During the hour and a half before President George W. Bush arrived at the Joyce Center on Notre Dame’s campus on March 4, the arena bustled with commotion. A John Phillips Sousa march played overhead above giant billboards shaped like faux Social Security cards announcing “What Each Worker Pays For Current Retirees,” “Strengthening Social Security for the 21st Century” and “Cost of Inaction.” Bar charts and graphics and red ink covered the three signs that formed the backdrop to the stage. The blue Presidential seal with an eagle in the center created each of the stage’s four corners.
After awhile, a string quartet of students played Dvorák as they sat in a circle on the main floor next to the stage, a mat over hardwoods where basketball players had run and dribbled a few days before. Yellow folding chairs lined the floor and were reserved for special guests. Indiana Governor Mitch Daniels signed autographs and had his picture taken with children who had access to the main floor. Tickets were not available to the general public.
People went in search of sodas and popcorn. There were chocolate chip cookies as big around as cereal bowls with red-white-and-blue icing spelling out “ USA.” A bright bank of lights stood above the media platform where TV cameras tilted on tripods.
Applause erupted and whoops and whistles. Cameras flashed. President Bush walked out. After introductions, the President took the podium and spoke.
“Thank you all. Please be seated. Thanks for coming.”
"More importantly, thanks for letting me come. We’re here to-"
“We’re here to have a dialogue with some of our fellow citizens about Social Security. But I’ve got some things I want to share with you before we get there.
“First, this is a serious conversation, and it’s an important conversation—a conversation about the future of the country.”
Whatever one believes about President Bush’s plan for overhauling the Social Security system, it is, indeed, time for a serious conversation about pensions, Social Security, and the economics of growing old in America.
The Elderly in America
The population in America is aging rapidly. Americans age 65 and older numbered 35.6 million in 2002. By the year 2030 with the retirement of the Baby Boomers, that group will double to roughly 71.5 million, according to the Administration on Aging, a division of the U.S. Department of Health and Human Services. Today about one in eight people in America is 65 or older. In 25 years, 20% of Americans will be senior citizens.
The average annual income of all people 65 years and older was $24,660 in 2002, according to the Social Security Administration. Married couples averaged $35,278, and unmarried men took home an annual $21,329. Single women lagged further behind with $16,819 in annual income.
“The biggest thing we run into with a person who is retiring is fear of running out of money,” said Rich Preuss (’82, ’80), owner of The Healy Group, a South Bend financial firm specializing in financial consulting, benefit planning and property and liability protection. “The older they get the greater that fear becomes. They don’t want to move back in with their children or be destitute.”
Currently two-thirds of the elderly count on Social Security as their major source of retirement income, said Doug Nguyen, Social Security Administration regional public affairs specialist. The average Social Security check is $995, he said. Some elderly also have pensions, assets and earnings from working.
Preparing Realistically for Retirement
Some workers may be overly optimistic about the standard of living they will have in the years immediately after retirement. Nearly half think they will have the same standard of living as immediately before retirement, and 19% think they will have a better standard of living, according to the 14th Retirement Confidence Survey, 2004. The survey was conducted by the American Savings Education Council (ASEC), the research firm Greenwald & Associates, and the Employee Benefit Research Institute (EBRI), a non-partisan, non-profit research organization focused on economic security and employee benefits.
More than 50% of Americans also believe they are eligible for full Social Security benefits earlier than they actually are, the survey found. Current full-benefit retirement ages range from 65 to 67 years old, depending on the year a person was born.
Americans also are scant savers. Not surprisingly, older workers generally have saved more than younger workers; nonetheless, more than half of all workers say they have put away less than $50,000 in total savings and investments, according EBRI.
“The fact is Americans are way undersaving,” said Preuss. “Our national savings rate is 1% or 2% of income. It is totally inadequate....What I advise my clients is to be saving at least 15% of their income if they start young—from age 30 on, say....When you’re in your 50s already, you don’t have the luxury of time or compound interest as much as you did when you were 30. I have a lot of clients who need to be putting away 40% of their income if they start late.”
Preuss said he sees situations in which older workers are in difficulty.
“I’ll have a 55- or 60-year-old come into my office and we’ll look and it’s obvious they won’t have enough for retirement,” he said. “They will have to adjust their standard of living way down, or they’re going to have to work longer or they’ll have to take more risk with their financial assets to try and get a higher rate of return. None of those are attractive alternatives.”
