[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
STRENGTHENING WORKER RETIREMENT SECURITY
=======================================================================
HEARING
before the
COMMITTEE ON
EDUCATION AND LABOR
U.S. House of Representatives
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, FEBRUARY 24, 2009
__________
Serial No. 111-3
__________
Printed for the use of the Committee on Education and Labor
Available on the Internet:
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COMMITTEE ON EDUCATION AND LABOR
GEORGE MILLER, California, Chairman
Dale E. Kildee, Michigan, Vice Howard P. ``Buck'' McKeon,
Chairman California,
Donald M. Payne, New Jersey Senior Republican Member
Robert E. Andrews, New Jersey Thomas E. Petri, Wisconsin
Robert C. ``Bobby'' Scott, Virginia Peter Hoekstra, Michigan
Lynn C. Woolsey, California Michael N. Castle, Delaware
Ruben Hinojosa, Texas Mark E. Souder, Indiana
Carolyn McCarthy, New York Vernon J. Ehlers, Michigan
John F. Tierney, Massachusetts Judy Biggert, Illinois
Dennis J. Kucinich, Ohio Todd Russell Platts, Pennsylvania
David Wu, Oregon Joe Wilson, South Carolina
Rush D. Holt, New Jersey John Kline, Minnesota
Susan A. Davis, California Cathy McMorris Rodgers, Washington
Raul M. Grijalva, Arizona Tom Price, Georgia
Timothy H. Bishop, New York Rob Bishop, Utah
Joe Sestak, Pennsylvania Brett Guthrie, Kentucky
David Loebsack, Iowa Bill Cassidy, Louisiana
Mazie Hirono, Hawaii Tom McClintock, California
Jason Altmire, Pennsylvania Duncan Hunter, California
Phil Hare, Illinois David P. Roe, Tennessee
Yvette D. Clarke, New York Glenn Thompson, Pennsylvania
Joe Courtney, Connecticut
Carol Shea-Porter, New Hampshire
Marcia L. Fudge, Ohio
Jared Polis, Colorado
Paul Tonko, New York
Pedro R. Pierluisi, Puerto Rico
Gregorio Kilili Camacho Sablan,
Northern Mariana Islands
Dina Titus, Nevada
[Vacant]
Mark Zuckerman, Staff Director
Sally Stroup, Republican Staff Director
C O N T E N T S
----------
Page
Hearing held on February 24, 2009................................ 1
Statement of Members:
Andrews, Hon. Robert E., a Representative in Congress from
the State of New Jersey, submission for the record......... 150
McKeon, Hon. Howard P. ``Buck,'' Senior Republican Member,
Committee on Education and Labor........................... 4
Prepared statement of.................................... 6
McMorris Rodgers, Hon. Cathy, a Representative in Congress
from the State of Washington, prepared statement of........ 147
Miller, Hon. George, Chairman, Committee on Education and
Labor...................................................... 1
Prepared statement of.................................... 3
Additional submissions:
``10 Myths About 401(k)s--And the Facts''............ 74
Matthew D. Hutcheson, independent pension fiduciary,
statement of....................................... 77
The American Society of Pension Professionals &
Actuaries (ASPPA), statement of.................... 83
The Profit Sharing/401k Council of America (PSCA),
statement of....................................... 88
Ariel/Schwab Black Investor Survey, Internet address
to................................................. 109
Mellody Hobson, president, Ariel Investments, LLC and
chairman, Ariel, statement of...................... 109
The American Benefits Council, statement of.......... 110
National Organization for Competency Assurance,
statement of....................................... 122
Questions submitted to the witnesses for the record.. 134
Titus, Hon. Dina, a Representative in Congress from the State
of Nevada, prepared statement of........................... 149
Statement of Witnesses:
Baker, Dean, co-director, Center for Economic and Policy
Research................................................... 18
Prepared statement of.................................... 20
Responses to questions for the record.................... 138
Bogle, John C., founder and former chief executive of the
Vanguard Group............................................. 8
Prepared statement of.................................... 10
Responses to questions for the record.................... 138
Munnell, Alicia, director, Center for Retirement Research,
Boston College and Peter F. Drucker professor of management
sciences................................................... 24
Prepared statement of.................................... 26
Center for Retirement Research article, dated February
2009................................................... 95
Responses to questions for the record.................... 141
Stevens, Paul Schott, president and CEO, Investment Company
Institute (ICI)............................................ 36
Prepared statement of, Internet address to............... 38
Additional submission.................................... 39
Responses to questions for the record.................... 145
STRENGTHENING WORKER
RETIREMENT SECURITY
----------
Tuesday, February 24, 2009
U.S. House of Representatives
Committee on Education and Labor
Washington, DC
----------
The committee met, pursuant to call, at 10:32 a.m., in room
2175, Rayburn House Office Building, Hon. George Miller
[chairman of the committee] presiding.
Present: Representatives Miller, Kildee, Payne, Andrews,
Scott, Woolsey, Hinojosa, McCarthy, Kucinich, Wu, Holt, Bishop
of New York, Sestak, Loebsack, Hirono, Altmire, Hare, Courtney,
Shea-Porter, Fudge, Polis, Titus, McKeon, Castle, Biggert,
Platts, Kline, Price, Guthrie, and Roe.
Staff present: Aaron Albright, Press Secretary; Tylease
Alli, Hearing Clerk; Lynn Dondis, Labor Counsel, Subcommittee
on Workforce Protections; Carlos Fenwick, Policy Advisor,
Subcommittee on Health, Employment, Labor and Pensions; David
Hartzler, Systems Administrator; Ryan Holden, Senior
Investigator, Oversight; Jessica Kahanek, Press Assistant;
Therese Leung, Labor Policy Advisor; Sara Lonardo, Junior
Legislative Associate, Labor; Joe Novotny, Chief Clerk; Megan
O'Reilly, Labor Counsel; Rachel Racusen, Communications
Director; Meredith Regine, Junior Legislative Associate, Labor;
Michele Varnhagen, Labor Policy Director; Mark Zuckerman, Staff
Director; Cameron Coursen, Minority Assistant Communications
Director; Ed Gilroy, Minority Director of Workforce Policy; Rob
Gregg, Minority Senior Legislative Assistant; Alexa
Marrero,Minority Communications Director; Jim Paretti, Minority
Workforce Policy Counsel; Ken Serafin, Minority Professional
Staff Member; and Linda Stevens, Minority Chief Clerk/Assistant
to the General Counsel.
Chairman Miller [presiding]. The House Committee on
Education and Labor will come to order. And we meet today to
explore the shortcomings in our nation's retirement system and
look at solutions, so that Americans can enjoy a safe and
secure retirement.
The current economic crisis has exposed deep flaws in our
nation's retirement system. These flaws were mostly hidden when
the market was doing well. Since the beginning of this crisis,
trillions of dollars have evaporated from workers' 401(k)
accounts. Millions of workers have seen a significant portion
of their retirement balance vanish in just a few short months.
The committee heard testimony last year that the decline
has forced many workers to consider postponing retirement or
rejoining the workforce if they have already retired. For many
retirees coping with rising costs for health care and other
basic expenses, this loss in income is simply devastating.
For too many Americans, 401(k) plans have become little
more than a high stakes crap shoot. If you don't take your
retirement savings out of the market before the crash, you are
likely to take years to recoup your losses, if at all.
As a result, we are realizing that Wall Street's guarantee
of predictable benefits and peace of mind throughout retirement
was nothing more than a hollow promise. And many more are
questioning whether our nation's retirement system as a whole
is sufficient to ensure retirement security.
Workers and retirees have historically depended upon three
sources of income during retirement: from the defined
contribution plans, defined benefit plans and other savings and
Social Security. One leg of our retirement system is Social
Security, and this program has never looked better than it does
today. When you consider the trillions that employees have lost
in retirement investments, thank goodness we didn't get sucked
into gambling with Social Security funds in the Wall Street
casino.
Another leg is traditional pension plans. But over the last
two decades, many companies have unceremoniously frozen or
terminated pension plans. Defined contribution plans, including
401(k)s, and other savings make up the third leg of our
nation's retirement system. However, the 401(k) is not the
supplemental retirement plan as it was originally designed. In
fact, more than two-thirds of the workers with retirement plans
rely solely on 401(k)-type plans as their primary retirement
vehicle.
While 401(k)s are a fact of life, this committee has found
that these plans in their current form do not and will not
provide sufficient retirement security for the vast majority of
Americans. This is why, in the short term, we must preserve and
strengthen the 401(k)s. Hidden fees and conflicts of interest
must be rooted out. And 401(k)s need to be run in the interest
of the account holder, not the financial service industry.
Wall Street middle men live off the billions they generate
from 401(k)s by imposing hidden and excessive fees that swallow
up workers' money. Over a lifetime of work, these hidden fees
can take an enormous bite out of workers' accounts.
Last Congress, I proposed a bill that would require simple
and straightforward disclosure of 401(k) fees. And Wall Street
opposed it. The ferocity of Wall Street's response to simple
fee disclosure leads me to believe that they do not want 401(k)
account holders to find out the billions they skim from
Americans' hard-earned savings.
I finally believe that workers have the right to know
exactly how much is taken from their accounts. Every penny
contributed to a 401(k) account is the worker's money, and it
should be used for the worker's retirement.
In addition, as one of our witnesses will testify today,
the interests of investment managers selling retirement
products to workers do not line up with the interests of the
account holders. Too often, the most marketed investment
options are the worst for workers in terms of expense and
performance.
Finally, in the long term, we should ask ourselves whether
our current system gives workers the ability to ensure a safe
and secure retirement. Witnesses appearing today will discuss
how the decades-old realignment of our retirement system is
putting enormous stress on the Americans' retirement security.
Being able to save for retirement after a lifetime of hard
work has always been a core tenet of the American dream.
Retirees ought to have financial security that allows them to
focus on family and friends without sacrificing their standard
of living. In the short-term, Congress must address ways to
improve defined contribution plans. The 401(k) needs to be more
transparent, fair and operated on behalf of account holders,
not Wall Street firms.
But, we must also ask the difficult questions about the
state of our nation's retirement system as a whole and look to
see whether we need to create a new leg of retirement security.
I hope this marks the beginning of an open and frank discussion
on where we are today and what we need to do as a country to
create a retirement system that works for all Americans, not
just the fortunate few.
In the coming weeks and months, this committee and Mr.
Andrews' subcommittee will be exploring these issues. And I
look forward to the testimony of today's witnesses. And with
that, I would like to recognize Congressman McKeon, my
colleague from California, who is the senior Republican on the
committee for his opening statement.
Prepared Statement of Hon. George Miller, Chairman, Committee on
Education and Labor
The Education and Labor Committee meets today to explore
shortcomings in our nation's retirement system and look at solutions so
that Americans can enjoy a safe and secure retirement.
The current economic crisis has exposed deep flaws in our nation's
retirement system. These flaws were mostly hidden when the market was
doing well.
Since the beginning of this crisis, trillions of dollars have
evaporated from workers' 401(k) accounts. Millions of workers have seen
a significant portion of their retirement balance vanish in just a few
short months.
The committee heard testimony last year that the decline has forced
many workers to consider postponing retirement or rejoining the
workforce if they have already retired. For many retirees coping with
rising costs for health care and other basic expenses, this loss in
income is simply devastating.
