Thursday, November 13, 2008

Ferguson: It's Time to Rethink Our Retirement Plans

Former Federal Reserve Vice Chairman Roger Ferguson, now president and CEO of TIAA-CREF, writes in today's Wall Street Journal of policy changes to help make retirement income more secure. Here are the highlights:

  • Automate participation and savings. Automatically enrolling employees in plans, then hiking savings with pay raises, overcomes the inertia that results in nearly a quarter of workers eligible for an employer-sponsored retirement plan not signing up. Automatic enrollment plans should mandate employer and employee contributions, and the percentage amounts of each. That's the approach some higher-education retirement plans follow. It may be one reason why 35% of faculty feel very confident in their retirement income prospects, compared with 25% of working Americans, according to the TIAA-CREF Institute.
  • Give workers the information they need. Most of us need advice that is objective -- from an adviser who receives no sales commission and thus has no incentive to push particular products -- and tailored to our individual goals. Retirement plans must include such advice for everyone who signs up.
  • Guarantee an income floor. Many retirement accounts focus on accumulation, but fail to include a payout mechanism to ensure retirees will not outlive their savings. Retirement plans should provide that by automatically converting all or a portion of the account balance to a low-cost annuity at retirement.
  • Encourage health-related savings. According to the Employee Benefit Research Institute, a couple that retires today will need from $200,000 to $635,000 to pay out-of-pocket health-care costs (above Medicare). Few private-sector employers offer workers an account to save for such costs. Last year's agreement among the Big Three automakers and the United Auto Workers to establish tax-free trusts for worker health is an approach gaining favor among academic institutions. Now Congress needs to enable people with these accounts to leave any unused balance to heirs. This will encourage people to hold on to their savings until the last years of their lives, when health-care money is most needed.
  • Diversify risk. If you had all your retirement in stocks, your account lost about 40% in recent weeks. If you had a mix of stocks and fixed-income holdings, you're down about 20%. Individuals need to properly diversify, and rebalance their accounts regularly to maintain a prudent mix of assets.

All good suggestions. Click here to read the whole article.


Paul Lawin said...

I’m not sure why I’m leaving a comment here, since regular readers of this blog have probably already thought of everything I’m going to say. But I see so many issues that I can’t let it go. So here’s where I disagree:

Mr. Ferguson’s premise: “It's not that 401(k)s are bad, it's just that they were conceived as supplementary retirement vehicles, not as a holistic retirement system.” I think 401k’s are “supplementary”. We already have one mandatory retirement program that provides an income floor, individual savings are additional.

When to save: Mr. Ferguson says all workers should be saving for retirement. I think that it’s better to get out of debt first, then start saving. People who do both at the same time are doubling up on fees paid to financial institutions.

How much to save: Mr. Ferguson uses McKinsey’s arbitrary “80% of income” target. I think that matching spending during your working years, adjusted for things like mortgage, taxes, and children, is a better goal. This is likely to be a lower number.

How to spend: Mr. Ferguson believes that 100% of people should annuitize. I have no problem with the theoretical superiority of annuity income for some people, but most people have complex priorities that often result in other choices. I expect that most of Mr. Ferguson’s peers are not annuitizing their retirement savings, I wonder what they would tell him.

Health care expenses: Mr. Ferguson wants people to have separate accounts for health care vs. everything else. I think that money is fungible, no reason to complicate this. He also advises that this account be held in assets to death, as opposed to his preference above for annuities. This is an odd combination.

The differences above are pretty much irrelevant if Mr. Ferguson is writing an advice letter to his customers. The customers can decide as they like. But when I read “…provided that policy makers, public officials and companies seize the opportunity this crisis presents”, I imagine tax subsidies, employer pressure, and mandates. I guess that's what bothers me.

Andrew G. Biggs said...

Paul -- Good points. A lot of this is pretty arbitrary. How much to save and how to draw it down depends on individual circumstances that are often hard to generalize. Moreover, there often isn't good analysis of how well people are actually doing at saving for retirement. While many folks claim there's a crisis, other very good analyses seem to indicate that most current retirees are doing quite well and most younger Americans are saving at reasonably adequate levels.

And as you point out, this becomes much more important when we shift from general advice to government policy.