As we navigate through the initial stage of the 21st century we confront issues (some old, some new) that will impact the financial security of our nation’s future retirees. Through undertaking a comprehensive review of these challenges facing future generations, we should develop a national retirement policy. Such a policy must reflect the projected demographic landscape of our nation, philosophical and social changes we have experienced, and the many relevant financial issues.

This paper is divided into five sections. The first three explore the fundamental sources of income that have served as the bedrock of retirement security for the last half century: Social Security, employer-sponsored retirement plans, and individual savings and investment. The fourth discusses the coordination and delivery of benefits from the available sources. This is reviewed from both the current perspective as well as how a retirement policy might consider the delivery of future benefits. The final section will propose a summary of issues that should be addressed as part of any meaningful discussion on a national policy that is created to achieve comprehensive, fair, and efficient retirement security. Note that the term retiree throughout this paper should be interpreted to include citizens that may have had little formal paid employment but nevertheless contributed to our country in other ways; e.g., raising families or providing volunteer services.

Some experts strongly believe that the preferred way to tackle this challenge should entail a more radical approach to change. They support alternate visions regarding the government’s role in helping citizens achieve financial retirement security. Some advocate moving toward much greater individual control with a minimum level of government involvement. Others support programs with greater government involvement then the current systems provide. Specific proposals and a critique of whether either approach would be preferable to working with current programs are beyond this essay’s scope. Nevertheless attempting to achieve radical change appears to be less likely to gain success in an environment driven by special interests. Additionally it does not appear that radical changes should be critical to delivering national retirement security both fairly and efficiently.

SOCIAL SECURITY
Impending Social Security fiscal problems should not be news to us. Changes in the ratio of tax-paying workers to benefit-receiving retirees will require either benefit reductions or increased taxes. Despite abundant disagreement about the problem’s extent and how it should be addressed, there is universal acceptance that action is required. However what and when is where different positions lie. Recommendations put forth to date include changes in the social security retirement ages, increases in payroll tax rates, increases in the taxable wage base, adjustments in benefit levels through alternative indexing, and different Trust Fund investment proposals. Others support more drastic changes that would mandate personal accounts to finance some portion of benefits for future retirees. The changes that are ultimately adopted must be part of an overall comprehensive strategy to modernize Social Security as opposed to only a “financial fix” that might ignore some fundamental problems with the current program.

We need to address the following three issues openly and honestly if we hope to achieve comprehensive Social Security reform.

• At the heart of the impending financial shortfall lies the basic program design which is highly dependent on generational wealth transference whereby current workers generally fund the benefits for today’s retirees. Historically this approach worked efficiently when the ratio of workers to retirees was high. However this ratio continues to decline rapidly, with a 2:1 worker-to-retiree ratio projection approximately 30 years into the future. We can attribute this decline largely to decreased fertility, longer life expectancies, and reduced immigration rates. At what point do we ask too much of younger generations to fund the financial security of older generations? We need to answer this question with respect to not only Social Security alone but in the context of the impending substantial Medicare shortfall as well as the looming national debt. The overall cost of these obligations could very well affect the high standard of living we have come to take for granted.

• Another issue we need to address relates to the use of the Social Security Trust Fund balance. Currently, and for the last several decades the funds collected through payroll taxes exceeded benefits being paid to retirees. This resulted from reforms to the program adopted in the early 1980s (when it nearly ran out of funds) with the goal of establishing a pre-funding level, in anticipation of baby boomer retirements. These cash-flow surpluses are projected to continue for approximately ten more years before reversing. To date the federal government spends and most likely will continue to spend these funds for non-Social Security expenses. Of course there is a promise and expectation that these funds (plus interest) will be repaid to the Trust Fund as needed to pay benefits. We are justified, however, in wondering how this repayment will be accomplished in light of our nation’s accumulating, staggering debts.

• The final Social Security issue to be addressed in this paper involves the progressive structure of the benefit formula. This provides Social Security with elements of a welfare program. The formula allots higher proportional benefits to workers who have paid less in lifetime Social Security payroll taxes. The assumption being that those who earn less can most benefit from proportionally higher retirement benefits than higher-wage earners. In addition, significant spousal benefits are paid to individuals who contributed very little into the program; reflecting the traditional family with a working husband and stay-at-home wife. Factors including, but in no means limited to the changes in family structure as well as the wide variation by individual in employer provided retirement benefits favor many individuals with disproportionably larger benefits than were actually paid for or are needed. It is critical that in the future the method we determine to deliver any enhanced progressive benefits be developed more efficiently so as to provide them with those with the greatest needs.

