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Revised September 2006

Why do single women have less retirement security?
Single men and women generally have less retirement security than married couples (Weller and Wolff 2005). This problem is especially acute for single women (never married, divorced, or widowed women) who get much less retirement income from traditional pensions or 401(k)s.

While male and female workers are now covered at similar rates—49.4% of men and 47.2% of women participated in a workplace retirement plan in 2004—there is a significant gap in lifetime coverage for men and women generally because women are more likely to have worked part-time and to have taken time off to raise children or for other reasons (Copeland 2005; Shaw and Hill 2001).

Because of this, the average single woman over 65 had employer retirement benefits worth only $28,800 in 2001, compared to $81,600 for single men and $162,000 for married couples (Weller and Wolff 2005).

Though single women also have less income from Social Security than single men or married couples, the difference is not as pronounced as the difference in workplace retirement plans due to the progressive nature of Social Security benefits and the fact that widows and some divorced women receive spousal benefits.

Why do minorities have less retirement security?
As with single women, a big factor is unequal access to workplace retirement plans.In 2004, 29% of Hispanics and 46% of African Americans participated in workplace retirement plans, compared to 53% of white workers (Copeland 2005).

Will Social Security be there when I retire?
Estimates by the Social Security trustees (who are political appointees) and the non-partisan Congressional Budget Office (CBO) predict that the Social Security trust fund will be solvent until 2040 (trustees) or 2052 (CBO) even if Congress does nothing. In other words, Social Security can pay full benefits for a long time to come. The trustees’ estimates in particular are based on pessimistic assumptions, including productivity, population, and economic growth projections below current and historical levels. Even if these pessimistic forecasts turn out to be true, a shortfall would emerge gradually and could be largely resolved by removing the cap on earnings subject to the Social Security tax. (For more information, see EPI’s Social Security Issue Guide.)

How will demographic trends affect our retirement system?
As in most industrialized countries,Americans are living longer and having fewer children. As a result, the ratio of workers to retirees is projected to fall from around 4 to 1 in 2005 to 2 to 1 in 2050, and funding for Social Security retirement benefits is projected to rise from 4.4% of GDP in 2000 to 6.2% in 2050, according to the Organisation for Economic Co-operation and Development (OECD 2005; Government Accountability Office 2005). Nevertheless, OECD pension expert Monika Queisser says, “I can’t think of any developed country that has a state pension system in better shape than the U.S.” (Forsythe and Fitzgerald 2005). In fact, most OECD countries are already spending more on public pensions (7.6% of GDP on average) than the United States is projected to spend in 2050 (EPI analysis of OECD data; Government Accountability Office 2005).

Relative to most OECD countries, the United States has a higher birthrate, more immigration, and a later retirement age; it also pre-funds a portion of future retirement benefits. All these factors, plus the relative meagerness of our public pension system, make the approaching demographic challenges highly manageable compared to Europe, where pensions tend to be generous and the population is shrinking. The problem in the United States isn’t whether the retirement policies are affordable, it’s whether they are adequate: the United States has almost twice the share of seniors living on less than half the median income as other OECD countries (EPI analysis of OECD data; Government Accountability Office 2005). It is also important to note that productivity growth allows countries to devote a shrinking share of GDP to meeting retirees’ basic needs, even in Europe and other countries with slowly shrinking populations.

What explains the shift from defined-benefit to defined-contribution plans?
When given a choice, workers overwhelmingly choose traditional DB pensions over 401(k)s, because most 401(k)s are rightly viewed as a second-rate benefit. Not long ago,only an ailing company would take the drastic step of freezing its pension and switching to a 401(k) plan, but this cost-cutting measure has increasingly been adopted even by profitable companies (Munnell et al. March 2006).

One explanation for this shift is the weaker bargaining power of workers, who have also seen wages languish despite rapid productivity growth in recent years. The falling unionization rate is a key factor, given the role unions play in educating members about the importance of pensions and negotiating retirement benefits: about 44% of workers covered under a collective bargaining agreement participate in a defined-benefit plan, compared to 18% of those not covered under a union contract (EPI analysis of Copeland 2006). Another explanation is the fact that retirement benefits for senior executives are increasingly separate from those of other employees. Executives are able to provide good benefits for themselves and poorer benefits to non-management employees.

Rising healthcare costs have also been blamed for the erosion of other employee benefits, but this does not explain why retirement benefits have been the particular target of cost-cutting measures. One explanation is that the financial industry earns higher fees from individual accounts than from managing pension funds, and thus has an incentive to promote DC plans. Regulatory and tax code changes have tilted the playing field against DB plans in recent years (Gebhardtsbauer 2003) and pension reform legislation still in the pipeline may hasten the flight from DB to DC plans.

Some employers may be catering to a younger, mobile workforce, rather than trying to retain experienced workers. And stinting on retirement benefits does not have an immediate and obvious impact on workers’ living standards, as would cutting wages or increasing health insurance co-pays, especially since studies have shown that people are overly optimistic about their retirement prospects (Helman et al. 2006).