For too many Americans, 401(k) plans have become little more than a
high stakes crap shoot. If you didn't take your retirement savings out
of the market before the crash, you are likely to take years to recoup
your losses, if at all.
As a result, we are realizing that Wall Street's guarantees of
predictable benefits and peace of mind throughout retirement was
nothing more than a hallow promise.
And, many more are questioning whether our nation's retirement
system as a whole is sufficient to ensure retirement security.
Workers and retirees have historically depended on three sources of
income during retirement--from defined contribution plans, defined
benefit plans and other savings, and Social Security.
One leg of our retirement system is Social Security, and this
program has never looked better. When you consider the trillions that
employees have lost in retirement investments, thank goodness we didn't
get suckered into gambling Social Security funds at the Wall Street
casino.
Another leg is traditional pension plans.
But over the last two decades, many companies have unceremoniously
frozen or terminated pension plans.
Defined contribution plans, including 401(k)s, and other savings
make up the third leg of our nation's retirement system.
However, the 401(k) is not the supplemental retirement plan as it
was originally designed.
In fact, more than two-thirds of workers with retirement plans rely
solely on 401(k) type plans as their primary retirement vehicle.
While 401(k)s are a fact of life, this committee has found that
these plans in their current form do not and will not provide
sufficient retirement security for the vast majority of Americans.
That is why in the short term, we must preserve and strengthen
401(k)s.
Hidden fees and conflicts of interest must be rooted out.
And, 401(k)s need to be run in the interest of account holders, not
the financial services industry.
Wall Street middle men live off the billions they generate from
401(k)s by imposing hidden and excessive fees that swallow up workers
money. Over a lifetime of work, these hidden fees can take an enormous
bite out of workers accounts.
Last Congress, I proposed a bill that would require simple and
straightforward disclosure of 401(k) fees. Wall Street opposed it.
The ferocity of Wall Street's response to simple fee disclosure
leads me to believe that they do not want 401(k) account holders find
out the billions they skim from Americans' hard-earned savings.
I firmly believe that workers have the right to know exactly how
much is taken from their accounts. Every penny contributed to a 401(k)
is the worker's money and it should be used for the worker's
retirement.
In addition, as one of our witnesses will testify today, the
interest of the investment managers selling retirement products to
workers do not line up with the interests of account holders.
Too often, the most marketed investment options are the worst for
workers in terms of expense and performance.
Finally, in the long term, we should ask ourselves whether our
current system gives workers the ability to ensure a safe and secure
retirement.
Witnesses appearing today will discuss how the decades-old
realignment of our retirement system is putting enormous stress on
Americans' retirement security.
Being able to save for retirement after a lifetime of hard work has
always been a core tenet of the American Dream. Retirees ought to have
financial security that allows them to focus on family and friends
without sacrificing their standard of living.
In the short-term, Congress must address ways to improve defined
contribution plans. The 401(k) needs to be more transparent, fair, and
operated on behalf of the account holder, not Wall Street firms.
But, we must also ask the difficult questions about the state of
our nation's retirement system as a whole and look to see whether we
need to create a new leg of retirement security.
I hope this marks the beginning of an open and frank discussion on
where we are today and what we need to do as a country to create a
retirement system that works for all Americans, not just the fortunate
few.
In the coming weeks and months, this committee and Mr. Andrews'
subcommittee will be exploring all these issues.
I look forward to today's testimony.
______
Mr. McKeon. Good morning, and thank you, Chairman Miller.
Last fall, as our nation's financial crisis was worsening,
the committee held several hearings devoted to the effects of
this crisis on retirement savings. We heard some troubling
testimony about the state of our nation's economic affairs, its
impact on workers and retirees and a range of proposals for
solutions. Some, I think, we would all agree upon. Others were
and remain far more controversial.
As I noted in the fall, our economy is in the midst of a
serious downturn, constrained by a global credit crisis and
burdened by the weight of toxic assets that have made it more
difficult for businesses large and small to maintain their day-
to-day operations, much less to create the new jobs our economy
needs.
And while it would be easy to dismiss the woes of the stock
market as merely impacting the wealthy, the reality is that
millions of Americans rely on investments in planning for
retirement. Because of this, a downturn in our financial
markets can have a real impact on workers' retirement security.
While the two major types of retirement plans, defined-
contribution and defined-benefit, have many differences, both
are impacted by the overall health of our economic system and
by investment performance in particular. 401(k)-type savings
plans are invested directly, usually managed by workers.
Defined-benefit plans require plan sponsors to manage millions
in assets over a period of many decades.
With the collapse in recent years of a number of defined-
benefit plans, we have seen the risk to workers and retirees
when plans are not effectively managed, or when benefits are
over-promised and under-delivered.
I understand that the bulk of our examination today will be
devoted to 401(k) plans and the defined contribution pension
system. I welcome this examination and trust that the
information we hear today will be of use to us.
I would caution, however, that to the extent we focus on
one side of the equation, the defined contribution side, we
must not ignore the other. It may be tempting this morning to
talk about the risks associated with defined contribution
plans, and how workers would be so much better off if they were
all in defined benefit plans. I think that simply misstates the
case.
As the Chairman well knows, our nation's defined benefit
plans are facing historic challenges in the wake of our
financial collapse. While workers with retirement savings in
401(k) plans are rightly worried about what the market is doing
in their retirement plans, workers in defined benefit plans
face their own worries about whether their companies will still
be standing, whether their jobs will still be there and whether
their promised benefits will be delivered in the wake of this
financial turmoil. I hope the Committee will pay the same
attention to those issues as we move forward.
Second, I hope that this morning's hearing will acknowledge
the full scope of the challenges facing Americans planning for
or entering retirement. I expect we will hear at some length
about fee disclosure in 401(k) plans and the need for
improvement. I know this is an issue of particular concern to
you, Chairman Miller, and one on which I expect we will again
see legislation in this Congress.
As I made clear last fall, I think all of us would support
improved disclosure that is meaningful and useful to
participants. And the question of how we go about that
improvement is a fair question for today's hearing.
I would caution, however, that we not suggest that
investment fees are to blame for the dramatic declines in
retirement savings which our nation's workers and retirees have
seen as a result of this historic financial crisis.
In a year where the S&P 500 lost 38 percent of its value,
to suggest that the problem is merely one of investment fees is
simply not factual or helpful. And indeed, on that point, it
bears note that while the S&P lost almost 40 percent of its
value, the best numbers available now suggest that the average
workplace retirement savings account lost 27 percent of its
value--still a difficult loss, but it does suggest that plans
can and will vary with performance and their management.
Finally, I think it is important to recognize that while
our defined contribution system could be improved, it would be
a real mistake to dismantle it, or nationalize it, as has been
suggested in this committee in the past. We have a heavy
responsibility in both the legislation we pass and the debates
we undertake.
In particular, I would make clear that now is not the time
to frighten people out of the market. Triggering a widespread
exodus from the system would only exacerbate the market's
downward trend, while cementing those deep losses. I hope
members and witnesses will keep this in mind with their
comments, their remarks today.
Given the fact that, historically and over time, these
plans have become vital retirement savings vehicles for
millions of Americans, I am very mindful that we do not take
any step, even our conversations, to discourage that this
morning.
With that, I welcome our witnesses and look forward to
their testimony and yield back.
Prepared Statement of Hon. Howard P. ``Buck'' McKeon, Senior Republican
Member, Committee on Education and Labor
Good morning, and thank you, Chairman Miller.
Last fall, as our nation's financial crisis was worsening, the
Committee held several hearings devoted to the effects of this crisis
on retirement savings. We heard some troubling testimony about the
state of our nation's economic affairs, its impact on workers and
retirees, and a range of proposals for solutions. Some I think we would
all agree upon. Others were and remain far more controversial.
As I noted in the fall, our economy is in the midst of a serious
downturn, constrained by a global credit crisis and burdened by the
weight of toxic assets that have made it more difficult for businesses
large and small to maintain their day-to-day operations, much less to
create the new jobs our economy needs. And while it would be easy to
dismiss the woes of the stock market as merely impacting the wealthy,
the reality is that millions of Americans rely on investments in
planning for retirement. Because of this, a downturn in our financial
markets can have a real impact on workers' retirement security.
While the two major types of retirement plans--defined-contribution
and defined-benefit--have many differences, both are impacted by the
overall health of our economic system and by investment performance in
particular. 401(k)-type savings plans are invested directly, usually
managed by workers. Defined-benefit plans require plan sponsors to
manage millions in assets over a period of many decades. With the
collapse in recent years of a number of defined-benefit plans, we have
seen the risk to workers and retirees when plans are not effectively
managed, or when benefits are over-promised and under-delivered.
I understand that the bulk of our examination today will be devoted
to 401(k) plans, and the defined contribution pension system. I welcome
this examination, and trust that the information we hear today will be
of use to us. I would caution, however, that to the extent we focus on
one side of the equation--the defined contribution side--we must not
ignore the other. It may be tempting this morning to talk about the
risks associated with defined contribution plans, and how workers would
be so much better off if they were all in defined benefit plans. I
think that simply misstates the case.
As the Chairman well knows, our nation's defined benefit plans are
facing historic challenges in the wake of our financial collapse. While
workers with retirement savings in 401(k) plans are rightly worried
about what the market is doing to their retirement plans, workers in
defined benefit plans face their own worries about whether their
companies will still be standing, whether their jobs will still be
there, and whether their promised benefits will be delivered in the
wake of this financial turmoil. I hope the Committee will pay the same
attention to these issues as we move forward.
Second, I hope that this morning's hearing will acknowledge the
full scope of the challenges facing Americans planning for, or
entering, retirement. I expect we will hear at some length about ``fee
disclosure'' in 401(k) plans, and the need for improvement. I know this
is an issue of particular concern to you, Chairman Miller, and one on
which I expect we will again see legislation in this Congress. As I
made clear last fall, I think all of us would support improved
disclosure that is meaningful and useful to participants. And the
question of how we go about that improvement is a fair question for
today's hearing.
I would caution, however, that we not suggest that investment fees
are to blame for the dramatic declines in retirement savings which our
nation's workers and retirees have seen as result of this historic
financial crisis. In a year where the S&P 500 lost 38 percent of its
value, to suggest that the ``problem'' is merely one of investment fees
is simply not factual or helpful. And indeed, on that point, it bears
note that while the S&P lost almost 40 percent of its value, the best
numbers available now suggest that the average workplace retirement
savings account lost 27 percent of its value--still a difficult loss,
but it does suggest that plans can and will vary with performance and
their management.
Finally, I think it is important to recognize that while our
defined contribution system could be improved, it would be a real
mistake to dismantle it, or nationalize it, as has been suggested in
this Committee in the past. We have a heavy responsibility in both the
legislation we pass and in the debates we undertake. In particular, I
would make clear that now is not the time to frighten people out of the
market. Triggering a widespread exodus from the system would only
exacerbate the market's downward trend, while cementing these deep
losses. I hope Members and witnesses will keep this in mind with their
remarks today. Given the fact that historically, and over time, these
plans have become vital retirement savings vehicles for millions of
Americans, I am very mindful that we do not take any step, even in our
conversations, to discourage that this morning.
With that, I welcome our witnesses and look forward to their
testimony. I yield back.
______
Chairman Miller. I thank the gentleman for his statement.