EMPLOYER SPONSORED RETIREMENT PROGRAMS: Over the last several decades the defined-contribution model has replaced the traditional defined-benefit plan as the most common employer-sponsored retirement plan. This change is attributable to pressures on corporate profits which are very sensitive to defined-benefit plan liabilities; a more mobile workforce; and policies established by Washington that have discouraged (or at best not encouraged) the use of traditional defined-benefit pension plans. The switch over to defined contribution plans initially encountered resistance, but is now commonplace and generally accepted. Exceptions lie with some larger union plans as well as with plans covering public employees such as educators. In time however the costs and liabilities associated with the defined-benefit model will continue to reduce the use of these plans even in those situations where change to date has been successfully resisted. The Pension Protection Act of 2006 incorporates many provisions that improve funding requirements for some of these traditional pension plans but does very little if anything to encourage the creation of new ones.

The defined-contribution model, unlike the traditional defined benefit model does not provide lifetime guaranteed benefit protection which helps to insure security for ever-increasing retiree life expectancies. In addition the use of defined contribution type plans generally places the risk associated with investment decisions on the employee. Often the investment alternatives provided and/or educational support available to the plan participants is lacking. In some cases the investment products offered are laden with unreasonable expenses. The managing of defined-contribution plan benefits with the goal of providing secure lifetime income poses an enormous challenge to many individuals, both before and after retirement.

Employer-provided retirement programs are voluntary yet are encouraged through availability of attractive tax incentives for qualified plans. To date all discussion that would legally mandate the adoption of retirement plans by employers has met significant resistance. With few exceptions larger employers sponsor some form of retirement plan for their employees; unfortunately this is not true for smaller organizations which represent the most rapidly growing segment of our nation’s business segment. The range of benefits can be vast for businesses that do provide retirement plans. Some employers offer only employee-funded 401k or 403b plans without employer contributions. Others provide very generous pension plans as well as 401k or 403b plans with attractive matching contributions. Unfortunately many plans of all sizes exclude coverage of part-time employees, leaving this segment of the workforce without sufficient benefits.

Many employees eligible to participate under employer-sponsored 401k, 403b, or similar plans contribute at insufficient levels or do not contribute at all. Exacerbating this problem, a good percentage of employees consume amounts distributed to them from employer plans when they change jobs instead of rolling over the funds to IRA rollover accounts or to retirement plans sponsored by a new employer. The Pension Protection Act of 2006 provided welcome legislation that should help increase employee participation under 401k plans and provide guidance with aspects of education where investment decisions are under participant control. Congress’s response to these shortfalls is a good start.

INDIVIDUAL SAVINGS AND INVESTMENT
U.S. workers rank among the lowest of all leading industrial nations in voluntary savings. Our preference for consumption over savings has made individual savings and investments the weakest of the three main retirement security sources for the overwhelming majority of our citizens. In addition as noted above many individuals when provided the opportunity are not contributing to employer-sponsored plans, and often prematurely consume available funds prior to retirement. The availability of a tax saver’s credit incentive for lower paid employees that contribute to plans shows only limited success in increasing participation. For decades the federal government through the availability of IRAs has provided tax incentives to save for retirement. Yet we find inadequate use of IRAs for numerous reasons: insufficient income available to save, lack of knowledge/comfort of how to invest savings, lack of discipline required for regular savings, and belief that Social Security and employer-provided retirement benefits (if available) will be sufficient to provide a secure retirement. Any comprehensive national retirement policy must not only address how to encourage personal savings but must be realistic when considering the extent to which individuals will voluntarily save. This is especially true among lower-paid and younger individuals.

Other sources may be available to fund retirement for some individuals. These include continued part-time employment, financial assistance from children, inheritances, and the use of home equity. It is important to consider how these potential income sources should impact a national retirement policy, especially the increasingly commonplace part-time employment. We also need to explore if other sources of retirement income currently exist or may be developed in the future.

