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The Specter Haunting Old Age

Working Longer: The Solution to the Retirement Income Challenge

by Alicia H. Munnell and Steven A. Sass
Brookings Institution Press, 288 pp., $29.95 (to be published in May)

The Conservatives Have No Clothes: Why Right-Wing Ideas Keep Failing

by Greg Anrig
Wiley, 304 pp., $25.95

The industrial revolution is more than two centuries old, but the first rich nations to provide for the retirement of their elderly did not do so until roughly a century ago. Until the late 1800s, when agriculture still dominated the newly industrializing economies, old people, especially in America, usually owned their farms or passed them on to their children, who looked after them. Those who worked the farms were also often taken in. Suffering among the elderly existed, of course, but life spans were relatively short.

As workers were forced off the farms and into factories and mines in the second half of the nineteenth century, however, more and more of them had no assets to fall back on, and the poverty of growing numbers of the elderly turned into a crisis that could no longer be ignored. Many people had to go on working until they were physically unable, and for most the possibility of a comfortable retirement did not exist.

In the late 1800s and early 1900s, as industrialization more fully transformed the old farm economies, continental Europe and Scandinavia began to establish government-run pension systems. But the US and Great Britain were slower to react. The US did not establish Social Security until 1935, fifteen to twenty-five years after similar programs were begun in many well-to-do European nations, and fifty years after Germany established its pioneering state system. Even Britain established a public pension program a generation before the US did.1

It was not until the post–World War II period, however, that many elderly Americans were able to maintain a standard of living in retirement that eventually came fairly close to the one they had as workers. At first, America’s Social Security benefits were small, but they were raised substantially over the next four decades, and financed by repeated increases in payroll taxes. At the same time, rapid US economic growth enabled corporations to expand their own pension programs aggressively. Some American companies, such as the Pennsylvania Railroad and American Express, had pioneered private pensions as early as the turn of the century, at first to encourage workers to retire. After World War II such company-sponsored pensions were designed to attract and keep workers in tight labor markets. The contributions to these plans were exempt from taxes. By the early 1960s the proportion of American workers with pension benefits had risen from 20 percent to more than 40 percent.

The corporate pension plans were far from adequate, however, often failing to invest sufficient funds to guarantee future benefits to all employees, imposing long job tenure requirements on workers before they qualified for their pensions, and using overly risky investment strategies. In 1974, the federal government passed new regulations requiring companies to correct many of these practices. The law also established the Pension Guaranty Benefit Corporation, a government insurance agency that would pay workers’ pensions if their companies failed.

By the 1970s, the combination of public and private pensions thus created an extraordinary new situation for many American workers: the prospect of a fairly comfortable old age. The average age at which men retired fell from nearly seventy-five in 1910 to less than sixty-five today. Still, benefits were linked with how long one worked and how much one earned. The tax exemption for pension contributions withheld from workers’ salaries cost the federal government tens of billions of dollars each year and contributions mostly benefited better-off workers who paid the highest tax rates. But the combined public and private system was, nevertheless, one of the remarkable achievements of twentieth-century American society. In the 1950s, one in three of the elderly lived in poverty; today, one in ten or so do.

Now, according to the British historian and political scientist Robin Blackburn, these gains are just as assuredly being reversed in the United States as well as in other rich nations, and lower-income workers hurt more than others. Blackburn believes that many elderly will fall back into outright poverty, be forced to take jobs in their late sixties and early seventies that are too demanding, if they can find jobs at all, and will be unable to afford needed health care as life spans increase and costs rise. Yet, as Blackburn writes in his impressive book Age Shock, there is little political interest in the problem: climate change, epidemics, nuclear proliferation—and in the US the rising costs of health care and the stagnation of wages—all seem more urgent and dramatic than the problem of poverty in old age.

To Blackburn, how rich nations treat their elderly is a measure of their decency and, perhaps more important, their ability to devise new ways of living. Modern societies now have the capacity to make old age a productive “third age,” he argues. But, as restraints on government spending become national priorities, and an ideology of privatization and free-market capitalism spreads, the hard-won state systems and the private pensions that supplement them have come under threat.

Blackburn is not talking about the solvency of Social Security. It is, he concedes, a serious concern, but like many analysts he believes that the expected shortfall between tax revenues and Social Security payments can be closed without great difficulty. The Social Security Administration, based on a seventy-five-year forecast, figures that as the proportion of elderly in the population increases, payroll taxes will not be adequate to meet the annual payouts by about 2041. It is true that all the rich Western nations, as well as Japan, are aging rapidly. In the US, the process is occurring less rapidly than in other countries, but as large numbers of people reach retirement age, the proportion of workers to retired people is shrinking. In the US, there are now somewhat more than three workers for every retired person, but by 2030, there will be only two.

