Nov. 3, 2011, 12:01 a.m. EDT
5 ways to improve the U.S. retirement system
U.S. has 10th best pension system of 14 countries studied
By Robert Powell,
MarketWatch
BOSTON (MarketWatch) — Different year. Same problems.
One year ago, the U.S. had the 10th best retirement-income system in the
world. One year later, that hasn’t changed, according to the third annual study
of the pension systems of 16 countries by Mercer and the Australian Centre for
Financial Studies.
In its study, Mercer and ACFS measured the overall pension benefits that are
being provided to the citizens of 16 countries, the likelihood that those
systems will be able to provide benefits in the future, and the integrity of
private retirement plans. (In previous years, the report assessed 14 countries.)
And, same as last year, the U.S. didn’t get such high marks. In fact, the
U.S. earned a “C” grade for its pension-plan system according to the 2011
Melbourne Mercer Global Pension Index, the same grade awarded to Poland and
Brazil. Read the Global Pension
report here.
The Netherlands and Australia earned the highest grades, a B+, for their
respective retirement-income systems. Read my
column from last year on the Melbourne Mercer index.
By its own admission, Mercer and ACFS said comparing diverse
retirement-income systems around the world is not easy.
“Retirement-income systems are diverse and often a number of different
programs,” according to a report published by the Organization for Economic
Cooperation and Development in March 2011. “Classifying pension systems and
different retirement-income schemes is consequentially difficult.” Read
the OECD’s report, “Pensions at a Glance 2011,” here.
At the moment, no country has a gold-standard pension system according to the
Melbourne Mercer index. To receive a best-in-class grade, the researchers said a
system would have to provide adequate retirement benefits, be sustainable over
the longer term and be trusted due to its strong and robust governing
structures.
Critics of the study
For his part, Nevin Adams, the director of education and external relations
at the Employee Benefit Research Institute and the co-director of EBRI’s Center
for Research on Retirement Income, suggested that Americans should view the
rankings with a large grain of salt.
“I wouldn't put too much stock in the rankings, though I think it's an
interesting exercise,” Adams said. “Pension system evaluation is something of a
moving target these days.”
Adams said that many of the retirement-income systems examined in the
Melbourne Mercer index are “themselves undergoing significant restructuring, and
that the evaluations, at least in some cases, seem to reflect a version of the
system which isn't likely to be in place in five years, and which, in many
cases, will, I think, be less ‘generous.’”
Five ways to fix the U.S. system
The researchers who created the Melbourne Mercer index said that Uncle Sam
could raise its overall grade by 1) raising the minimum pension for low-income
pensioners; 2) adjusting the level of mandatory contributions to increase the
net replacement ratio for median-income earners; 3) improving the vesting
benefits for all plan members and maintaining the real value of retained
benefits through to retirement; 4) reducing pre-retirement leakage by further
limiting the access to funds before retirement; and 5) introducing a requirement
that part of the retirement benefit must be taken as an income stream.
Retirement-income experts said the researcher’s recommendations are not new
ideas, but they did agree, in the main, that acting on those suggestions would
improve the overall U.S. retirement system.
“The recommendations for the U.S. are not surprising, or striking,” Adams
said. “You could sum it up by saying, ‘make people contribute more, make them
wait longer to get their benefits, pay them (particularly lower income workers)
more benefits, increase vesting so that they earn more benefits faster, and
limit their ability to tap into those retirement benefits before retirement.’
Essentially, make people put in more so that they can get more later.”
Mandatory contributions and guaranteed income
For his part, Phil Waldeck, a senior vice president at Prudential Retirement,
said there are several ways to improve the adequacy of pension benefits and
place more Americans on the road to a secure retirement.
The first one, he said in an email, is increasing the level of mandatory
contributions, which many employers are addressing today through mandatory
enrollment.
Another would be to require that a portion of a retiree's benefit be taken as
a guaranteed income stream.
“With the shift from defined-benefit to defined-contribution plans, this has
long been a concern,” Waldeck said. “This issue is being addressed through the
addition of investment and payout options within defined-contribution plans
designed to provide lifetime income to retirees, but it will likely not come as
a mandate in this country.”
Some have noted that the recent request for comment from the Securities and
Exchange Commission and Department of Labor about mandatory annuities received a
strong negative response. Our guaranteed income stream is Social Security, which
most lower income earners are going to be reliant on for most of their
replacement income.
Waldeck agreed with the Melbourne Mercer index researchers that there should
be “further limitations on access to retirement plan funds in the pre-retirement
period.”
That might mean, for instance, making it harder for participants to take
loans from their retirement plan.
Said Waldeck: “All of these measures can lead to a better outcome for
retirees and help to ensure their retirement security.”
Three issues to face
Josh Cohen, the defined-contribution practice leader at Russell Investments,
said most Americans, going forward, are going to rely on workplace savings and
Social Security for their retirement-income needs.
From his perspective, there are three major issues the U.S. needs to contend
with, two of which are significant public policy challenges.
The first is the sustainability of the Social Security system, and only
political will can resolve that, Cohen said. The second is the very real problem
of workplace coverage.
“Millions of Americans have no access to workplace savings — primarily
seasonable employees, part-time employees, small-business employees and the
self-employed,” Cohen said. “There is no easy answer to this given we have a
voluntary system in the U.S.”
The third issue, as noted by the Melbourne Mercer index researchers, is the
ability for defined-contribution plans to provide sufficient income adequacy.
“The good news there is that while the results have been mixed so far, we have a
good idea about what to do to make these plans more effective going forward,”
Cohen said. “We know that defined-contribution plan participants can accumulate
significant savings and that adding certain plan features can help facilitate
success.”
Specifically, he said automatic enrollment can boost participation in plans
when available, automatic escalation can increase savings rates to more
appropriate levels, and defaulting participant assets into target-date funds can
help participants invest at a more age appropriate risk levels.
Still, there are two areas that need work. One, as the Melbourne Mercer index
researchers said, is to prevent leakage, particularly at the point of a job
change, and two, to help participants manage the unique risks in the spend-down
phase of retirement.
Fiscal realities
Cohen also said some of the proposals coming out of the various commissions
to deal with our fiscal deficit are another threat to the current
defined-contribution system.
Most of those proposals “look to reduce the level of tax incentives related
to defined-contribution plan contributions,” Cohen said. “This can tremendously
undermine the current system, discourage savings and dissuade some companies
from even offering a plan. So, while the government is looking to solve one
problem related to our deficits, they could be exacerbating our
retirement-security problem.”
Others, meanwhile, suggest that the U.S. might not be able to improve its
retirement-income system given the fiscal realities not only of the government
but Americans in general.
“We don't — and shouldn't — live our lives as though the only thing going on
is saving for retirement,” Adams said.
“Higher contributions to retirement funds now, whether by employers or
employees, will surely diminish the funds available for other here-and-now
necessities,” he said. “Not allowing people to tap into their 401(k) in times of
financial hardship will, one, surely create additional hardship, and, two,
diminish people's willingness to save voluntarily at the levels we know they
should.”