COORDINATION AND DELIVERY
As part of the formation of a comprehensive national retirement policy we should not only discuss the sources of funds available for retirement security but we must address the following key issues.
1. How each available source should integrate with and complement each other.
2. The level of overall benefits sufficient to provide retirement security.
3. How best to fairly and efficiently deliver benefits

Determination of what portion of benefits should come from each of the three sources of retirement funding can be viewed in an interesting manner. Whether it is the individual, an employer-sponsored plan, or from the government, one can argue (and many do) that the individual actually pays (directly or indirectly) for these benefits. For example, the amount that employers pay in payroll taxes under Social Security on behalf of an employee is a form of compensation that could rightfully be paid to that employee. This would not negatively impact the employer’s profitability if the employer could choose not to fund the Social Security program but instead pay this amount to the employee as additional compensation. A similar argument can be made for employer-funded retirement plans; if the plans did not exist, funds used to provide those benefits could otherwise be paid to employees. As individuals we could then on our own invest these funds for retirement.

Of course there is no guarantee that employers actually would pay the funds to employees or that workers would be responsible enough to set them aside for retirement. Analyzing retirement funding in this light might impact the discussion about how best to achieve the goals of widespread retirement security, inasmuch as the argument is made that individuals are actually funding their own retirement regardless of the ultimate source of the retirement income. Note however that although employees may be paying indirectly for the benefits (based upon the above argument) we should acknowledge that Social Security and some employer-provided benefits do not represent a proportional cost to benefit return at the individual level. We can attribute this to: intergenerational funding, variations in actual individual longevity, alternative employer-sponsored plan benefits, and the welfare element which is part of the Social Security program.

How much income constitutes sufficient benefits? This question might require the Wisdom of Solomon to answer. To start we need to agree on what responsibility we have as a society, if any, to provide citizens with retirements free from the fear of financial hardship. Whether this goes beyond the basic necessities of food, shelter, and healthcare is fair game for legitimate debate. What are the differences, if any, in responsibilities to retirees that live to 100 as opposed to 80? What about those who did not save individually for retirement? Do we differentiate between those who could afford to save from those who did not have sufficient income to save? What about those who did not regularly work for employers who sponsored retirement plans and thus could not accumulate sufficient employer-sponsored plan benefits? The questions are potentially limitless.

Currently benefit delivery for the majority of our retirees comes predominately from Social Security which provides lifetime retirement income, followed for some retirees by employer-sponsored retirement plan benefits (some paid in the form of annuities and others as lump sums). Finally, personal savings fund a small percentage of our population’s retirement. Whether we view all benefit funding as being provided by individuals (directly or indirectly as described above) may impact the debate on the fairness of the allocation among sources. This also must be evaluated in context of the role intergenerational benefit funding plays as well as welfare aspects that transfer wealth from those that have more to those that have less.

An effective benefit delivery discussion would be incomplete without addressing the need for retirees to hedge against the dangers of outliving retirement funds. With the demise of traditional employer-provided lifetime monthly pensions for many workers (defined benefit plans), the only guaranteed lifetime income that many can rely on is Social Security. We need to explore how best to provide security to protect against life expectancy ranging into the 90s and for some beyond 100, but without expecting that all retirees will live to such ripe old ages.

Ultimately individuals will come to retirement with different income levels from various sources, alternative expectations for retirement expenditures, different health scenarios and life-expectancy assumptions, as well as with other factors that will make each retirement planning process unique. The minority will want to and be able to use educational materials to create a plan and to select optimum financial products for his/her needs. The overwhelming majority will not be in this position and will need unbiased guidance from competent, well-informed professionals. They will need this service initially and, in some cases, will require periodic monitoring. Most financial professionals in today’s market depend on commission-based income and thus may not be as independent as we might wish in guiding retirees through this crucial process. Overcoming potential conflicts of interest may impact how financial services are to be delivered to retirees.

POLICY CREATION
A national retirement policy should be a “plan” embraced by organizations representing the diverse retirement security interests of workers, retirees, employers, financial institutions, pension professionals, and other interested entities. The policy should emanate from representative organizations willing to engage in open, candid dialogue and debate, preferably working through a respected nonpartisan organization experienced in developing national public policy. Below is a summary of sixteen ideas based on the above issues that could be part of the agenda of a policy formation discussion. In addition there will certainly be many other pertinent topics.

1. Intergenerational Funding of Social Security Benefits
Reducing this dependence could be achieved most efficiently through transition from the current approach of a primarily pay-as-you-go program to one with substantially more pre-funding. Whether this transition should continue to incorporate the current defined-benefit model or move toward a model that incorporates defined-contribution elements is a design issue. Such transition can be achieved under either approach. What is critical is the understanding that in order to achieve the goal of reducing intergenerational dependency, we will require larger current contributions and/or lower future benefits.