If current estimates are right, and they may well be pessimistic, to make the system solvent will require raising social security taxes two percentage points, or reducing benefits by an equivalent amount. The current payroll tax for Social Security is 12.4 percent of wages, and another 3 percent is required for Medicare, shared equally by the employer and employee. Raising taxes will not be easy, but it is certainly manageable. Even if taxes were not raised, Social Security will still be able to pay 75 percent of its benefits after 2041. That’s hardly the end of the system.

Less well known, however, is that even if Social Security is made solvent, its benefits as a proportion of a worker’s average income over a lifetime will recede significantly in the next two decades. First, because of changes made in the 1980s, the retirement age is being raised step by step to sixty-seven, reducing the payout over the years. Second, Medicare payments for hospitalization are taken out of Social Security checks and these will continue to rise rapidly. Third, more of the income from Social Security will be subject to income tax because companies will not be required to adjust existing exemptions upward to reflect inflation. As a result, Alicia Munnell and Steven Sass, of the Center for Retirement Research at Boston College, predict in their forthcoming book, Working Longer: The Solution to the Retirement Income Challenge, that Social Security benefits will, on average, replace only 30 percent of pre-retirement income for a retiree in the middle of the income distribution by 2030, compared to 40 percent today.2 This “replacement state” may in fact be less than 30 percent because the reductions do not include the premiums retirees will have to pay for the new Social Security drug prescription plan.

At the same time, private retirement plans offered by employers are likely to replace a smaller share of income as well—for some a far smaller share. One problem is that many large companies are increasingly defaulting on their payments, including Bethlehem Steel, Kemper Insurance, US Airways, and Polaroid. The Pension Benefit Guaranty Corporation compensates for only part of these unpaid liabilities, and even so its obligations are soaring.

In his recent book, The Great Risk Shift, Yale political scientist Jacob Hacker describes what happened to the family of Victor Saracini, the pilot of the United Airlines jet plane that was the second to crash into the World Trade Center on September 11, 2001. UAL declared bankruptcy the following year and turned over its pension liabilities to the Pension Benefit Guaranty Corporation. But the government agency imposes a maximum on the amount it will guarantee for any single worker, leaving Vincent’s widow, Ellen Saracini, with only half the retirement income the company promised.

The second and more widespread concern is that the traditional pensions, known as defined benefit plans, are being abandoned rapidly in favor of personal savings plans, known as defined contribution plans. These newer employer-sponsored plans—mostly 401(k)s—are not backed by the Pension Benefit Guaranty Corporation and can be far more risky for workers. Today, some three in five workers have such a plan—compared to one in five with traditional pension plans. In the early 1980s, it was the reverse. In the 401(k) plans, workers contribute from every paycheck; the amount they contribute and any income earned on the savings are exempt from taxes until withdrawn on retirement. Employers typically also supplement employee contributions. Among the attractions of the personal savings plans is that they are completely portable; a worker has them for life, regardless of whether the employer changes. A worker who leaves a job with a traditional pension, by contrast, will often lose some or all of the benefits because they are tied to years of work at that company.

But unlike traditional pensions, the personal savings plans rely on workers themselves to decide whether and how much to contribute, after which companies may also also match or otherwise contribute to the worker’s plan. And workers on average are not contributing nearly enough to sustain retirement income that is comparable to that of the old-style pensions. Economists estimate that a worker with a median salary of roughly $45,000 today who is enrolled in a 401(k) for his or her working life and contributes 6 percent of each paycheck to the account would accumulate some $300,000 discounted for inflation by age sixty-five. Yet as of 2004, Munnell and Sass observe, the typical worker aged fifty to sixty-four had actually accumulated only $50,000 or so through a 401(k) or similar kind of plan—enough to replace only 10 or 20 percent of pre-retirement income.

Workers also must manage their own investments in 401(k) plans, usually through arrangements made by the companies with financial institutions that administer the company plan and offer a variety of investment options with lesser or greater degrees of risk. Many workers have little idea how to manage these sophisticated investments and will lose—or have already lost—a large part of their holdings. Nothing is quite so telling regarding contemporary greed as the 2005 documentary The Smartest Guys in the Room, which showed Jeffrey Skilling, the CEO of Enron, urging his employees to invest their 401(k) savings in Enron stock—rather than in a diversified range of investments—while he was selling his own shares.3

  1. 1

    Alicia H. Munnell and Steven A. Sass, Social Security and the Stock Market: How the Pursuit of Market Magic Shapes the System (W.E. Upjohn Institute for Employment Research, 2006), pp. 21–27.

  2. 2

    The average is roughly measured in current dollars to take account of inflation.

  3. 3

    Directed by Alex Gibney and based on the book of the same name by Bethany McLean and Peter Elkind (Portfolio, 2003).

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