Mending the cracked nest egg

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Many Americans’ retirement nest eggs have fallen and cracked into pieces. Is yours still intact?

Our plight has been on the minds of legislators lately. The House Education and Labor Committee recently held a hearing, “Strengthening Worker Retirement Security,” at which the disastrous condition of our retirement plans was discussed among experts from academia and the investment industry. They are trying to put our nest eggs back together again.

“The current economic crisis has exposed deep flaws in our nation’s retirement system,” declared committee Chair George Miller, D-Calif., in opening remarks at the first of a series of such hearings. Rep. Howard P. McKeon, R-Calif., cautioned against sounding the alarm bells. “Now is not the time to frighten people out of the market,” he warned. “Triggering a widespread exodus from the system would only exacerbate the market’s downward trend, while cementing these deep losses.”

All the experts at the hearing agreed that a strong Social Security system is important. Aside from that, they offered solutions that run the gamut from a government-run system to improvements to the existing free-market system. It makes you wonder: If capitalism isn’t working, would another system be better?

‘Animal Farm’ redux

Believe it or not, the livestock in George Orwell’s “Animal Farm” dreamed about retiring one day. It’s the tale of domesticated animals that broke free from the tyranny of Farmer Jones and lived in a communal system in which they shared the fruits of their labor — though the pigs got a larger share. Published in 1945, the book was a satire on Communism, though with just minor revisions it could serve as a spoof on contemporary capitalism.

The protagonists harbored retirement dreams similar to ours.

At the beginning, when the laws of “Animal Farm” were first formulated, the retiring age had been fixed for horses and pigs at 12, for cows at 14, for dogs at nine …. Liberal old-age pensions had been agreed upon. As yet no animal had actually retired on pension, but of late the subject had been discussed more and more. … For a horse, it was said, the pension would be five pounds of corn a day and, in winter, 15 pounds of hay, with a carrot or possibly an apple on public holidays. Boxer’s twelfth birthday was due in the late summer of the following year.

Of course, none of the animals ever retired. As the workhorse Boxer approached retirement, he fell ill and, instead of being nursed back to health and turned out to pasture, he was sent to the glue factory, where his hide and other parts were sold off and the proceeds used to buy whiskey for the pigs. He had lived by his favorite maxim, “I will work harder,” until his dying day.

Work longer!

In fact, Americans should work longer, advised Alicia Munnell, director of the Center for Retirement Research at Boston College, at the hearing.

“Older workers, whose 401(k) balances have been decimated by the financial crisis, have three options: They can save more, they can live on less in retirement or they can work longer. Saving enough to offset the impact of the financial collapse is virtually impossible,” she testified. (As an example, someone with eight years to retirement who had been on track to replace 50 percent of his income in retirement would have to increase his savings rate from 6 percent to 21 percent to compensate for the market drop.)

“Reducing an already modest retirement income further is undesirable. So the only real option is to keep working,” she said.

Among other things, working longer enables workers to:
  • Increase current income.
  • Get a bigger Social Security check if they delay enrollment.
  • Contribute longer to a retirement plan.
  • Shorten the period of retirement.

That last point kills me.

Munnell also advocates “a new tier of retirement income” that would replace 20 percent of a worker’s pre-retirement income. She suggests a setup something like the Federal Thrift Savings Plan (the savings plan of federal workers), stocked with “sensible target date funds” that workers could not access and that should be paid out as annuities at retirement.

A social system

Dean Baker, co-director of the Center for Economic and Policy Research, offered a solution with guarantees for those who sign up.

To supplement the meager savings of workers, Baker advocates a voluntary government-run pension system that would provide a modest guaranteed rate of return. Workers could opt to invest 3 percent or a modest amount of money, say, $1,000 or $2,000 a year, into this plan. At retirement, they would get regular payouts. The guaranteed return would be like that of a conservatively invested portfolio.

The government would assume market risk and perhaps be called upon to protect the funds as it did when it guaranteed money market funds. And this wouldn’t cost taxpayers anything, he said.

His plan would make a difference in workers’ retirement security. “For example, at a 3 percent rate of return, a worker who saved $1,000 a year for 35 years would be able to get an annuity of $4,200 a year at age 65.”

Hmm. That’s better than nothing, but just barely enough to pay for some corn and bales of hay and possibly the odd apple to enjoy on holidays.

New and improved capitalism

Paul Schott Stevens, president and CEO of the Investment Company Institute, presented solutions designed to protect the system as it currently exists — but with enhancements. You might expect him to do this, since the ICI is an industry trade group with a membership composed primarily of investment management firms that have a vested interest in increasing — not losing — market share.

“Congress should not mandate specific investment options or distribution methods or attempt to regulate exposure to investment risk,” said Stevens in written testimony.

“Nor should Congress undermine the ability of plans to pay for services using asset-based fees. Finally, reliable data make it clear that the costs of 401(k) plans and mutual funds in those plans are very reasonable. Congress should reject attempts to scrap or undermine the existing system or fundamentally alter its structure.”

In other words, things are just fine the way they are. Stevens’ suggestions for improvements build on the current structure and include the following:

  • Improve disclosure about fees, risks, performance, etc., of 401(k) investment options (but “voluminous and detailed disclosure will not serve the interests of participants”).
  • Consider requiring 401(k) plans to adopt automatic enrollment and automatic increases of contributions.
  • Make savings plans less complex so that more employers offer them.

Stevens proposed “Model T,” a retirement plan like the 401(k) that would include automatic enrollment and simple diversified investment options, but employers would be relieved of “burdensome plan testing.” He’s referring to discrimination testing that plans must undergo to ensure that employees at all income levels participate in a plan rather than just highly compensated employees.

In other words, the Model T represents capitalism on all cylinders, with few solutions that address risk.

Impose a new order

The problem with the status quo, in a nutshell, is that money managers extract value rather than create it, says John Bogle, founder and former chief executive of the Vanguard Group. “The investor feeds at the bottom of the costly food chain of investing.”

Bogle criticized everything from “unwise and often speculative investment choices,” to a financial system rife with conflicts of interest and greed. The major flaws in our 401(k) system, he says, are inadequate savings, too many opportunities for participants to raid their accounts, inappropriate asset allocation, and excessive investment costs — not to mention high distribution costs for participants who annuitize their nest eggs.

So what’s the solution? Get rid of every other type of defined contribution plan out there and consolidate investments in a single plan available to everyone. It should be overseen by an independent Federal Retirement Board that would act in the best interests of plan participants. Offer only low-cost broad market index funds through private providers. Balance risk and return through diversification and sensible asset allocation. For instance, the percentage of fixed income could match the age of the participant (a 60-year-old investor would have 60 percent in bond funds) with stock index funds making up the balance. Finally, mitigate longevity risk (the risk of outliving your money) by offering low-cost annuities at the time of retirement.

This solution would shake up the system, and we’d have to give up regular IRAs, Roth IRAs, 401(k)s, 403(b)s — all the defined contribution plans that we’ve gotten to know.

But the dialogue is only getting started. The solutions offered by experts give us fodder to masticate as we work hard and contemplate our future theoretical, if not actual, retirement.

Written by
Barbara Whelehan
Contributing writer
Barbara Whelehan is a contributing writer for Bankrate. Barbara writes about a range of subjects, including homebuying, real estate, retirement, taxes and banking.