2. Alternative Approaches to Current Use of Excess Social Security Funds
It is important to debate alternative methods of investing excess Social Security funds (either partially or fully). When proposed in the past this approach was criticized, based on the belief that our government (directly or indirectly) should not be investing in private businesses (domestic or international) or in foreign countries. Such an idea seems outdated in today’s global economy. Nevertheless investments must be generally secure, well diversified, and done without inappropriate government influence.

3. Social Security Restructuring to Improve Progressive Benefit Delivery
One way to achieve this would be a transformation to a benefit structure with two tiers. One would provide a benefit directly related to payroll taxes paid by each individual and on behalf of that individual by his/her employer. The second tier should be a supplemental, individual need-based benefit. This second-tier benefit should reflect all sources of retirement income available to the retiree and his or her dependent. A special payroll tax, paid by all workers, would finance this supplemental benefit. This feature would preserve the progressive element of Social Security.

4. Employer-Sponsored Programs that Guarantee Lifetime Benefits
The traditional defined benefit plan is unlikely to find traction from its ongoing demise unless the government adopts strong initiatives to encourage their use. Actions that should help would include: allow employee pre-tax contributions to fund defined benefit plans, provide alternatives to the PBGC insurance program, and allow benefits earned under defined benefit plans to be adjusted based on the plans’ funded status (for plans that satisfy certain specified investment and contribution level standards).

Another avenue that could be pursued toward providing lifetime income protection for employees would entail creating tax -favored incentives that allow employers to pre-fund longevity insurance benefits (discussed in detail below). In addition a comprehensive analysis is needed to determine how best to encourage the use of annuity contracts under defined contribution plans that can provide lifetime income as opposed to the standard lump sum benefit.

5. Framework to Provide Easily Accessible Unbiased Educational Programs
The most effective time to start any educational process is at an early age. The government should look to ways to encourage a universal high school course requirement. Such a course would cover the more important financial concepts that help prepare young people to understand how to achieve long-term financial security. Curricula should include: understanding different investment categories, classes, and products, recognizing risk/reward characteristics of investments, concepts of investment diversification, and understanding how investments are bought and sold, including fees and costs associated with such products and transactions. Of course education is a lifetime endeavor, thus government sponsored/funded adult education classes covering financial security should be promoted.

6. Curtailing Individuals’ Premature Use of Retirement Funds
Increasing the current penalty tax (10%) on distributions from IRAs and employer-sponsored plans that are not rolled over would discourage the premature use of funds that should be preserved for retirement. However, recognizing that some financial hardships necessitating premature fund distributions may occur, there should be available exceptions to these higher penalty tax rates.

7. Approaches to Encourage Small Businesses to Establish Retirement Plans
Incentives for small, profitable businesses to establish plans already exist; these include tax incentives and the businesses’ ability to attract and retain quality employees. Tax credits currently available to establish small business plans generally are not large enough to offset the cost of the plan administration. Smaller, less profitable businesses generally do not have sufficient funds and thus there is little incentive to establish and maintain plans. In addition because most small companies are not attractive client prospects to those in the retirement-plan business, professionals that can best provide independent expertise seldom approach these businesses to help them to establish plans. To date most simplified retirement plan options that have been made available for small businesses have failed to meaningfully expand plan coverage.

We should consider a different type of government-sponsored, simplified retirement program available to small businesses. Such an option would use IRA-type accounts that incorporate Department of Labor-approved investment choices. The program would be funded by employees, require a small employer contribution, would be exempt from ERISA compliance rules, and provide tax credits to the businesses based on the cost of employer contributions to the plan for the non-key employees.

8. Coverage of Permanent Part-Time Employees Currently Excluded From Plans
Many employer-sponsored plans (based on an option permitted by law) exclude employees providing less than 1000 paid hours of service per year. It may be appropriate to consider eliminating this permitted exclusion for those part-timers deemed to be permanent (e.g., worked for the employer for at least 3 years). Another alternative might allow employers the choice of providing coverage for permanent part-time employees under a program as outlined previously (See no. 7).

9. Encouraging Savings by Individuals: Personally and through Employer Plans
This can best be achieved through investment and retirement planning education, more universal coverage of employees under employer-sponsored plans, and the availability of more easily understood investment products.

