit plan. As a result, the
employer is responsible for making sure the money is there for the worker, and the plan
qualifies for government insurance if the employer fails to do that.

Cash-balance plans, though, generally do not provide as generous a benefit for long-serving
workers as traditional pensions do. Thus, a number of companies that have converted their
traditional plans to cash-balance plans have encountered strong resistance from older
workers. International Business Machines Corp. was sued over its conversion, and a federal
judge in Illinois ruled two years ago that cash-balance plans violate federal age-discrimination
laws. IBM is appealing, but in the meantime, employers say the uncertainty surrounding these
plans is too great.

The House pension bill would specify that cash-balance plans are allowable, but the provisions
would apply only to plans or conversions done in the future, leaving existing plans
unprotected.

* Tax incentives. Almost every taxpayer likes a break, and much of the retirement system is
based on the theory that tax benefits for retirement saving will increase savings.

However, the reality is widely debated. Some economists think that savers are savers and
non-savers are non-savers and that the main effect of a tax benefit is to cause the savers to
shift to the tax-preferred saving vehicle. In their view, the savers don't increase their saving
much, and few non-savers start saving as a result of tax breaks.

Others, though, regard tax breaks as strong incentives for retirement and other saving.

The Bush administration has repeatedly proposed special broad-based savings vehicles for
retirement and other purposes. The administration's proposed retirement savings account, or
RSA, would also encourage saving by simplifying the current tangle of 401(k)s, IRAs and other
vehicles that many taxpayers find confusing.

Others are pushing for more specialized tax breaks. In addition to the life insurers, who
support proposals to exclude some annuity income from tax, the Investment Company
Institute, a mutual fund industry group, favors allowing investors who buy into mutual funds
with after-tax money to defer taxes on capital gains realized within the fund until the investor
actually cashes in shares. Under current law, gains realized inside a fund are taxable even to
fund shareholders who leave the gain to be reinvested. This rule has caused a tax shock to
many a fund investor, and the ICI says eliminating it would encourage saving and investing.

Also, some experts suggest the tax laws be changed to allow people to split their tax refunds,
sending part to savings and taking part in cash. Current law requires that the refund go to one
place, and while it is possible for a person to obtain his entire return and then save part of it,
studies show low-income taxpayers are not likely to do that. But asked if they would like to
save a portion of it, they say they would if they could simply redirect some of the money.