And I would just, if I might remark on it, it is the intent of
the chair of this committee to have an exhaustive set of
hearings on pension security in this country, including public
plans, including defined benefit plans, including the Pension
Guaranty Corporation, under the of leadership of Mr. Andrews
and his subcommittee.
As I said earlier, the market shined a light on serious
problems with 401(k) plans, it is also shining the light on
serious problems with other pension plans in terms of,
certainly, the expectations of the participants, but also their
ability to deliver.
Thank you to all of the witnesses for agreeing to testify
today and to give us the benefit of your experience and
expertise.
Our first witness will be John C. Bogle who is the founder
and former chief executive of Vanguard, the mutual fund
organization he created in 1974. While at Vanguard, Mr. Bogle
founded the first indexed mutual fund. And Vanguard is now
among the largest mutual fund organizations in the world with
current assets totaling over $1 trillion. Mr. Bogle received
his BA Princeton University.
Dr. Dean Baker is the co-director of the Center of Economic
and Policy Research, which he founded in 1999. Dr. Baker is the
author of many books on economic issues, including Plunder and
Blunder, the Rise and Fall of the Bubble Economy. He received a
BA from Swarthmore College and his Ph.D. in Economics from the
University of Michigan.
Dr. Alicia H. Munnell is Peter Drucker professor of
management sciences at Boston College's Carol School of
Management and also serves as the Director for the Center of
Retirement Research in Boston College. Prior to joining Boston
College, she served during the Clinton Administration as both
the Treasury Department and the Social Security Administration.
Dr. Munnell has earned her BA from Wellesley College, and MA
from Boston University, and a Ph.D. from Harvard University.
Paul Schott Stevens has served as president and chief
executive officer of the Investment Company Institute since
2004. Outside ICI, Mr. Stevens' career included various roles
in private law practice as corporate counsel and in government
service. Mr. Stevens received his BA from Yale University and
received his JD from the University of Virginia.
Mr. Bogle, you are 80 years old. And we are still worried
about where you went to college. It is kind of interesting,
isn't it? We keep going back in time. Anyway, we are going to
begin with you. A green light will go on when you begin to
testify. Then there will be an orange light after 4 minutes.
We would suggest that you think about wrapping up your
statement at that time. But we want you to finish your thoughts
and the purposes of your testimony. And then we will open it up
for questions from the committee.
We will go through all of the witnesses first for your
testimony. And I believe you are going to have to turn on your
mike, Mr. Bogle. And again, welcome to the committee. And we
look forward to your testimony.
STATEMENT OF JOHN C. BOGLE, FOUNDER, VANGUARD GROUP
Mr. Bogle. All right. Am I on the air now?
Chairman Miller. You are on the air.
Mr. Bogle. All right. Well, good morning, Chairman Miller,
and thank you. And members of the committee, thank you for your
invitation to join you today to talk about some things that
have been on my mind for a very long time.
I think it is perhaps best for me to begin by summarizing
the ideal system that I think is the ideal system for
retirement today.
Chairman Miller. We are going to bring the mike a little
closer to you.
Mr. Bogle. Okay, very good--that I have outlined in my
statement. Number one, for individual savers who have the
financial ability to save for retirement, there would be a
single defined contribution plan structured, consolidating all
those 401(k), IRAs, Roth IRAs, 403(b)s and so on, a defined
contribution system, a unitary defined contribution system that
would be open to all of our citizens.
It would be dominated by low-cost, even mutual, providers
of services, yes, inevitably focused on all market index funds,
investing for the long term and overseen by a newly created
federal retirement board that would establish sound principles
for the private sector to observe, and asset allocation and
diversification, in order to assure appropriate investment risk
for each participant in the system, and also to assure full
disclosure of all plan costs.
The board, in essence, would also restrict loans very
greatly from the system and preclude cash outs when employees
change jobs, and would also appraise and approve qualified
service providers.
Number two, the idea of number one, is to establish
appropriate investment risk, something we have lost sight of
for individuals. And point two is to deal with longevity risk,
that other great risk to retirement security that we outlive
our resources, mitigated by creating a simple, low-cost annuity
plan as a mandatory offering at some point in all DC plans,
with some portion of each participants' balance going into this
option on retirement.
And number three, and most importantly, we should extend
the existing ERISA requirement that plan sponsors,
corporations, meet a standard of fiduciary duty to encompass
mutual fund planned providers as well. In fact, I think we need
to go further.
I believe we need a federal standard of fiduciary duty for
all money managers who are agents, who in my opinion have
failed abjectly in their responsibility to serve first the
interest of their principals, all those mutual fund shareowners
and pension beneficiaries. Therefore these agents bear a heavy
responsibility for the financial crisis we are now facing.
Now, why do we have to reform the system? Well, we need a
new system of worker retirement security, because the present
system is imperiled and is headed toward a train wreck of
considerable force.
It is not just the 50 percent plus the client in stock
prices that we have seen, with $10 trillion, almost $10
trillion of market value erased, some of which--I should
importantly--I can't deal with it in my opening statement. But
it is in my testimony and my prepared statement, some of which
represented speculative phantom wealth, overvalued markets
developed by speculators that are described in the statement.
So some of the wealth that has evaporated was phantom wealth.
But that only begins that market decline, that big loss,
the list of reasons for retirement plans to change the system,
the problems that we have created in the system. Retirement
plans own about half of all U.S. stock. And in turn, they have
borne about $5 trillion of the $10 trillion decline, a
whopping--I am using 30 percent, Congressman. But 27 percent
might be a better number--a whopping 27 percent hit to the
retirement system itself.
So we are not saving nearly enough. We now know, for
retirement, corporations have been stingy in funding their
defined benefit plans. And they assumed higher levels of
return, they are even remotely capable of achieving. They are,
in effect, a bad joke, the future 8.5 percent returns these
retirement plans were claiming before the great fall of the
market last year. And in addition, they have been derelict in
funding their defined contribution plans, largely 401(k)s,
which have a balance of a pitiful $15,000, the median balance.
What is more, nearly 100 companies already in the last year
have either reduced or suspended their contributions to their
benefit plans, just as stock prices have come down by that huge
amount, creating some kind of extra value at some point. In
addition, pension managers and plan participants have made
unwise and often speculative investment choices. Too much in
equities, especially for investors nearing retirement; too many
hedge funds, also known as absolute return funds, now known as
absolute negative return funds; too much real estate, and so
on.
Our financial system, especially our mutual funds and our
hedge funds also are greedy to fault. And they consume far too
large a share of the returns created by our business and
economic system. So we must recognize that the interest of our
money managers and marketers are in direct conflict with the
financial interests of the investors to whom they provide
services.
If I could just make one more point, I guess my time has
run out here, has it? I would like to just make one more really
important point, if I may. All this trading back and forth
among investors is not a zero-sum game. The financial system,
the traders, the brokers, the investment bankers, the money
managers, the middlemen, Wall Street as it were, takes a cut of
all this frenzied activity, leaving investors as a group only
with what is left. Yes, the investor feeds at the bottom of the
food chain of investing.
So what do we have to do to encourage and maximize
retirement savings? Using a biblical phrase, if I may, we must
drive the money changers, or at least most of them, out of the
temples of finance.
Now, here is the most important point in my remarks. I
asked you in my testimony to read it twice. If we investors
collectively own the markets, as we do, but individually
compete to beat our fellow market participants, we lose the
game because of those costs. But if we investors abandoned our
inevitably futile attempts to obtain an edge over other market
participants and simply hold our share of the market portfolio,
we win the game. It is not very complicated.
So that is why, inevitably, we will be focused on stock and
bond index funds.
Thank you, Mr. Chairman. Sorry to run a little over.
[The statement of Mr. Bogle follows:]
Prepared Statement of John C. Bogle, Founder and Former Chief Executive
of the Vanguard Group\1\
Our nation's system of retirement security is imperiled, headed for
a serious train wreck. That wreck is not merely waiting to happen; we
are running on a dangerous track that is leading directly to a serious
crash that will disable major parts of our retirement system. Federal
support--which, in today's world, is already being tapped at
unprecedented levels--seems to be the only short-term remedy. But long-
term reforms in our retirement funding system, if only we have the
wisdom and courage to implement them, can move us to a better path
toward retirement security for the nation's workers.
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\1\ The opinions expressed in this speech do not necessarily
represent the views of Vanguard's present management.
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One of the causes of the coming crisis--but hardly the only cause--
is the collapse of our stock market, erasing some $8 trillion in market
value from its $17 trillion capitalization at the market's high in
October 2007, less than 18 months ago. However, this stunning loss of
wealth reflects, in important part, a growing and substantial
overvaluation of stocks during the late 1990s and early 2000s,
``phantom wealth'' which proved unjustified by corporate intrinsic
value. (I'll discuss this subject in greater depth later in my
statement.)
But four other causes must not be ignored. One is the inadequacy of
national savings being directed into retirement plans. ``Thrift'' has
been out in America; ``instant gratification'' in our consumer-driven
economy has been in. As a nation, we are not saving nearly enough to
meet our future retirement needs. Too few citizens have chosen to
establish personal retirement accounts, and even those who have
established them are funding them inadequately and only sporadically.
Further, our corporations have been funding their pension plans on the
mistaken assumption that stocks would produce future returns at the
generous levels of the past, raising their prospective return
assumptions even as the market reached valuations that were far above
historical norms.\2\ And the pension plans of our state and local
governments seem to be in the worst financial condition of all.
(Because of poor transparency, inadequate disclosure, and non-
standardized financial reporting, we really don't know the dimension of
the shortfall.)
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\2\ For example, in 1981, when the yield on long-term U.S. Treasury
bonds was 13\1/2\ percent, corporations assumed that future returns on
their pension plans would average 6 percent. At the end of 2007,
despite the sharp decline in the Treasury bond yield to 4.8 percent,
the assumed future return soared to 8\1/2\ percent. Even without the
large losses incurred in the 2008 bear market, it seems highly unlikely
that such a return will be realized.
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Second is the plethora of unsound, unwise, and often speculative
investment choices made not only by individuals responsible for
managing their own tax-sheltered retirement investment programs (such
as individual retirement accounts and defined-contribution pension
plans such as 401(k) thrift plans provided by corporations and 403(b)
savings plans provided by non-profit institutions), but also
professionally managed defined benefit plans, largely created in
earlier days by our nation's larger corporations and by our state and
local governments.
Third, conflicts of interest are rife throughout our financial
system. Both the managers of mutual funds held in corporate 401(k)
plans and the money managers of corporate pension plans face a
potential conflict when they hold the shares of the corporations that
are their clients. It is not beyond imagination that when a manager
votes proxy shares against a company management's recommendation, it
might not sit well with company executives who select the plan's
provider of investment advice. (There is a debate about the extent to
which those conflicts have actually materialized.) In trade union
plans, actual conflicts of interest among union leaders, union workers,
investment advisers, and money managers have been documented in the
press and in court. In defined benefit plans, corporate senior officers
face an obvious short-term conflict between minimizing pension costs in
order to maximize the earnings growth that market participants demand,
and incurring larger pension costs by making timely and adequate
contributions to their companies' pension plans in order to assure
long-term security for the pension benefits they have promised to their
workers.