10. Improved Investments under 401k and Other Defined-Contribution Plans
Fortunately we are experiencing a trend toward the use of lifestyle, lifecycle and managed risk-based portfolio type investments under participant-directed employer sponsored plans. We also are witnessing changes in the requirement to disclose fees and other expenses associated with both investment and record-keeping services that impact plan participant benefits. These positive developments are a result of the efforts by the professional community servicing these plans as well as the government. We are at the early stages in both areas and must further these developments, especially with respect to fee and expense transparency. Too many employers still provide plan investment options that are not in the best interest of the plan participants as a result of the underlying fee and expense structure.

We might also consider requiring that all participant-directed defined contribution plans include investment approach options as outlined above (lifestyle, lifecycle or managed portfolio). We could require that participants not electing to use such an approach provide a statement to the plan trustees stating that they are aware of risks associated with investing and have the knowledge or professional assistance available to structure their own asset allocation models.

11. Determination of What Constitutes a Minimum Retiree Income Level
One approach might be a geographically based determination of costs associated with basic retirement living necessities. Another might be a retirement replacement income based on national average earnings. Clearly other standards can be developed. This determination of minimum income level would be used to establish financial safety nets for those who have been unable to accumulate sufficient retirement assets and income.

12. Benefit Integration and Minimum Financial Security
Many will be able to accumulate sufficient means of retirement income from the various sources. This should become more universal with improvements in employer-plan coverage, benefit alternatives, individual participation, education, improved investment options, and awareness of the importance of personal savings. However not all retirees will be so fortunate. This is where the second-tier Social Security benefit (See no. 3) would take effect. This would entail a comprehensive individual approach to protect those retirees who do not have sufficient retirement income. However it will be critical to structure these benefits in such a manner as not to encourage a dependence on their use.

13. New Financial Products/Plans for Unexpectedly Long Retirement Periods
Retirees living into their 90s or beyond will face the challenge of having one’s retirement nest egg last until their deaths. Newly designed products referred to as longevity insurance provides benefits only to those who survive to an age beyond what was expected when they retired. What makes longevity insurance particularly attractive is the potentially high benefit level available per dollar of paid premium. This is possible for two reasons. First is that many policy buyers can expect to receive no benefit assuming the policy benefit age is at least as far in the future as one’s life expectancy at the time of purchase of the policy. This provides for the pooling of risk (the essence of insurance) and significant leverage on a benefit-to-cost ratio. Second is that the insurer will not be required to pay out a benefit for many years and thus can engage in longer-term investments providing higher rates of return and thus greater ultimate benefits.

It is too soon to know whether retirees will buy this insurance type, as impediments to their use exist. Included is insurance anti-selection since those individuals most likely to buy them are comfortable assuming a long enough life expectancy to collect benefits. This will drive up the premiums and/or reduce the benefits as the insurance companies will need to use mortality tables more inclined to protect them from losses. In addition unless there is sufficient demand for these policies there may not be enough insurance carriers in the market to generate price competition. Thus individual longevity insurance policies may end up just being an expensive “boutique” product for a select few consumers. Longevity insurance would be most cost-efficient and broadly delivered through the use of employer and union-sponsored welfare plans. To create widespread appeal, the government should act to provide favorable tax incentives to employers adopting such plans.

14. A Financial Consultant Community Focused on Retirement Needs
Financial planning for retiring and retired individuals differs from planning for those still in the workforce. Planning and products must be geared toward the use of accumulated assets as opposed to asset accumulation. The financial services community should establish a designation for professionals who have demonstrated expertise in the particular needs of clients entering or already in retirement as well as comprehensive knowledge of the product range and planning appropriate for these needs.

15. Avoiding Conflicts of Interest in Financial Advisor Compensation
To limit potential for conflicts, it should be required that all commissioned income for products sold to retirees is fully disclosed in an understandable format prior to actual sale. We should also consider promoting the use of retirement specialist advisors compensated on a time-based fee arrangement as opposed to commissions.

16. Impact of Alternative Potential Retirement Income Sources
When exploring the financial resources available for retirement exclusive of Social Security, employer sponsored plan benefits, and individual savings, these additional sources of funds should impact on an individual basis the retirement savings process. In addition the determination of any second-tier Social Security benefits as noted above will be subject to the existence of such funds.

Once created the retirement policy would serve as the blueprint to encourage both governmental and nongovernmental initiatives designed to achieve the goal of financial security for retirees. Through proper education, support from the government, the expertise of the various professional types servicing this industry, and long-term planning, this can be achieved in a fair, efficient, and responsible manner. It is important that this challenge be met by an appreciation as to the importance of the many different elements that will be needed to deliver a comprehensive solution.

By: Mark Shemtob