For workers who have pulled up a chair at the kitchen table with calculator in hand and tried to figure out how much money they’ll need in retirement, the amounts can be significant. Many financial planners say that the average retiree will need at least 70% of his or her annual pre-retirement income to live a modestly comfortable retirement, according to the survey. After age 65, the average American will live 17.5 more years, according to the Social Security Administration. To maintain 70% of a $60,000 annual income after age 65, Ballpark Estimate® of ASEC calculates that a worker will need to have saved about $451,000 during his or her working life. This figure assumes the individual receives current Social Security benefits of $14,500 throughout his retirement. This estimate also assumes a person will realize a constant real rate of return of 3% after inflation, is currently age 65 and retiring, and will live another 22 years. Individuals or married couples wanting a substantially higher standard of living in retirement would need to save several hundred thousand dollars more.
A shift is underfoot in America away from a public policy of caring collectively for the elderly toward a policy of individual responsibility. The private sector, through pensions, has transitioned toward a worker managing and investing his or her own plan and now that trend is spilling over into the public sector’s government programs.
“Twenty-five years ago, companies took care of workers. That’s not the case anymore,” said Accountancy Professor Fred Mittelstaedt, who specializes in pension research. “As state and federal governments run deficits, they may also reduce retirement benefits. It will be up to workers to take care of themselves.”
Retirement income is a three-legged stool, said Social Security’s Nguyen, made up of pensions, Social Security and private savings. Increasingly, workers must educate and prepare themselves to oversee each of these on their own.
Pensions in Transition
Until 30 years ago, many companies offered workers traditional pensions that sent out monthly checks for life. This gave workers great security in retirement. Many provided extensive spousal benefits as well. These so-called defined benefit plans were guaranteed by the federal government, through the Pension Benefit Guaranty Corporation (PBGC), in case a company went bankrupt.
These traditional pensions began disappearing because they weren’t very flexible, companies wanted to avoid the costs and risks, and the nature of work in America changed. By 1997, less than one in four workers was covered by a traditional defined benefit plan, according to EBRI.
Today, many more pension plans do not guarantee a monthly check in retirement, but instead companies contribute a certain amount of an employee’s salary each year to an investment vehicle. There is no certainty about how much money will be available to live on in retirement—that depends on the investing skills of the employee and the turns in the stock market. These defined contribution plans, such as 401(k)s, which were introduced in the 1980s, are numerous. They are also “portable”—able to be rolled over from one job to the next—and meet the needs of a mobile workforce.
Explaining the newer-style defined contribution plans, Mittelstaedt said, “...the plans define what goes in as opposed to what comes out. The employee, as opposed to the employer, is at risk for their retirement benefits.”
The advantage of a defined contribution plan is the employee has a choice in the funds he chooses to invest in and may potentially reap a higher return than in a traditional pension, especially if the worker changes jobs frequently. Mittelstaedt said some defined contribution plans can also be quite favorable when the company makes generous contributions. On the other hand, there are risks, especially for people living on the margin, who will be most financially vulnerable in retirement. The money may run out.
“In the case of 401(k)s, a concern is that low-income workers will not participate. High-income workers are in a better position to defer salary, and consequently, obtain larger employer matching contributions,” Mittelstaedt said. “When low-income workers are barely covering living expenses, they are less likely to contribute to the plan and take advantage of employer matching. By not taking advantage of employer matching, the employee is essentially giving back a portion of his compensation and foregoing retirement income.”
The Social Security Debate
Until recently, Social Security was considered untouchable. But today, similar to the transition in pensions, a shift from collective care to individual responsibility, with a portion of the funds, is being discussed. It is within this context that President Bush is promoting personal retirement accounts.
Social Security was created in 1935 at a time when 20% of Americans were unemployed and 10,000 banks had failed. One of the last industrialized countries in the world to create such a program, America designed its insurance system after the German model, launched in 1890 under Chancellor Otto Von Bismark.
The program was expanded in 1939 to provide survivor benefits to spouses and dependents of deceased workers, and in 1956 it was extended to disabled workers and their dependents. Today, roughly 37% of Social Security benefits are paid to survivors, the disabled and their dependents. Social Security was provided as a safety net and intended to constitute only a portion of retirement income, Nguyen said.
Notre Dame Economics Professor Teresa Ghilarducci said that Social Security has met its mandate to lift older Americans out of poverty. “It’s certainly a good thing when you look at the success of the Social Security system,” she said. “It is clearly a success. Both sides of the debate...recognize the important function of the government to prevent poverty among the elderly.”
Ghilarducci also points out that current Social Security provides $600,000 in life insurance and $400,000 in disability insurance to the average 27-year-old worker with a couple of dependents and a nonworking spouse, according to Social Security Administration data.
By now, most Americans have heard the familiar projections about the Social Security trust fund. If no intervention is taken by 2017, retirees will begin drawing more money out in benefits from the fund than is paid in taxes by a shrinking American workforce. The government would then begin to draw on the fund’s interest. In 2027 the fund would draw on its $5 trillion to $6 trillion principal, and if current trends continue, the surplus in the trust fund will be spent by 2041. At that time, the government would only be able to guarantee 74% of the existing benefit to retirees, paid by annual taxes on workers.
