Toward Fairer Retirement Savings

How workers invest today will shape their future, so why should the rules about who can sock away how much be so convoluted?

By Christopher Farrell

Baby boomers are getting older. The most analyzed group in history, this massive generation has wielded disproportionate influence over the economy and society as it has aged. For instance, between 1950 and 1970, primary-school enrollment soared from 21 million to 34 million students, an increase that forced a frenetic expansion of the kindergarten-12th grade education system.

When boomers began working in large numbers toward the end of the 1960s and throughout the 1970s, the U.S. labor force grew at a compound rate of almost 2.6% a year, compared to a 0.45% annual pace during the 1980s, after most of the boomers had entered the workforce. So it's little wonder that the boomer mantra of the past decade has been "401(k)" -- national shorthand for investing for retirement.

The enthusiastic, mass embrace throughout the '90s for retirement savings through equities was partly driven by an unprecedented stock market boom. But it was also an unanticipated byproduct of a corporate campaign in the previous decade to rein in benefit costs.


  Companies retreated from offering their workers expensive, traditional "defined benefit" pension plans in favor of low-cost "defined contribution" plans, such as the 401(k). With the older defined-benefit plan, the employer bears all the investment risk and commits to a fixed payout, typically based on a salary and years-of-service formula.

In sharp contrast, with the 401(k), workers assume the responsibility for their retirement plans and funding arrangements. Employees decide how much money to invest and where to invest it, depending on the limits established by law and the choices offered by the employer. Most experts would agree that's an improvement.

Yet the private retirement savings system is capricious, and it includes 401(k)s, 403(b)s, 457s, SIMPLEs, SEP-IRAs, IRAs, and Roth IRAs to name only the best-known plans. The rules, income limits, and restrictions vary significantly among most of these tax-advantaged savings programs.


  For instance, a 40-year-old worker at a company with a 401(k) can set aside a maximum of $11,000 in pretax dollars this year, while an employee at a small company with a SIMPLE plan has a $7,000 limit. A stay-at-home spouse running the family household can save at most $3,000 in pretax dollars in an IRA.

So why not attach the retirement-savings plan to the individual and have just one rule for everyone -- say, 15% of income, or $15,000. And the retirement plan would include "nonworking" spouses.

However logical such an approach is, it's likely that politics would intervene and that Congress would take a long time to enact changes. In any event, given current market conditions, it has become painfully clear that under this private retirement-savings approach, employees bear all the investment risk. Whether a worker lives in a condo or a trailer three decades from now largely depends on investment decisions made today.


  "Tying the fate of the American family to the level of the Dow Jones [industrial average] represented a radical restructuring of America's pension system," write William Wolman and Anne Colamosca in The Great 401(k) Hoax. (Wolman was BusinessWeek's chief economist for many years before his recent retirement from that position. He's now a senior contributing economics editor.)

Wolman's and Colamosca's book is a searing indictment of the 401(k). A free-market elite in Washington and Wall Street, they say, has mostly sold workers a bill of goods. Instead of pocketing rich gains from investing in stocks for the long haul, as the Wall Street money machine advertises, workers are likely to earn mediocre returns at best as the economy and stock market stagnate for years.

Although I'm more optimistic than they are about growth prospects for the economy in the coming decade or so, they make a compelling pessimistic case. They're also dead-on in criticizing the nation's pension system as inadequate.


  The biggest concern is that about half the population has no access to a private pension. This column has argued for allowing the millions of such workers to piggyback on the existing Social Security system. Workers could make additional contributions to Social Security, and the money could be invested in indexed stock and bond funds.

Still, any consensus on reforming Social Security will take years to evolve. In the meantime, Congress could act relatively quickly to address the retirement worries of millions of people by simply attaching one pension to a person rather than to an employer's tax status.

In the New Economy, job mobility is a given, and there are many more part-time workers than in prior decades. Individuals and families can look after their interests better than employers, especially if the rules are simple and standardized.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online

Edited by Beth Belton

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