Fourth, our financial system is a greedy system, consuming far too
large a share of the returns created by our business and economic
system. Corporations generate earnings for the owners of their stocks,
pay dividends, and reinvest what's left in the business. In the
aggregate, over the past century, the returns generated by our
businesses have grown at an annual rate of about 9\1/2\ percent per
year, including about 4\1/2\ percent from dividend yields and 5 percent
from earnings growth. Similarly, corporate and government bonds pay
interest, and the aggregate return on bonds averaged about 5 percent
during the same period.
But these are the gross returns generated by the corporations that
dominate our system of competitive capitalism (and by government
borrowings). Investors who hold these financial instruments, either
directly or through the collective investment programs provided by
mutual funds and defined benefit pension plans, receive their returns
only after the cost of acquiring them and then trading them back and
forth among one another. While some of this activity is necessary to
provide the liquidity that has been the hallmark of U.S. financial
markets, it has grown into an orgy of speculation that pits one manager
against another, and one investor (or speculator) against another--a
``paper economy'' that has, predictably, come to threaten the real
economy where our citizens save and invest. It must be obvious that our
present economic crisis was, by and large, foisted on Main Street by
Wall Street--the mostly innocent public taken to the cleaners, as it
were, by the mostly greedy financiers.
Extracting Value From Society
I've written about our absurd and counterproductive financial
sector at length. Writing in the Journal of Portfolio Management in its
Winter 2008 issue, here are some of the things that I said about the
costs of our financial system: ``* * * mutual fund expenses, plus all
those fees paid to hedge fund and pension fund managers, to trust
companies and to insurance companies, plus their trading costs and
investment banking fees * * * totaled about $528 billion in 2007. These
enormous costs seriously undermine the odds in favor of success for
citizens who are accumulating savings for retirement. Alas, the
investor feeds at the bottom of the costly food chain of investing,
paid only after all the agency costs of investing are deducted from the
markets' returns * * * Once a profession in which business was
subservient, the field of money management has largely become a
business in which the profession is subservient. Harvard Business
School Professor Rakesh Khurana is right when he defines the standard
of conduct for a true professional with these words: `I will create
value for society, rather than extract it.' And yet money management,
by definition, extracts value from the returns earned by our business
enterprises.''
These views are not only mine, and they have applied for a long
time. Hear Nobel laureate economist James Tobin, presciently writing in
1984: ``* * * we are throwing more and more of our resources into
financial activities remote from the production of goods and services,
into activities that generate high private rewards disproportionate to
their social productivity, a `paper economy' facilitating speculation
which is short-sighted and inefficient.''
In his remarks, Tobin cited the eminent British economist John
Maynard Keynes. But he failed to cite Keynes's profound warning: ``When
enterprise becomes a mere bubble on a whirlpool of speculation, the
consequences may be dire * * * when the capital development of a
country becomes a by-product of the activities of a casino * * * the
job (of capitalism) will be ill-done.'' That job is indeed being ill-
done today. Business enterprise has taken a back seat to financial
speculation. The multiple failings of our flawed financial sector are
jeopardizing, not only the retirement security of our nation's savers
but the economy in which our entire society participates.
Our Retirement System Today
The present crisis in worker retirement security is well within our
capacity to measure. It is not a pretty picture:
Defined Benefit Plans. Until the early 1990s, investment risk and
the longevity risk of pensioners (the risk of outliving one's
resources) were borne by the defined benefit (DB) plans of our
corporations and state and local governments, the pervasive approach to
retirement savings outside of the huge DB plan we call Social Security.
But in the face of a major shift away from DB plans in favor of defined
contribution (DC) plans, DB growth has essentially halted. Assets of
corporate pension plans have declined from $2.1 trillion as far back as
1999 to an estimated $1.9 trillion as 2009 began. These plans are now
severely underfunded. For the companies in the Standard & Poor's 500
Index, pension plan assets to cover future payments to retirees has
tumbled from a surplus of some $270 billion in 1999 to a deficit of
$376 billion at the end of 2008. Largely because of the stock market's
sharp decline, assets of state and local plans have also tumbled, from
a high of $3.3 trillion early in 2007 to an estimated $2.5 trillion
last year.
The Pension Benefit Guaranty Corporation. This federal agency,
responsible for guaranteeing the pension benefits of failing corporate
sponsors is itself faltering, with a $14 billion deficit in December
2007. Yet early in 2008--just before the worst of the stock market's
collapse--the agency made the odd decision to raise its allocation to
diversified equity investments to 45 percent of its assets, and add
another 10 percent to ``alternative investments,'' including real
estate and private equity, essentially doubling the PBGC's equity
participation at what turned out to be the worst possible moment.
Defined Contribution Plans. DC plans are gradually replacing DB
plans, a massive transfer from business enterprises to their employees
of both investment risk (and return) and the longevity risk of
retirement funding. While DC plans have been available to provide the
benefits of tax-deferral for retirement savings for well over a half-
century,\3\ it has only been with the rise of employer thrift plans
such as 401(k)s and 403(b)s, beginning in 1978, that they have been
widely used to accumulate retirement savings. The growth in DC plans
has been remarkable. Assets totaled $500 billion in 1985; $1 trillion
in 1991; $4.5 trillion in 2007. With the market crash, assets are now
estimated at $3.5 trillion. The 401(k) and 403(b) plans dominate this
total, with respective shares of 67 percent and 16 percent or 83
percent of the DC total.
Individual Retirement Accounts. IRA assets presently total about
$3.2 trillion, down from $4.7 trillion in 2007. Mutual funds (now some
$1.5 trillion) continue to represent the largest single portion of
these investments. Yet with some 47 million households participating in
IRAs, the median balance is but $55,000, which at, say, a 4 percent
average income yield, would provide but $2,200 per year in retirement
income per household, a nice but far from adequate, increment.
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\3\ I have been investing 15 percent of my annual compensation in
the DC plan of the company (and its predecessor) that has employed me
since July 1951, when I first entered the work force. I can therefore
give my personal assurance that tax-deferred defined contribution
pension plans, added to regularly, reasonably allocated among stocks
and bonds, highly diversified, and managed at low cost, compounded over
a long period, are capable of providing wealth accumulations that are
little short of miraculous.
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Focusing on 401(k) Retirement Plans
Defined contribution pension plans, as noted above, have gradually
come to dominate the private retirement savings market, and that
domination seems certain to increase. Further, there is some evidence
that DC plans are poised to become a growing factor in the public plan
market. (The federal employees' Thrift Savings Plan, with assets of
about $180 billion, has operated as a defined contribution plan since
its inception in 1986.) Even as 401(k) plans have come to dominate the
DC market, so mutual fund shares have come to dominate the 401(k)
market. Assets of mutual funds in DC plans have grown from a mere $35
billion in 1990 (9 percent of the total) to an estimated $1.8 trillion
in 2008 (51 percent).
Given the plight in which our defined benefit plans find
themselves, and the large (and, to some degree, unpredictable) bite
that funding costs take out of corporate earnings, it is small wonder
that what began as a gradual shift became a massive movement to defined
contribution plans. (Think of General Motors, for example, as a huge
pension plan now with perhaps $75 billion of assets--and likely even
larger liabilities--surrounded by a far smaller automobile business,
operated by a company with a current stock market capitalization of
just $1.3 billion.)
I would argue the shift from DB plans to DC plans is not only an
inevitable move, but a move in the right direction in providing worker
retirement security. In this era of global competition, U.S.
corporations must compete with non-U.S. corporations with far lower
labor costs. So this massive transfer of the two great risks of
retirement plan savings--investment risk and longevity risk--from
corporate balance sheets to individual households will relieve pressure
on corporate earnings, even as it will require our families to take
responsibility for their own retirement savings. A further benefit is
that investments in DC plans can be tailored to the specific individual
requirements of each family--reflecting its prospective wealth, its
risk tolerance, the age of its bread-winner(s), and its other assets
(including Social Security). DB plans, on the other hand, are
inevitably focused on the average demographics and salaries of the
firm's work force in the aggregate.
The 401(k) plan, then, is an idea whose time has come. That's the
good news. We're moving our retirement savings system to a new
paradigm, one that will ultimately efficiently serve both our nation's
employers--corporations and governments alike--and our nation's
families. Now for the bad news: our existing DC system is failing
investors. Despite its worthy objectives, the deeply flawed
implementation of DC plans has subtracted--and subtracted
substantially--from the inherent value of this new system. Given the
responsibility to look after their own investments, participants have
acted contrary to their own best interests. Let's think about what has
gone wrong.\4\
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\4\ I recognize that the Pension Protection Act of 2006 provided
important improvements to the original 401(k) paradigm, as described in
Appendix A, attached.
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A Deeply Flawed System
I now present my analysis of the major flaws that continue to exist
in our 401(k) system. We need radical reforms to mitigate these flaws,
in order to give employees the fair shake that must be the goal if we
are to serve the national public interest and the interest of
investors.
Inadequate savings--The modest median balances so far
accumulated in 401(k) plans make their promise a mere shadow of
reality. At the end of 2008, the median 401(k) balance is estimated at
just $15,000 per participant. Indeed, even projecting this balance for
a middle-aged employee with future growth engendered over the passage
of time by assumed higher salaries and real investment returns, that
figure might rise to some $300,000 at retirement age (if the
assumptions are correct). While that hypothetical accumulation may look
substantial, however, it would be adequate to replace less than 30
percent of pre-retirement income, a help but hardly a panacea. (The
target suggested by most analysts is around 70 percent, including
Social Security.) Part of the reason for today's modest accumulations
are the inadequate participant and corporate contributions made to the
plans. Typically, the combined contribution comes to less than 10
percent of compensation, while most experts consider 15 percent of
compensation as the appropriate target. Over a working lifetime of,
say, 40 years, an average employee, contributing 15 percent of salary,
receiving periodic raises, and earning a real market return of 5
percent per year, would accumulate $630,000. An employee contributing
10 percent would accumulate just $420,000. If those assumptions are
realized, this would represent a handsome accumulation, but substantial
obstacles--especially the flexibility given to participants to withdraw
capital, as described below--are likely to preclude their achievement.
Excess flexibility. 401(k) plans, designed to fund
retirement income, are too often used for purposes that subtract
directly from that goal. One such subtraction arises from the ability
of employees to borrow from their plans, and nearly 20 percent of
participants do exactly that. Even when--and if--these loans are
repaid, investment returns (assuming that they are positive over time)
would be reduced during the time that the loans are outstanding, a
dead-weight loss in the substantial savings that might otherwise have
been accumulated at retirement.
Even worse is the dead-weight loss--in this case, largely
permanent--engendered when participants ``cash out'' their 401(k) plans
when they change jobs. The evidence suggests that 60 percent of all
participants in DC plans who move from one job to another cash out at
least a portion of their plan assets, using that money for purposes
other than retirement savings. To understand the baneful effect of
borrowings and cash-outs, just imagine in what shape our beleaguered
Social Security System would find itself if the contributions of
workers and their companies were reduced by borrowings and cash outs,
flowing into current consumption rather than into future retirement
pay. It is not a pretty picture to contemplate.
Inappropriate Asset Allocation. One reason that 401(k)
investors have accumulated such disappointing balances is due to
unfortunate decisions in the allocation of assets between stocks and
bonds.\5\ While virtually all investment experts recommend a large
allocation to stocks for young investors and an increasing bond
allocation as participants draw closer to retirement, a large segment
of 401(k) participants fails to heed that advice.