While once there was an intergenerational approach to social policy—my grandmother benefited from Social Security, so by extension, I have benefited—today’s “ownership society” demands a return on every dollar. Mittelstaedt said where Social Security is concerned, it is important to take a broader, intergenerational view.
“Sometimes the conversations are too narrow,” Mittelstaedt said. “The first generations of retirees to receive Social Security obtained huge direct returns because they had not contributed to the system. Later generations are in some ways still paying for this initial wealth transfer. However, the later generations also may have benefited indirectly through larger bequests left by the earlier beneficiaries and through having more family resources during childhood. Additionally, social programs are designed to benefit society at large. For example, when childless couples pay school taxes, they do not receive a direct return on their investment. Given that Social Security is also a social program, it is unclear to me why it should be singled out as giving inadequate direct returns.
“If no one has asked current workers to think about the other generations and the goals of Social Security, then it’s easy to understand why they might focus on the individual direct return.”
Whatever the structure, Preuss said he is not optimistic about the future of Social Security. “I can tell you most people my age or less that come through my office expect to get nothing from Social Security,” he said. “They have no confidence in the system because the government changes the rules.”
Equal Access Investing
As individuals become responsible for more of their retirement investing, the issue of access to financial information becomes important. Not only must American’s access it, but they must understand how to interpret it.
In an effort to create a level playing field, recent U.S. laws were passed to try to ensure that individual investors have access to the same up-to-the-minute Wall Street information as institutional and professional investors do. But with complex off-balance-sheet transactions, global financing and supply chains and repatriated profits, individual investors must dig deep into fund and company footnotes, time the market correctly, and find other ways to compete against very sophisticated investors in the marketplace.
Recent studies of small investor behavior with funds and individual stocks show a variety of results regarding savings.
An EBRI issues brief examining recently retired people (born between 1931 and 1941) found that roughly half of the study group saw at least a 50% increase in their total wealth between 1992 and 2002. Yet about 15% had lost at least half of their total wealth. And almost 10% of those starting out with less than $40,000 in assets lost all of their savings.
Finance Professors Rick Mendenhall and Robert Battalio studied the trading behavior of small investors buying and selling individual stocks. The study, “Earnings Expectations, Investor Trade Size, and Anomalous Returns Around Earnings Announcements,” found that small investors interpreted earnings data naively, used less-sophisticated methods of timing transactions and often bought when institutional investors sold.
Battalio drew an analogy between small investors buying individual stocks and amateurs playing professional sports.
“You know, I try to play basketball for the pros and I just can’t get there,” he said. “Same thing...”
Mendenhall recommended that small investors diversify and invest in index funds rather than trying to beat the market. “You should diversify broadly...a few to several mutual funds, within one family for convenience, and keep your costs low, stay the course, weather the storms,” he said. “And it seems to me like everyone knows that but apparently they don’t. Even bright, successful people don’t know that.”
Another study by Finance Professor Alok Kumar titled “Who Gambles in the Stock Market?”, based on individual stock trades between 1991 and 1996, found that individuals earning less than $15,000 annually were the most likely to gamble and take losses in the stock market. As people’s incomes rose, they made fewer poor choices.
Experts agree that increased financial education among workers is key to successful retirement planning. Also, access to one-on-one advising with a financial professional or group seminars are an advantage.
As America shifts from a communitarian system where companies and the government bore the responsibility for caring financially for the elderly to a system of individual choice and personal responsibility, there will be costs as well as benefits.
In sum, questions remain. Will most Americans pursue financial education? Who will teach them? What happens when an individual doesn’t invest as well as his neighbor or doesn’t save at all? Will there be the expectation that the government or companies step in? What is acceptable risk for the most financially vulnerable in society?
“I think that many people who invest in defined contribution plans think about the upside risk but not the downside risks,” said Mittelstaedt. “In general, I don’t think people assess risk very well.”
Where Social Security is concerned, the President remains optimistic and believes that Americans will rise to the occasion, taking charge of their futures.
“There is a myth in America that only certain people can be an investor, the investor class. You’ve heard that discussed before. I guess that’s kind of the pin-stripe, Wall Street types. That’s not what I think about America. I think everybody in this country has got the capacity to manage a personal account. I think everybody should be allowed to be able to take his or her own money and watch it grow over time.”
—Rachel Reynolds is the Director of Feature Writing at Mendoza College of Business and managing editor of Notre Dame Business.
Anyone wanting to calculate their retirement savings needs with the Ballpark Estimate® can go to www.asec.org