For nearly three decades, working Americans have been part of a huge experiment with their future well-being: Old-fashioned pensions that guaranteed specific retirement benefits have given way to old-age benefits that depend on personal investing in the financial markets.
But now, with those markets in crisis and the value of workers’ investments plunging, a bundle of ideas for modifying the system or replacing it entirely -- ideas shunted aside when the stock market was soaring -- are about to get a careful new look.
For one thing, Democrats have campaigned on the promise of a better deal for middle-class Americans. Also, many workers are aghast at the sudden discovery that their retirement years may be a lot less golden than they expected.
Even for people who have faithfully participated in the new retirement plans, which depend on annual savings and investment in 401(k) and similar accounts, much if not all of what they gained in the stock market over the last 10 years has been wiped out.
So far this year, the average worker’s 401(k) account balance has dropped between 21% and 27%, depending on the worker’s age and time with his or her employer, according to the Employee Benefit Research Institute.
That’s a potentially disastrous turn of events, because the key to making the savings plans work is the hoped-for gains from long-term investing, not just the amount workers set aside.
The present system is further called into question by the fact that millions of Americans have not had such plans available to them or have not participated for other reasons, including stagnant incomes that made saving difficult or impossible.
“The current 401(k) system has not turned out to be as secure as we want it to be,” said Rep. George Miller (D-Martinez), chairman of the House Education and Labor Committee. “It has not provided the returns that we want it to. And it’s not provided the level of savings that we want it to. It’s kind of failing on a number of fronts.
“Should there be a serious reassessment? Absolutely,” he said.
Miller’s committee already has held two hearings on the effects of the financial crisis on retirement savings plans. At one, a professor from New York’s New School for Social Research called for creating government-backed retirement savings accounts that would offer a guaranteed, inflation-adjusted 3% return. The government would contribute to the accounts using money gained by eliminating the annual tax breaks for 401(k) savings -- about $80 billion.
The idea has not been embraced by key lawmakers, perhaps in part because abolishing the tax break on 401(k) savings could reduce participation.
But the fact that the idea received a serious hearing before Congress is a measure of how much the crisis has shaken confidence in the 401(k) approach.
“In July, my plan was looked on at best as a noble idea . . . but completely unrealistic,” said the plan’s author, Teresa Ghilarducci, a professor of economic policy analysis at the New School and a longtime critic of 401(k) plans. “I was viewed as thinking out of the box, and now I’m in the box.”
Other ideas for overhauling the 401(k) system are being advanced. UC Berkeley political scientist Jacob Hacker, author of “The Great Risk Shift,” has proposed a variation of guaranteed government retirement accounts.
And the Aspen Institute’s Initiative on Financial Security last year proposed several changes, including individual retirement accounts that have a government contribution match for lower-income workers and guaranteed annuities to supplement Social Security.
U.S. corporations used to offer pensions known as defined-benefit programs because employers promised to pay specified benefits, usually based on workers’ earnings and years of service.
The predominant system today is known as a defined-contribution plan. Workers agree to have specified amounts deducted from their pay and put into investment accounts such as 401(k)s. As incentive to participate, the workers receive tax breaks.
At retirement, workers commonly take the total in their account and buy an annuity. The bigger the sum in the account, the bigger the worker’s monthly stipend.
Until recently, employers usually contributed to workers’ accounts as well. Many now cap their contributions or have stopped contributing entirely.
The transition to the defined-contribution system occurred largely over the last two decades, with relatively little public debate. In 1983, 62% of workers with employer-sponsored retirement plans had a defined-benefit plan, according to Boston College’s Center for Retirement Research. By 2004, only 20% of such workers had defined-benefit pensions.
And the proportion of workers who relied solely on 401(k) plans rose to 63%, from 12%.
The transformation allowed people to benefit if they made smart investment decisions or if the markets soared.
But it put retirement income at risk when the economy turned bad.
“We suddenly found ourselves, without anyone making a purposeful decision, in a world where the primary plan was this 401(k),” said Alicia H. Munnell, director of the Center for Retirement Research. “In the wake of this financial crisis, I think a consensus is emerging that we just can’t have a retirement system that exposes people to this type of risk.”
President-elect Barack Obama so far has called for modest changes to the 401(k) system, such as temporarily allowing penalty-free withdrawals for people facing economic trouble and suspending requirements that seniors older than 70 1/2 make annual withdrawals from their accounts.
Defenders of the defined-contribution system say the problem is that people expect too much.
“What happened in the ‘90s -- and there’s still a little carry-over -- is that some people are expecting returns in their plans that are unrealistic,” said David L. Wray, president of the Profit Sharing/401k Council of America, which represents companies that sponsor 401(k) plans. He said a major overhaul wasn’t needed for what he called “a very efficient savings machine.”
Jerry Bramlett, president of BenefitStreet Inc., an independent advisor for 401(k) and other defined-contribution plans, said that people who wanted a more guaranteed return could shift their 401(k) money into bonds and other low-risk investments. But that carries its own risk: The money may not grow enough to retire on.
“Exchanging the equity investments in your retirement account for Treasury bills is not a sound long-term investment strategy and will subject retirees to substantial inflation risks,” Bramlett told Rep. Miller’s committee last month.
Wray said a well-balanced portfolio would earn 7% to 8% annually compounded over time.
“The average 401(k) participant is 45,” Wray said. “There is plenty of time for the historical correction that comes from these kind of situations to occur and for people to be in good shape.”
The Investment Company Institute, which represents mutual fund companies, said the average 401(k) account balance was up 79% from 1999 to 2006, despite falling 8% from 1999 to 2002 at the end of the tech stock boom and the 2001 recession.
Critics don’t see it that way. “The market might recover from a crash, but people don’t recover from aging,” Ghilarducci said. “For many people the market will recover two years after they’re dead.”
The risk of being caught in a market downturn at the moment of retirement is amplified if workers don’t balance their investments, making sure that as they near retirement, they lower the percentage of stocks in their accounts and increase the percentage of lower-risk bonds and other securities.
But even Noble Prize-winning economists have admitted that they don’t closely monitor their 401(k) statements -- allowing an initially well-balanced portfolio to become dangerously overexposed to stocks as those investments grow faster than bonds.
According to the nonpartisan Employee Benefit Research Institute in Washington, 27% of people between 56 and 65 had more than 90% of their 401(k) investments in stocks at the end of 2006. Special target-date funds that automatically rebalance workers’ accounts as they near retirement age have an average of only about 51% of their investments in stocks for people that age.
“If you’re not really managing your assets well in these critical years, it’s going to have a huge impact on your retirement years,” said Jean Setzfand, director of financial security for senior advocacy group AARP. “One of the lessons that we’re learning is consumers have a really hard time grasping the concept of risk.”
But people have had little trouble grasping the concept of fear as the financial crisis has deepened. An AARP survey of workers 45 or older found that 65% said they would have to delay retirement if the economy didn’t improve significantly.
President Bush counsels patience, saying time will make good the losses as markets recover. But most experts think it will be many years before that happens. And many workers will find that they can’t wait it out. They will be forced to retire by medical misfortune, company downsizing or other factors beyond their control.
Such workers will have to live out the rest of their lives on whatever their depleted savings yield -- probably much less than they expected or need to maintain a semblance of their pre-retirement lifestyles.
That’s why Democrats -- with a new president and bigger majorities in Congress -- are expected to put the retirement system under the microscope in the months ahead.