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\5\ These data are derived from a Research Perspective dated
December 2008, published by the Investment Company Institute, the
association that represents mutual fund management companies,
collecting data, providing research, and engaging in lobbying
activities.
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Nearly 20 percent of 401(k) investors in their 20s own zero
equities in their retirement plan, holding, instead, outsized
allocations of money market and stable value funds, options which are
unlikely to keep pace with inflation as the years go by. On the other
end of the spectrum, more than 30 percent of 401(k) investors in their
60s have more than 80 percent of their assets in equity funds. Such an
aggressive allocation likely resulted in a decline of 30 percent or
more in their 401(k) balances during the present bear market,
imperiling their retirement funds precisely when the members of this
age group are preparing to draw upon it.
Company stock is another source of unwise asset allocation
decisions, as many investors fail to observe the time-honored principle
of diversification. In plans in which company stock is an investment
option, the average participant invests more than 20 percent of his or
her account balance in company stock, an unacceptable concentration of
risk.
Excessive Costs. As noted earlier, excessive investment
costs are the principal cause of the inadequate long-term returns
earned by both stock funds and bond funds. The average equity fund
carries an annual expense ratio of about 1.3 percent per year, or about
0.80 percent when weighted by fund assets. But that is only part of the
cost. Mutual funds also incur substantial transaction costs, reflecting
the rapid turnover of their investment portfolios. Last year, the
average actively managed fund had a turnover rate of an astonishing 96
percent. Even if weighted by asset size, the turnover rate is still a
shocking--if slightly less shocking--65 percent. Admittedly, the costs
of this portfolio turnover cannot be measured with precision. But it is
reasonable to assume that trading activity by funds adds costs of 0.5
percent to 1.0 percent to the expense ratio. So the all-in-costs of
fund investing (excluding sales loads, which are generally waived for
large retirement accounts) can run from, say 1.5 percent to 2.3 percent
per year. (By contrast, low-cost market index funds--which I'll discuss
later--have expense ratios as low as 0.10 percent, with transaction
costs that are close to zero.)
In investing, costs truly matter, and they matter even more when
related to real (after inflation) returns. If the future real
investment return on a balanced retirement account were, say, 4 percent
per year (5 percent nominal return for bonds, 8 percent for stocks,
less 2.5 percent inflation), an annual cost of 2.0 percent would
consume fully 50 percent of that annual return. Even worse, over an
investment lifetime of, say, 50 years, those same costs would consume
nearly 75 percent of the potential wealth accumulation. It is an ugly
picture.
Given the centrality of low costs to the accumulation of adequate
retirement savings, then, costs must be disclosed to participants. But
the disclosure must include the all-in costs of investing, not merely
the expense ratios. (I confess to being skeptical about applying cost-
accounting processes to the allocation of fund expenses among
investment costs, administrative costs, marketing costs, and record-
keeping costs. What's important to plan participants is the amount of
total costs incurred, not the allocation of those costs among the
various functions as determined by accountants and fund managers who
have vested interests in the outcome.)
Failure to deal with longevity risk. Even as most 401(k)
plan participants have failed to deal adequately with investment risk,
so they (and their employers and the fund sponsors) have also failed to
deal adequately with longevity risk. It must be obvious that at some
point in an investment lifetime, most plan participants would be well-
served by having at least some portion of their retirement savings
provide income that they cannot outlive. But despite the fact that the
401(k) plan has now been around for three full decades, systematic
approaches to annuitizing payments are rare and often too complex to
implement. Further, nearly all annuities carry grossly excessive
expenses, often because of high selling and marketing costs. Truly low-
cost annuities remain conspicuous by their absence from DC retirement
plan choices. (TIAA-CREF, operating at rock-bottom cost and providing
ease and flexibility for clients using its annuity program, has done a
good job in resolving both the complexity issue and the cost issue.)
The New Defined Contribution Plans
Given the widespread failures in the existing DC plan structure,
and in 401(k) plans in particular, it is time for reform, reform that
serves, not fund managers and our greedy financial system, but plan
participants and their beneficiaries. We ought to carefully consider
changes that move us to a retirement plan system that is simpler, more
rational and less expensive, one that will be increasingly and
inevitably focused on DC plans. Our Social Security System and, at
least for a while, our state and local government systems would
continue to provide the DB backup as a ``safety net'' for all
participating U.S. citizens:
1. Simplify the DC system. Offer a single DC plan for tax-deferred
retirement savings available to all of our citizens (with a maximum
annual contribution limit), consolidating today's complex amalgam of
traditional DC plans, IRAs, Roth IRAs, 401(k) plans, 403(b) plans, the
federal Thrift Savings Plan. I envision the creation of an independent
Federal Retirement Board to oversee both the employer-sponsors and the
plan providers, assuring that the interests of plan participants are
the first priority. This new system would remain in the private sector
(as today), with asset managers and recordkeepers competing in costs
and in services. (But such a board might also create a public sector DC
plan for wage-earners who were unable to enter the private system or
whose initial assets were too modest to be acceptable in that system.)
2. Get Real About Stock Market Return and Risk. Financial markets,
it hardly need be said today, can be volatile and unpredictable. But
common stocks remain a perfectly viable--and necessary--investment
option for long-term retirement savings. Yet stock returns have been
oversold by Wall Street's salesmen and by the mutual fund industry's
giant marketing apparatus. In their own financial interests, they
ignored the fact that the great bull market we enjoyed during the final
25 years of the 20th century was in large part an illusion, creating
what I call ``phantom returns'' that would not recur. Think about it:
From 1926 to 1974, the average annual real (inflation-adjusted) return
on stocks was 6.1 percent. But during the following quarter-century,
stock returns soared, an explosion borne, not of the return provided by
corporations in the form of dividend yields and earnings growth, but of
soaring price-to-earnings ratios, what I define as speculative return.
This higher market valuation reflected investor enthusiasm (and
greed), and produced an extra speculative return of 5.7 percent
annually, spread over 20 full years, an event without precedent. This
speculative return almost doubled the market's investment return
(created by dividend yields and earnings growth), bringing the market's
total real return to nearly 12 percent per year. From these speculative
heights, the market had little recourse but to return to normalcy, by
providing far lower returns in subsequent years. And in fact, the real
return on stocks since the turn of the century in 1999 has been minus 7
percent per year, composed of a negative investment return of -1
percent and a negative speculative return of another -6 percent, as
price-earnings multiples retreated to (or below) historical norms.
The message here is that investors in their ignorance, and
financial sector marketers with their heavy incentives to sell, well,
``products,'' failed to make the necessary distinction between the
returns earned by business (earnings and dividends) and the returns
earned by, well, irrational exuberance and greed. Today, we realize
that much of the value and wealth we saw reflected on our quarterly
401(k) statements was indeed phantom wealth. But as yesteryear's
stewards of our investment management firms became modern-day salesmen
of investment products, they had every incentive to disregard the fact
that this wealth could not be sustained. Our marketers (and our
investors) failed to recognize that only the fundamental (investment)
returns apply as time goes by. As a result, we misled ourselves about
the realities that lay ahead, to say nothing of the risks associated
with equity investing.
3. Owning the Stock Market--and the Bond Market. Investors seem to
largely ignore the close link between lower costs and higher returns--
what I call (after Justice Brandeis) ``The Relentless Rules of Humble
Arithmetic.'' Plan participants and employers also ignore this
essential truism: As a group, we investors are all ``indexers.'' That
is, all of the equity owners of U.S. stocks together own the entire
U.S. stock market. So our collective gross return inevitably equals the
return of the stock market itself.
And because providers of financial services are largely smart,
ambitious, aggressive, innovative, entrepreneurial, and, at least to
some extent, greedy, it is in their own financial interest to have plan
sponsors and participants ignore that reality. Our financial system
pits one investor against another, buyer vs. seller. Each time a share
of stock changes hands (and today's daily volume totals some 10 billion
shares), one investor is (relatively) enriched; the investor on the
other side of the trade is (relatively) impoverished.
But, as noted earlier, this is no zero-sum game. The financial
system--the traders, the brokers, the investment bankers, the money
managers, the middlemen, ``Wall Street,'' as it were--takes a cut of
all this frenzied activity, leaving investors as a group inevitably
playing a loser's game. As bets are exchanged back and forth, our
attempts to beat the market, and the attempts of our institutional
money managers to do so, then, enrich only the croupiers, a clear
analogy to our racetracks, our gambling casinos, and our state
lotteries.
So, if we want to encourage and maximize the retirement savings of
our citizens, we must drive the money changers--or at least most of
them--out of the temples of finance. If we investors collectively own
the markets, but individually compete to beat our fellow market
participants, we lose. But if we abandon our inevitably futile attempts
to obtain an edge over other market participants and all simply hold
our share of the market portfolio, we win. (Please re-read those two
sentences!) Truth told, it is as simple as that. So our Federal
Retirement Board should not only foster the use of broad-market index
funds in the new DC system (and offer them in its own ``fall back''
system described earlier) but approve only private providers who offer
their index funds at minimum costs.
4. Asset Allocation--Balancing Risk and Return. The balancing of
returns and risk is the quintessential task of intelligent investing,
and that task too would be the province of the Federal Retirement
Board. If the wisest, most experienced minds in our investment
community and our academic community believe--as they do--that the need
for risk aversion increases with age; that market timing is a fool's
game (and is obviously not possible for investors as a group); and that
predicting stock market returns has a very high margin for error, then
something akin to roughly matching the bond index fund percentage with
each participant's age with the remainder committed to the stock index
fund, is the strategy that most likely to serve most plan participants
with the most effectiveness. Under extenuating--and very limited--
circumstances participants could have the ability to opt-out of that
allocation.
This allocation pattern is clearly accepted by most fund industry
marketers, in the choice of the bond/stock allocations of their
increasingly popular ``target retirement funds.'' However, too many of
these fund sponsors apparently have found it a competitive necessity to
hold stock positions that are significantly higher than the pure age-
based equivalents described earlier. I don't believe competitive
pressure should be allowed to establish the allocation standard, and
would leave those decisions to the new Federal Retirement Board.
I also don't believe that past returns on stocks that include, from
time to time, substantial phantom returns--borne of swings from fear to
greed to hope, back and forth--are a sound basis for establishing
appropriate asset allocations for plan participants. Our market
strategists, in my view, too often deceive themselves by their slavish
reliance on past returns, rather than focusing on what returns may lie
ahead, based on the projected discounted future cash flows that,
however far from certainty, represent the intrinsic values of U.S.
business in the aggregate.
Once we spread the risk of investing--and eliminate the risk of
picking individual stocks, of picking market sectors, of picking money
managers, leaving only market risk, which cannot be avoided--to
investors as a group, we've accomplished the inevitably worthwhile
goal: a financial system that is based on the wisdom of long-term
investing, eschewing the fallacy of the short-term speculation that is
so deeply entrenched in our markets today. Such a strategy effectively
guarantees that all DC plan participants will garner their fair share
of whatever returns our stock and bond markets are generous enough to
bestow on us (or, for that matter, mean-spirited enough to inflict on
us). Compared to today's loser's game, that would be a signal
accomplishment.
