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The Twenty-First Century Retirement Model Is Coming into Focus

Walter Russell Mead

The transition away from the blue social model to something that works better under contemporary conditions is a difficult and complex process, and retirement planning is one of the most important areas for adjustment. Fortunately, we are starting to see progress on this front. The Wall Street Journal reports that companies are successfully encouraging workers to put away more money in 401(k) accounts, portable retirement plans that are well-suited to the demands of the modern economy:

Bosses are turning to a new way of convincing employees to save more: make them do it.

Companies from Apache Corp. to Google Inc. to Credit Suisse Group AG have boosted the percentage of worker paychecks automatically diverted to 401(k) plans well above the long-held standard of 3%.

Some are setting aside as much as 10% of their workers’ money or automatically increasing the amounts by 1% a year unless employees opt out. But not all are matching the increased savings with company contributions.

The moves are the latest attempt by companies to transfer the burden of retirement costs to workers. Millions of Americans aren’t putting enough money aside, despite reforms designed to bulk up nest eggs and encourage employees to sock away more. […]

Companies that have bumped up the default savings rate say they’ve been surprised by the lack of pushback from employees, who are free to lower their savings rate or opt out of the automatic increases.

In the glory days of the blue model, the basic retirement tool was simple: defined benefit pension plans offered by your employer. This meant that after retirement (and in blue model days many companies had compulsory retirement ages of around 65) you would, in addition to Social Security, get a lifetime pension from your employer based on a combination of your years of service and your salary.

Blue apologists defend this system as the ‘gold standard’ in retirement and they bitterly attack any move away from it as a destruction of worker rights and a form of class warfare. However, because the economy has changed, this system—which was never as fair or as benign as blue acolytes claim—no longer works very well for many people.

In today’s economy, job hopping is a normal and necessary part of successful careers. Industries rise and fall, companies shift product lines and operations. Also, peoples’ lives change. Women (and some men) leave the workforce or shift careers when children come. (In the old blue days so many people are nostalgic about, discrimination against women on the job was legal, and in many industries and companies women were extremely rare. The old pension system never worked well for working women.)

Defined benefit pension systems have rules that strongly favor long term workers. Workers often didn’t qualify for pensions until they worked a threshold number of years—if you left the company before you ‘vested’, you lost your pension benefits. And because length of service played a large role in calculating pension benefits, workers who changed jobs or careers often ended up with very small pensions. There have been heartrending cases of workers in manufacturing companies who lost everything when their jobs went abroad before they had worked enough years to collect a good pension. And in their 40s and 50s, many could not replace those jobs or the lost pension benefits.

Another consequence of the transition to a post-blue economy: a defined benefit pensions is less reliable. The pension plan is only as solid as the company that guarantees it. That might have been tolerable 50 years ago, when the American economy was more stable and less dynamic than it is now. But these days, companies can and do go bankrupt regularly. There aren’t many floppy disk manufacturers around and the phonograph needle manufacturing industry went belly up years ago. Even new economy companies like Netflix could see their business models swiftly upended by technological change. Accelerating technological change and increased global competition not only mean more job shifting; they mean that more companies go out of business—and that means more insecurity for people who are depending on a single employer to guarantee their life pensions.

So for reasons that have nothing to do with evil corporate greed, there is a strong case for moving from an employer centered pension system that favors life time employment to a worker centered, portable model.

That is what 401(k) plans are all about. Workers make contributions into tax deferred accounts; companies match those contributions depending on their policies, and over a career the pension follows the worker. This is good news: You can accumulate retirement savings all through your career, no matter how many different employers you have. You don’t lose if you change jobs, and you don’t lose out if your employer goes broke.

Ultimately, the new economy makes a new, worker-based pension system necessary. However, the shift isn’t happening smoothly and there are several problems. Some have to do with the transition from the old system to something new, some with the difficulties of setting up an appropriate regulatory and management system for something as complex and important as a retirement system on which tens of millions of elderly Americans of very different economic circumstances will depend. Finally, there is the problem of resistance: the opposition of interests who want to preserve the blue model system for various reasons.