Why are 401(k) balances so low?
As noted earlier, a study by the Center for Retirement Research found that the typical worker had only 20-40% of expected accumulations in his or her 401(k) and IRA accounts (the study assumes workers should set aside at least 9% of earnings beginning at age 35). One explanation is that some 401(k) participants, especially older workers, also have defined-benefit pensions from current or past employers and do not need to set aside as much. However, this only explains part of the apparent shortfall. Other explanations include the fact that some participants have not always been eligible for (or have not always have participated in) a 401(k) plan; contribute less than 9% of their pay; earn low investment returns (the study assumed a 7.6% rate of return); or have cashed out some of their 401(k) savings (Munnell and Sundén 2004; Munnell and Sundén 2006).

Do the Pension Benefit Guarantee Corporation’s woes spell doom for traditional pensions?
The stock market lost almost 40% of its value between 2000 and 2002, and has yet to fully recover. This has affected both 401(k) balances and pension funds, though the latter have received more attention because employers must make up the shortfall (whereas 401(k) participants are simply out of luck). An increase in bankruptcies among DB plan sponsors—who not only faced higher pension contributions but were also clustered in ailing sectors like airlines, auto parts, and steel—has caused the Pension Benefit Guarantee Corporation (PBGC), the federal agency that insures private-sector pensions, to run a $23 billion deficit. By one estimate, future losses could cost an additional $92 billion (Cohen 2006). Though substantial, this is less than the annual cost of subsidies for 401(k)s and IRAs, most of which benefit high earners and do little to encourage retirement saving. Still, the PBGC’s woes, and accounting changes that are expected to lower the reported net worth of companies with traditional pensions, highlight the problem of relying on employers to voluntarily provide retirement benefits.

An extra $4,500 a year doesn’t sound like much. Aren’t I better off with a 401(k) or IRA?
Not unless you’re one of the lucky few.More than half of all households have no 401(k) or IRA, and even those who do have one do not benefit much since most of the tax breaks go to families in the top fifth of the income distribution. While $4,500 a year (or $3,360 with cost-of-living adjustments) may sound like a modest amount, it would be a substantial boost for most people, since the typical retiree relies on $12,000 in Social Security benefits for most of his or her annual income.

What is the Saver’s Credit?
The Saver’s Credit, which is limited to lower-income families, provides a tax credit for 401(k) and IRA contributions. The credit is equivalent to a dollar-for-dollar match on the first $2,000 contribution for low-income households—individuals earning $15,000 or less and married couples earning $30,000 or less. (There are somewhat less generous credits for individuals earning $15,001-$25,000 and couples earning $30,001-$50,000.) Though the Saver’s Credit is far from perfect—structured as a non-refundable tax credit, it does not help families who earn too little to pay income taxes—it does partly compensate for the regressive nature of the current system which provides far larger tax benefits to high-income families who contribute to retirement accounts than to low-income families. However, the Saver’s Credit is scheduled to expire at the end of 2006 and had not been extended at time of writing (Horney et al. 2006; Gale et al. 2005).

What is a cash balance plan?
A cash balance plan is a hybrid between a traditional pension and a 401(k) plan. Cash balance plans avoid one of the main problems of traditional defined-benefit pensions: the fact that the benefit structure is weighted against mobile workers. But they also share one of the disadvantages of 401(k)s: benefits are usually paid out as lump sums and retirees can outlive their savings. Despite some controversy over their impact on older workers, cash balance plans have grown in popularity, and about one in five large employers now sponsors one (Cahill and Soto 2003).

With cash balance plans, as with traditional defined-benefit pensions, the employer bears the entire cost as well as the investment risk, and benefits are guaranteed by the PBGC. However, unlike traditional pensions, benefits are based on total earnings, not final earnings, which means workers accrue benefits at a steady pace throughout their careers instead of seeing the value of their benefits escalate only if they retire after many years with the same employer. Another advantage of cash balance plans—from the employer’s point of view—is that costs are somewhat more predictable, though generally no lower than for traditional pensions.

Unlike 401(k)s, cash balance plans must offer an annuity option to retirees, but the available evidence—from 401(k) plans that do offer annuities—suggests that few retirees will take this option, and that some retirees may therefore outlive their savings.

Another issue that has arisen around cash balance plans is that older workers can see a drop in anticipated benefits when employers switch from defined-benefit pensions to cash balance plans, even if other workers benefit from the switch. This has understandably led some workers to file age discrimination lawsuits—though the Pension Protection Act of 2006 gave the green light to future conversions. However, making the switch to a cash balance plan optional, as some employers have done, is a solution that discriminates against no one.

These issues notwithstanding, cash balance plans are an enormous improvement over 401(k)s, because guaranteed, employer-provided benefits are almost always better for workers than risky, employee-funded plans. For mobile workers who manage their savings well after retirement, cash balance plans may also be preferable to traditional pensions.

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Sources

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