Under the present system, some of us will outlive our retirement
savings and depend on our families. Others will go to their rewards
with large savings barely yet tapped, benefiting their heirs. But like
investment risk, longevity risk can be pooled. So as the years left to
accumulate assets dwindle down, and as the years of living on the
returns from those assets begin, we need to institutionalize, as it
were, a planned program of conversion of our retirement plan assets
into annuities. This could be a gradual process; it could be applied
only to plan participants with assets above a certain level; and it
could be accomplished by the availability of annuities created by
private enterprise and offered at minimum cost, again with providers
overseen by the proposed Federal Retirement Board (just as the federal
Thrift Savings Plan has its own board and management, and operates as a
private enterprise).
5. Mutuality, Investment Risk, and Longevity Risk. The pooling of
the savings of retirement plan investors in this new DC environment is
the only way to maximize the returns of these investors as a group. A
widely diversified, all-market strategy, a rational (if inevitably
imperfect) asset allocation, and low costs, delivered by a private
system in which investors automatically and regularly save from their
own incomes, aided where possible by matching contributions of their
employers, and proving an annuity-like mechanism to minimize longevity
risks is the optimal system to assure maximum retirement plan security
for our nation's families.
There remains the task of bypassing Wall Street's croupiers, an
essential part of the necessary reform. Surely our Federal Retirement
Board would want to evaluate the possible need for the providers of DC
retirement plan service to be mutual in structure; that is, management
companies that are owned by their fund shareholders, and operated on an
``at-cost'' basis; and annuity providers that are similarly structured.
The arithmetic is there, and the sole mutual fund firm that is
organized under such a mutual structure has performed with remarkable
effectiveness.\6\
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\6\ I'm only slightly embarrassed to be referring here to Vanguard,
the firm I founded 35 years ago. (My modest annual retainer is
unrelated to our asset size or growth.) Even a glance at Vanguard's
leadership in providing superior investment returns, in operating by
far at the lowest costs in the field, in earning shareholder
confidence, and in developing returns and positive cash flows into our
mutual funds (even in the face of huge outflows from our rivals during
2008) suggests that such a structure has well-served its shareholders.
---------------------------------------------------------------------------
Of course that's my view! But this critical analysis of the
structure of the mutual fund industry is not mine alone. Listen to
Warren Buffett. ``[Mutual fund] independent directors * * * [have] been
absolutely pathetic * * * [They follow] a zombie-like process that
makes a mockery of stewardship * * * `[I]independent' directors, over
more than six decades, have failed miserably.'' Then, hear this from
another investor, one who has not only produced one of the most
impressive investment records of the modern era but who has an
impeccable reputation for character and intellectual integrity, David
F. Swensen, Chief Investment Officer of Yale University: ``The
fundamental market failure in the mutual fund industry involves the
interaction between sophisticated, profit-seeking providers of
financial services and naive, return-seeking consumers of investment
products. The drive for profits by Wall Street and the mutual fund
industry overwhelms the concept of fiduciary responsibility, leading to
an all too predictable outcome: * * * the powerful financial services
industry exploits vulnerable individual investors * * * The ownership
structure of a fund management company plays a role in determining the
likelihood of investor success. Mutual fund investors face the greatest
challenge with investment management companies that provide returns to
public shareholders or that funnel profits to a corporate parent--
situations that place the conflict between profit generation and
fiduciary responsibility in high relief. When a fund's management
subsidiary reports to a multi-line financial services company, the
scope for abuse of investor capital broadens dramatically * * *
Investors fare best with funds managed by not-for-profit organizations,
because the management firm focuses exclusively on serving investor
interests. No profit motive conflicts with the manager's fiduciary
responsibility. No profit margin interferes with investor returns. No
outside corporate interest clashes with portfolio management choices.
Not-for-profit firms place investor interests front and center * * *
ultimately, a passive index fund managed by a not-for-profit investment
management organization represents the combination most likely to
satisfy investor aspirations.''
What Would An Ideal Retirement Plan System Look Like?
It is easy to summarize the ideal system for retirement savings
that I've outlined in this Statement.
1. Social Security would remain in its present form, offering basic
retirement security for our citizens at minimum investment risk.
(However, policymakers must promptly deal with its longer-run
deficits.)
2. For those who have the financial ability to save for retirement,
there would be a single DC structure, dominated by low-cost--even
mutual--providers, inevitably focused on all-market index funds
investing for the long term, and overseen by a newly-created Federal
Retirement Board that would establish sound principles of asset
allocation and diversification in order to assure appropriate
investment risk for each participant.
3. Longevity risk would be mitigated by creating simple low-cost
annuities as a mandatory offering in these plans, with some portion of
each participant's balance going into this option upon retirement.
(Participants should have the ability to opt-out of this alternative.)
4. We should extend the existing ERISA requirement that plan
sponsors meet a standard of fiduciary duty to encompass plan providers
as well. (In fact, I believe that a federal standard of fiduciary duty
for all money managers should also be enacted.)
It may not be--indeed, it is not--a system free of flaws. But it is
a radical improvement, borne of common sense and elemental arithmetic,
over the present system, which is driven by the interest of Wall Street
rather than Main Street. And, with the independent Federal Retirement
Board, we have the means to correct flaws that may develop over time,
and assure that the interests of workers and their retirement security
remain paramount.
______
Chairman Miller. Mr. Baker. Dr. Baker.
STATEMENT OF DEAN BAKER, CO-DIRECTOR, CENTER FOR ECONOMIC AND
POLICY RESEARCH
Mr. Baker. Thank you very much, Mr. Chairman, for inviting
me to speak here today. I will say a few points of emphasizing
some of the problems, which I think are all too apparent in the
current system, and also try to throw out some quick thoughts
on potential solutions.
First point, in terms of basic problems, I mean, we all
know we have just seen a massive collapse of the stock market.
And we are facing with a situation wherein so far as people had
retirement accounts, and here I am thinking of the baby boom
generation, the 77 million baby boomers on the edge of
retirement, they are overwhelmingly in the form of defined
contribution accounts. Defined benefits accounts, whether we
like them or not, are rapidly disappearing and certainly going
to disappear more quickly in the near future as more and more
companies freeze their accounts or end them all together.
So we are looking at a situation where, if people had
accounts, they had defined contribution accounts of course. And
we all know that those have taken a very large hit. Now, on top
of that, one of the points that I want to emphasize in my
testimony is that the main source of wealth for most baby
boomers approaching retirement is housing. And that also has
taken a very large hit. And I think many people failed to fully
appreciate the impact that this is likely to have on the
retirement of middle-income baby boomers.
I know that there were a number of surveys that have looked
at baby boomers' intentions to use the equity in their home for
retirement. And I know that most of the surveys show that most
don't intend to do that. I would argue that, in spite of their
intentions, I think realistically the vast majority of retirees
and certainly baby boomer retirees will be, at least in part,
dependent on the wealth in their home for their retirement. And
there are three reasons for that.
One is that if you have a paid-off mortgage, obviously you
are much better situated in retirement, than if you have to
continue to make payments on your mortgage long into your
retirement. Secondly, many retirees do anticipate moving. And
it makes a very big difference if you leave your house and have
a large amount of equity to use as a down payment or possibly
even purchase outright the home that you expect to live in
during your retirement years.
The third reason is simply that this is fall-back money in
the event of emergency, in the event of an unexpected medical
condition or other emergency that requires money. If you have
no equity in your home, then you obviously have much less fall-
back money.
Now, we recently analyzed the Federal Reserve for its
survey of consumer finance. I have to confess, we didn't get
the most recent data that just came out last week. We will have
that shortly. But we are working off the 2004 data. And we just
made some crude estimate of what baby boomers can anticipate
having in retirement based on the recent declines in the stock
market and in housing prices.
And our calculations show that, for younger baby boomers,
those between the ages of 45 to 54, their total wealth,
including equity in their home, all wealth apart from defined
benefit retirement accounts, has fallen from $150,000 in 2004,
which was none too generous, to just $82,000 in 2009. And just
to put that $82,000 in context, this is median household, that
would purchase less than half of the median house.
So we are looking at a situation where half of the baby
boomers, half of the younger baby boomers, if they took all
their wealth, would be able to purchase less than half the
median house. Alternatively, if we converted that into
annuities, so they were age 65, that would get you an annuity
of about $6,000 a year, $500 per month. That would not go very
far in retirement, again assuming that you have no equity in
your home in that scenario.
If we looked at older baby boomers, those between 55 and
64, the situation is almost as bad. We have projected their
wealth. Total wealth would be $142,700. That is a decline of 38
percent from where it stood in 2004. That would be sufficient
for 80 percent of the purchase price of the median home. Again
if you took all your wealth and used nothing on anything else,
you would be able to purchase 80 percent of the median home.
Alternatively, the annuity you can get for that would be
about $10,000 a year, or perhaps a little more than $800 a
month. And again, that is assuming that you have no equity in
your home.
I think, long and short, people were taking much, much
greater risk than they realized, not only with the money that
they had in the defined contribution 401(k)-type plan, but also
in their home, which they were led to believe as a safe asset.
Now, just very quick points, because I realize I don't have
very much times. First, and I realize this isn't necessarily
the purview of this committee, but I think a point that we
can't emphasize enough. The Federal Reserve Board must take
seriously its responsibility to combat asset bubbles.
I know the Federal Reserve Board, under Chairman Greenspan,
did not feel that was part of their responsibility. I think
there is absolutely nothing more important that the Federal
Reserve Board could do than to combat asset bubbles. And I
think the current situation demonstrates that clearly. They
gambled with the wealth of the country's homeowners. And we all
lost very badly.
Secondly in this context, I think it is very important for
the Congress and president to re-affirm the commitment to
Social Security and Medicare. The baby boomer generation that
are retired or near retirement have just lost on the order of
$15 trillion in wealth between their houses and their stock.
And we have to assure these people that the one thing they
could count on will still be their Social Security and
Medicare.
The last point, we obviously need to do more in terms of
retirement accounts. I will just say two very quick things
about this. There have been efforts to set up state accounts
that would be great experiments, California being the most
important; Washington State also very close to setting up
state-managed system accounts. These have had bipartisan
support. Certainly Governor Schwarzenegger in California has
been a big supporter of this.
With a little assistance from Congress, I think those plans
can make progress. They would be good models, good experiments,
for Congress to look at.
Last point is that, given the risk that people have taken,
and that I think many were not willing to take, not anxious to
take, I think the opportunity to look at some sort of defined
benefit that the government can guarantee, a modest amount, say
$1,000, per worker per year. I think that would be a very ripe
opportunity that could offer a great deal security to the
nation's workers at really no cost to the government.
So I realize we have lots of very big problems on our
hands. I appreciate the committee's interest in this. And I
hope we can make progress on that. Thank you for hearing me.
[The statement of Mr. Baker follows:]
Prepared Statement of Dean Baker, Co-director, Center for Economic and
Policy Research
Thank you, Chairman Miller for inviting me to share my views on the
problems of the current system of retirement income, and ways to
improve it, with the committee. My name is Dean Baker and I am the co-
director of the Center for Economic and Policy Research (CEPR). I am an
economist and I have been writing about issues related to retirement
security since 1992.
My testimony will have three parts. The first part, which will be
the bulk of the testimony, will explain how the current crisis has
jeopardized the retirement security of tens of millions of workers. The
second part will briefly reference some of the longstanding
inadequacies of our system retirement income, reminding members of
problems with which they are already quite familiar. The third part
will outline some principles that may guide the committee in
constructing legislation to improve retirement security.
