United States: U.S. Pension Policy Needs More Math and Less Politics

If more of our elected officials were experts in math instead of politics, America’s pension policy wouldn’t be in the fix it’s in now.

In Europe, where the pensions of current retirees are bankrolled by current workers, there’s a crisis because the average household produced fewer than two children.

Unlike Europe, which has a pension mandate, we in the U.S. have a voluntary system in which employers can either volunteer to foot the bill for its workers or decide to shift the bill to them. The crisis hasn’t hit yet but it will.

Before the 1980s, most of pensions were the "we’ll-foot-the bill" defined benefit variety, in which your boss paid the tab. The more egregious pension crisis, however, is with the "you-foot-the-bill" defined contribution plans—better known as 401(k) plans.

After the Enron debacle, everybody thought we could fix these plans by limiting the amount of company stock in the plan. But the biggest problem with 401(k) plan isn’t having all your eggs in one basket but not having enough eggs in the first place.

Contrary to their name, contributions in a 401(k) plan are rarely defined; rather Congress decides the annual maximum that 401(k) participants can give tax deferred—whether the participant’s salary is $30,000 or $300,000. In raising the maximum deferral amount from $10,000 to $15,000 as they did in 2001, Congress perpetuate the fiction that tax-relief incentives are a sufficient stimulus to transform Americans from spenders to savers. It also perpetuated the fiction that $15,000 a year is sufficient to bankroll a one-size-fits-all pension.

Americans aren’t savers because we’ve bought into the myth that spending like there’s no tomorrow boosts our affluence and gooses up the economy. In 2000, the personal savings rate was .1%, the lowest it’s been since the Great Depression. In 1974, the year that the Employee Retirement Income Security Act was enacted and the Individual Retirement Account was created, Americans socked away almost 10 cents of every dollar they made.

The only way to turn Americans into savers is the way millions of them were convinced to kick the cigarette habit—by warning them that NOT saving is ultimately hazardous to their retirement wealth. More importantly, we’ve got to show them the math: most American families need to amass about a $1 million or more in savings by the time they reach age 65 in order to generate a sufficient nest egg to last 25 or 30 years. And that simply can’t be accomplished unless they contribute to their 401(k) accounts for their entire 40-year career so that compound interest can perform its maximum magic. For that reason, the "catch-up contributions" recently enacted by Congress for people over age 50—a mere $1,000 in 2002-- is a remedy that’s too little and too late.

Right now Congress is fiddling while the clock is ticking. The first wave of baby boomers is scheduled to start retiring in eight years. If we wait until then to address the retirement crisis, it won’t be an expensive problem. It will be an unsolvable problem.