The biggest problem for the transition has been under-saving. People whose parents relied on defined benefit systems haven’t grown up with the expectation that you need to make large, regular contributions into your retirement plan starting with your earliest years in the workforce. In many cases, younger workers and workers without a lot of spare cash failed to salt enough money away. As a result, we have a transitional generation whose retirement savings are way short of what they will likely need. That’s likely to be a big policy headache as the post-defined benefit generations hit old age.

As this Journal article shows, companies are beginning to respond. One response is ‘auto-enroll’, so that workers have to opt out of payroll deductions for their retirement plans rather than opting in. Another is to raise the default level of retirement contributions, so that workers are putting a higher percentage of their pay into these accounts. Increasing numbers of companies are also putting more into worker accounts, matching contributions. The Journal article suggests that these more effective methods are spreading through corporate America. That is a very positive sign.

However, there is still more to be done. Most Americans are not very knowledgable about financial markets and investing. This is partly a problem of blue model educational systems. The assumption was that most Americans could be financially passive, and that understanding financial markets beyond maybe credit cards and home mortgages wouldn’t be an important life skill. That was true in the days of defined benefit programs; it certainly isn’t anymore.

These days, responsible educators need to prepare students to be the master of their own financial fate—to understand basic investment principles, to manage a growing portfolio, to make smart choices about investment advisors and so on. (Public school K-12 educators, unlike most college teachers, still mostly have defined benefit plans, and many may not fully grasp the nature of the economy in which their students will have to make their way.) The average person is going to have to be smarter about money in a world in which most people can no longer rely on a single company to guarantee their financial future. This is just a fact, and our institutions have to get used to it.

It is also the case that a self-driven retirement system is going to require some changes in the financial services industry. Because retirement accounts are tax exempt and because they will increasingly be the main way that most families prepare for retirement, there is a solid case for regulation and oversight. The state needs the new system to work—otherwise, future budgets will be bloated by the demand of well organized seniors for the government to make up the shortfall in their savings.

Wall Street, sad to say, does not always have the interest of the small saver and investor at heart. Particularly in the transitional years, the financial service industry that deals with 401 (k)-type accounts must be regulated with these needs in mind. That doesn’t mean regulated to death as many nanny statists would like, but there is a happy medium between a regulatory straitjacket and the wild west. Getting this framework right, and keeping the costs of managing what will ultimately be vast asset pools down will be an important focus of financial markets policy for some time to come.

Federal, state and even local governments may also want to think about adding matching contributions for low income workers. Because the money will grow at compound interest, this is a relatively cheap way to ensure that more Americans can manage their retirements well, and to encourage more people to develop the habit of saving.

Finally, there is the question of resistance. Unions, for example, grew up in the blue era and, so far, have not been very successful at figuring out how they can survive and serve worker needs in our brave new world. Lifetime employment is increasingly a thing of the past, nimbleness matters more than stability for many companies, and global competition keeps rewriting the rules. All three of these trends disrupt the classic business model of trade unions, and there is a tendency to fight unwanted change instead of adjusting to it. Additionally, unions often have a role, a lucrative role in many cases, in managing traditional pension funds. They don’t want to give that up. And public sector unions, increasingly dominant in both the labor movement and Democratic party politics, want to keep public employment as blue as possible: lifetime employment and defined benefit pensions to go with it.

Yet opponents cannot fight reality forever. Worker-centered pension systems work better for working people under 21st century conditions than defined benefit pensions do. But critics are right that the new system isn’t finished yet. It still needs to be improved and further developed. Fortunately, trends like the ones described in the Journal article suggest that more change is on the way. At the moment, the American people are still caught in the transition between two different systems. That isn’t sustainable, and although the full range of changes we need can’t come overnight, progress needs to be made.

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