How the Current Crisis has Jeapordized Retirement Security
The collapse of the housing bubble, coupled with the plunge in the
stock market, has exposed the gross inadequacy of our system of
retirement income. CEPR's analysis of data from the Federal Reserve
Board's 2004 Survey of Consumer Finance (SCF), indicates that the
median household with a person between the ages of 45 to 54, saw their
net worth fall by more than 45 percent between 2004 and 2009, from
$150,500 in 2004, to just $82,200 in 2009 (all amounts are in 2009
dollars).\1\
---------------------------------------------------------------------------
\1\ We used the 2004 SCF, because the micro data from the 2007 is
not yet available. This analysis, by my colleague David Rosnick and
myself, will soon be available on the website of the Center for
Economic and Policy Research, www.cepr.net.
---------------------------------------------------------------------------
This figure, which includes home equity, is not even sufficient to
cover half of the value of the median house in the United States. In
other words, if the median late baby boomer household took all of the
wealth they had accumulated during their lifetime, they would still owe
more than half of the price of a typical house in a mortgage and have
no other asset whatsoever.\2\
---------------------------------------------------------------------------
\2\ These calculations exclude wealth in defined benefit pensions.
---------------------------------------------------------------------------
The situation for older baby boomers is similar. The median
household between the ages of 55 and 64 saw their wealth fall by almost
38 percent from $229,600 in 2004 to $142,700 in 2009. This net worth
would be sufficient to allow these households, who are at the peak ages
for wealth accumulation, to cover approximately 80 percent of the cost
of the median home, if they had no other asset.
Even prior to the recent downturn, the baby boom cohorts were not
well prepared for retirement. Most members of these cohorts had been
able to save far too little to maintain their standard of living in
retirement. They would have found it necessary to work much later into
their lives than they had planned, or to accept sharp reductions in
living standards upon reaching retirement.
The situation of the baby boomers has been made much worse by the
economic and financial collapse of the last two years. Ironically, the
sharpest decline in wealth took place in an asset that many were led to
believe was completely safe, their house. Real house prices have fallen
by more than 30 percent from their peak in 2006 and will almost
certainly fall at least another 10-15 percent before hitting bottom.\3\
---------------------------------------------------------------------------
\3\ This is based on data from the Case-Shiller 20 City index. The
peak level was reached in May of 2006. Most data is from November of
2008. These data are based on sales prices, which means that they
reflect contracts that were typically signed 6 to 8 weeks earlier. This
means that the most recent data is close to 5 months out of date at
present. With prices in the index falling at a rate of more than 2
percent monthly, house prices may already be close to 10 percent lower
than the level indicated in the November data.
---------------------------------------------------------------------------
The plunge in house prices has been especially devastating both
because it was by far the largest source of wealth for most baby
boomers, and also because the high leverage in housing. The fact that
housing is highly leveraged is of course a huge advantage to homeowners
in times when prices are rising. If a homeowner can buy a $200,000
house with a 20 percent down payment, and the house subsequently
increases 50 percent in value, the homeowner gets a very high return,
earning $100,000 on a down payment of just $40,000.
However, leverage also poses enormous risks. In this case, if the
home price falls by 20 percent, then the homeowner has lost 100 percent
of her equity. This is exactly the sort of situation confronting tens
of millions of baby boomers at the edge of retirement. They just
witnessed the destruction of most or all of the equity in their home.
Our analysis of the SCF indicates that almost one fourth of late baby
boomers who own homes have so little equity that they will need to
bring cash to settle their mortgage at their closing. In a somewhat
more pessimistic scenario, almost 40 percent of the home owning
households in this cohort will need to bring cash to a closing.
The collapse in the housing equity of the baby boom cohort in the
last two years will have enormous implications for their well-being in
retirement. Instead of having a home largely paid off by the time they
reach their retirement years, many baby boomers will be in the same
situation as first time home buyers, looking at large mortgages
requiring decades to pay down. Furthermore, the loss of equity in their
current homes will make it far more difficult for baby boomers to move
into homes that may be more suitable for their needs in retirement.
Millions of middle class baby boomers will find it difficult to raise
the money needed to make a down payment on a new home.
While the focus of pension and retirement policy has usually been
pensions and Social Security, it is important to recognize the role of
housing wealth for two reason. First, the massive loss of housing
wealth due to the collapse of the housing bubble is likely to be a
factor that has an enduring impact on the living standards of the baby
boom cohorts in their retirement years.
The other reason why Congress should recognize the importance of
housing wealth is that this pillar of retirement income is not as
secure as it has often been treated. In other words, the risks
associated with housing wealth have generally not been fully considered
in evaluating the security of retirement income. While it is reasonable
to hope that the economy will not see the same sort of nationwide
housing bubble for many decades into the future, if ever, there will
nonetheless be a substantial element of risk associated with
homeownership, since there will always be substantial fluctuations in
local housing markets. This means that workers who have much of their
wealth in their home already face substantial risks to their retirement
income even before considering their financial investments.
Here also the baby boom cohort has received a very unpleasant
surprise in the last two years as stock market has plunged by more than
40 percent from its peak in November of 2007.\4\ While the data does
not yet allow us to determine exactly how badly the baby boom cohorts
have been hit by this decline, it is virtually certain that they felt
the biggest impact, simply because they had the most wealth to lose.
The Fed's data show that at the end of 2007, more than 70 percent of
the assets in defined contribution pension plans were held either
directly or indirectly in the stock market.\5\
---------------------------------------------------------------------------
\4\ This refers to the decline as measured by the S&P 500, which is
a much broader measure than the Dow Jones Industrial Average.
\5\ This is taken form the Flow of Funds Table, L.118c, lines 12
plus 13, divided by line 1, available at http://www.federalreserve.gov/
releases/z1/Current/z1r-6.pdf.
---------------------------------------------------------------------------
The baby boomers' losses on their stockholdings will compound the
losses incurred on their homes. Of course most baby boomers had managed
to accumulate relatively little by way of stock wealth even prior to
the market collapse of the last year and half. In 2004, the median
household headed by someone between the ages of 55 to 64 had
accumulated less than $100,000 in financial assets of all forms,
including holdings of stock and mutual funds. Median financial wealth
for this age group had fallen to just over $60,000 in 2009 following
the collapse of the stock market. The younger 45 to 54 cohort had
median financial wealth of just $40,000 in 2004. This had fallen to
less than $30,000 in 2009.
To summarize, our system of retirement income security was
completely unprepared for the sort of financial earthquake set in
motion by the collapse the of the housing bubble and its secondary
impact on the stock market. Older workers were already inadequately
prepared for retirement even prior to these events. The events of the
last two years now put most of the baby boom cohorts facing retirement
with very little to depend on other than their Social Security and
Medicare benefits.
While a full picture of retirement income would also incorporate
estimates of the income that these workers will receive from defined
benefit pensions, the vast majority of workers in these age cohorts
will receive little or nothing from traditional defined benefit pension
plans. Defined benefit plans have been rapidly declining in importance
for the last quarter century. This pace of decline is increasing with
the downturn as many companies that still have defined benefit plans
lay off workers and others freeze benefit levels to conserve cash.
Other Problems with the Defined Contribution Pension System
The prior discussion highlights the problem of risk for which the
current defined contribution system was completely inadequate. I will
just briefly note some of the other problems that have been frequently
raised in prior years.
Inadequate coverage--In spite of efforts to simplify the process
for employers, most businesses still do not offer workers the
opportunity to contribute to a pension at their workplace. Almost half
of private sector workers are not currently contributing to a pension
plan at their workplace. The primary reason that workers do not
contribute because their employer does not offer the option. The Bureau
of Labor Statistics reported a take up rate of 83 percent in their most
recent survey.\6\
---------------------------------------------------------------------------
\6\ Bureau of Labor Statistics, ``Employee Benefits in the United
States, 2008,'' available at http://www.bls.gov/news.release/pdf/
ebs2.pdf.
---------------------------------------------------------------------------
The lack of coverage is overwhelmingly a small business issue. Two
thirds of the workers employed in firms with more than 100 workers are
contributing to a pension. Just one-third of the workers in workers
employing less than 50 workers are contributing to a pension.
Lack of portability--In the modern economy, workers change jobs
frequently either by choice or necessity. When workers leave a job with
a pension, they generally cannot simply role over their accumulated
funds into a plan operated by their new employer (if there is one).
While recent legislation has sought to promote rollovers into IRAs, it
is still too early to know how effective these rules will be. Until we
have a fully portable pension system, changing jobs still provides an
opportunity for leakage of funds from retirement accounts.
High Fees--While some pension plans are very efficient, many plans
charge annual fees in excess of 1.5 percentage points. These fees can
substantially reduce retirement savings. For example, a 1.0 percentage
point difference in fees can reduce retirement accumulations by almost
20 percent over a thirty five year period. Private insurance companies
will charge between 10 percent and 20 percent of the value of an
accumulation to convert it into an annuity. This further reduces
workers' retirement income.
Principles for a New Pension System
The events of the last two years have brought home the extent to
which the current pension system exposes workers to risk both in the
value of their pension and also their housing wealth. The federal
government has the ability to shield workers from this risk, at very
little cost to taxpayers.
Before discussing principles for expanding retirement security, it
is important to note the security that the government already does
provide through Social Security and Medicare. With the collapse of
retirement savings over the last two years, as well as the plunge in
housing equity, the baby boom cohorts will be hugely dependent on these
two social welfare programs. It is therefore more essential than ever
that Congress maintain the integrity of these programs and ensure that
the baby boom cohorts can at least count on the benefits that they have
been promised.
The main lesson of the last two years is that, in addition to the
problems stemming from inadequate coverage and high costs, the current
pension system subjects workers to far more risk than has been
generally recognized. The government can solve all three problems by
allowing workers the option to contribute to a government run pension
system that would provide a modest guaranteed rate of return.
The system would be a universal system like Social Security,
however it would be voluntary. To try to maintain high rates of
enrollment, there can be a default contribution from all workers of 3
percent, up to a modest level, such as $1,000 a year. Workers could be
allowed to contribute some additional amount, for example an additional
$1,000 per year, that would also earn them the same guaranteed rate of
return.
The system should also be structured to encourage workers to take
their payouts in the form of annuities, except in the case of life
threatening illness. For example, a nationwide system could easily
offer free annuitization, while charging a modest penalty (e.g. 10
percent) to workers who take their money out of the account in a lump
sum.
Ideally, there would be tax subsidies for low and moderate income
workers that would make it easier for them to put aside 3.0 percent, or
more, of their wages. However, if budget limitations make subsidies
impractical, there is no reason that Congress could not move ahead to
establish a structure and consider adding subsidies at some future
date.
The guaranteed return should be set at a level that is consistent
with a long-term average return on a conservatively invested portfolio.
Such a guarantee should pose little new risk to the government. As
recent events have shown, in extreme cases, the government will step in
to protect savings, as it did when it opted to guarantee money market
funds, even where it has no legal obligation to make such a commitment.
Guaranteeing a modest rate of return over a long period of time should
present very little additional risk to the government.
The funds in this system would be kept strictly separate from the
general budget. The investment would be carried through by a private
contractor in a manner similar to the way in which the Federal
Employees Thrift Saving Plan current invests the savings of federal
employees.
Even a modest contribution could make a large difference in the
retirement security of most workers. For example, at a 3 percent rate
of return, a worker who saved $1,000 a year for 35 years would be able
to get an annuity of $4,200 a year at age 65. This would be 14 percent
of the wage of a worker who earned $30,000 a year during their working
lifetime. Such a sum would be a substantial supplement to their Social
Security benefits. A contribution of $2,000 a year would be sufficient
to provide an annuity that is almost equal to 30 percent of this
worker's earnings during their working career.
The formulas for this sort of plan can be altered in any number of
ways, but the point is that Congress can enormously increase the
retirement security of tens of millions of workers simply by making a
system with a defined rate of return available to them. This could be
done at no cost to the taxpayers.
Conclusion
The events of the last two years have shown how exposed workers'
retirement income is to market risk. The collapse of the housing bubble
has called attention to the fact that the value of not only their
pensions, but also their homes, fluctuate with the market, while their
homes are an even more important asset for most workers.
While fully restoring the lost wealth of the baby boom cohorts may
not prove feasible, Congress can take effective steps to create a
better retirement system for future generations. This can be done at no
cost to taxpayers, simply by having the government assume market risk
by averaging returns over time. There are no economic or administrative
obstacles to going this route, it is simple a question of political
will.
______
Chairman Miller. Thank you.
Dr. Munnell.
STATEMENT OF ALICIA MUNNELL, DIRECTOR, CENTER FOR RETIREMENT
RESEARCH AT BOSTON COLLEGE AND PETER F. DRUCKER PROFESSOR OF
MANAGEMENT SCIENCES
Ms. Munnell. Chairman Miller, Ranking Member McKeon.
Chairman Miller. I am not sure your microphone is----
Ms. Munnell. I appreciate the opportunity to testify today
about what we have learned about 401(k) plans in the wake of
the financial crisis and to offer some ideas for strengthening
our retirement security. As you indicated, I direct the Center
for Retirement Research at Boston College. We look at Social
Security, public and private pensions and also individual
saving and work decisions.
Even before the financial crisis, we were very concerned
about the ability of 401(k) plans to serve as the sole
supplement to Social Security. I am not here to beat up on
401(k) plans. They were just never intended to do this. They
were meant to be supplementary plans on top of old-fashioned
defined benefit plans.
They left all the responsibility up to the individuals. All
of us individuals make terrible decisions. As a result,
balances in these plans were very low. The 2007 Survey of
Consumer Finances indicates, for people approaching retirement,
the median balance was $60,000. That is before the crisis.
The Pension Protection Act has made steps to make these
plans work more effectively. But they are not a cure-all. And
we haven't even considered the drawdown aspects of these plans,
which are going to be a huge challenge.
Now comes along this huge financial tsunami. And we see
that people are exposed to enormous investment risk also. These
balances in these accounts have declined sharply. If it was
$60,000 before the financial crisis, it is about $40,000 after.
The financial crisis has also affected the real economy. We
have lost about 3.7 million jobs. Unemployed people cannot
contribute to their plans. And unemployed people also feel like
they have to tap their plans to help them over really rough
times. The hardship withdrawal rate has ticked up. It is still
quite low. But my view is that, if this weak economy continues,
you are going to see more and more people taking hardship
withdrawals.
The other thing we have seen is employers have cut back on
their employer match. They are not doing this because they are
evil. They have to make choices. And they are probably doing
this instead of laying people off. But it does mean, if it
persists for a long time, that people are going to have less in
the way of retirement income going forward.
The question is what to do with all this. And I think one
point I would like to make is that working longer is going to
have to be an important part of the solution. Even before the
financial crisis, we argued that working longer was important.
We have a declining retirement income system. And yet, we
have people living longer. Working longer avoids the actuary
reduction, Social Security, lets your assets accumulate, and
shortens the period of which you have to retire. For older
people who are caught in this financial crisis, in fact, that
is all they can do. They really do not have time to save a lot
more money.
The final point is that working longer can't solve the
whole problem. We need to shore up our retirement income
system. And I think that has two parts. One is restoring
balance to Social Security. Social Security has really shined
during this particular crisis. Those checks go out. They
provide valuable money, modest benefits, but inflation index
and go on for life. We need to make sure that those benefits
are not cut back even further.
There is no free lunch. We have to pay up if we are going
to do that. But I think that is important.
The other thing is I strongly believe that we need a new
tier of retirement income between Social Security and 401(k)
plans. I think this tier needs to provide benefits about equal
to 20 percent of pre-retirement earnings. I think it needs to
be on a funded basis in the private sector. It needs to avoid
having people take money out while they are working. Benefits
needs to be paid out as an annuity.
It is complicated precisely how to design it, because of
the trade-off between how much you put in and rate of return.
So if you can get high rates of return, you have low
contributions; high contributions, low rate of return. So there
is much work to be done there. Perhaps the best we can do is a
model, something like the Federal Thrift Savings Plan. But it
would be nice to think if we can do something more creative.
The main message I want to leave with you is that we need
more organized retirement savings. We have a declining Social
Security system, even under current law, as the retirement age
increases. And we have a very fragile system of 401(k) plans.
And they are just together not going to be enough for future
retirees.
Thank you very much.
[The statement of Ms. Munnell follows:]
Chairman Miller. Mr. Stevens.
STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND CEO, INVESTMENT
COMPANY INSTITUTE (ICI)
Mr. Stevens. Thank you, Chairman Miller, Ranking Member
McKeon and members of the committee. On behalf of the ICI and
its members who are entrusted with the retirement savings of 46
million U.S. households, I am pleased to testify this morning.
Let me start out, Mr. Chairman, by joining you in your call
to ``preserve and strengthen the 401(k) system.'' Today, half
of the nation's retirement assets are invested in DC plans or
IRAs. That is more than $8 trillion. And most of those dollars
would not have been saved without 401(k)s. In our view, that is
just one measure of the success of the system and on the strong
base upon which we have to build.
True, the bear market that we are in is wider, deeper and
more unsettling than any downturn in generations. And it has
had a significant impact on retirement savings. One large
record keeper reports that average balances in defined
contribution accounts fell by 27 percent in 2008. These
declines are especially hard on workers nearing retirement. But
every 401(k) saver, no matter what, takes a deep breath before
opening an account statement these days. And I know I am among
them.
These declines cannot be traced to any fundamental flaw in
401(k) plans. Balances are down, because the stock market is
down. The S&P 500 fell by 38 percent last year. All retirement
plans shrank in 2008, not just DC plans, but also IRAs, defined
benefit pensions in both the private and public sectors, and
the Federal Thrift Savings Plan. There is no shelter from this
market storm.
Yet despite these declining balances, working Americans
strongly support 401(k)s. We know this, because we examined
account records of 22 million DC participants in late 2008.
They were not panicking. As of October, only 3 percent had
stopped contributing to their accounts. And fewer than one in
25 had taken any withdrawals. Clearly, 401(k) savers are
staying the course.
We also surveyed 3,000 U.S. households between October and
December. In the teeth of the worst markets in 70-plus years,
our survey respondents affirmed their support for 401(k) plans.
Almost three-quarters want to preserve the tax incentives of
these plans. And more than 80 percent reject the idea that
government should take over investment decisions for
individuals' retirement accounts.
Now, none of this is to say that 401(k) is a flawless
system. In fact, we believe it can and it must be improved. In
my written testimony, I spell out seven proposals that ICI
believes Congress should consider to strengthen our retirement
system.
First, we should improve disclosure, not just about fees,
but also as the recent market developments underscore, about
risks, about performance and more. ICI began calling for
improved disclosure in participant-directed plans in 1976, 5
years before the 401(k) was even born. We have strongly
advocated that the Department of Labor complete its
comprehensive disclosure agenda. And we thank the leadership of
this committee for bringing much-needed attention to this
issue.
Second, to help retirees manage their assets more
effectively, we should relax the rules on required minimum
distributions. The age for RMDs was set at 70\1/2\ in 1962. And
life expectancies have increased markedly since then. Our
research shows that many retirees do not begin to take
distributions until they are forced to by these rules.
Chairman Miller and Ranking Member McKeon, among others on
the committee, recently worked on a bipartisan basis to suspend
these rules for this year. And we should build on that work
going forward.
Third, we need to make it easier for employers to diversify
participants out of heavy concentrations of company stock as
they near retirement. Workers should not have to face the
double risk of losing both their jobs and a significant portion
of their retirement savings if a single company fails. Some
far-sighted employers have proposed plans to help their workers
reduce that risk. We should remove the barriers in current law
that block these ideas.
Fourth, we should consider requiring all 401(k) plans to
use automatic enrollment and automatic savings escalation.
Employers have embraced these features rapidly since the
Pension Protection Act was enacted in 2006. We need to watch
this trend very carefully and consider whether it supports this
fundamental change in the 401(k) system.
Fifth, we must make it easier for employers to offer
savings plans and for all workers, even those of very modest
means, to save for their future. My written testimony suggests
two ideas. The first is a greatly simplified employer plan,
which could reduce some barriers for employers who want to
offer retirement benefits. Second, we suggest a novel proposal
for R Bonds, a new series of treasury savings bonds
specifically designed to help workers save on a voluntary
basis, even if they don't have a plan at work.
Sixth, we must redouble our efforts to provide financial
and investor education to all Americans at every age. And this
is a job for educators, government at all level, financial
institutions like mutual funds, and for that matter, all firms
that serve the retirement market.
Lastly, as President Obama has emphasized just this week,
we must put Social Security on a sound financial footing for
the indefinite future. Social Security has been, and will
continue to be, the primary source of retirement income for
millions of workers. If Washington wants to bolster confidence
in retirement security, it should fix Social Security.
We are pleased to offer these reform proposals for your
consideration. I look forward to your questions.
Thank you, Mr. Chairman.
[The statement of Mr. Stevens may be accessed at the
following Internet address:]
http://www.ici.org/statements/tmny/09--house--401k--tmny.html#TopOfPage
______
[An additional submission of Mr. Stevens follows:]
------
Chairman Miller. Thank you very much.
And thanks to all for your testimony.
Mr. Bogle, I am sure that I have probably been misquoting
you. But I have suggested that you have raised the issue saying
that the issue for investors and savers is a competition
between the miracle of compounded interest and the tyranny of
increasing cost. And that suggested to me that you believe that
costs do matter in the long-term management of people's
retirement savings. Is that a fair statement.
Mr. Bogle. Yes, sir, Mr. Chairman. That is a very fair
statement. And as far as I can tell you, there is not a single
academic study that does anything but reaffirm that point.
There is not a single independent financial publication, say
Morningstar, for example, that doesn't affirm it in spades. It
is basically universally true.
What I would add is, however, of course we need better
disclosure of costs for employers and employees alike, because
costs are the reason that the returns of institutions and the
returns of all investors as a group fall short of the returns
earned by stock funds and bond funds, as I said in my
testimony.
What I want to emphasize, though, is that we seem to be
relying on the fund's expense ratio, its expenses as a portion
of the asset as the talisman, or it is the standard of what
costs are. And those costs run somewhere between eight-tenths
of 1 percent to 1.3 percent a year. That number, Mr. Chairman,
grotesquely understates the total amount of costs involved in
mutual funds, even when you don't talk about sales loads, which
are largely outside of the large retirement plan arena, however
are very tough on some of the smaller retirement plans.
And the other cost, which is huge, is the substantial
undisclosed transaction cost that mutual funds in particular
incur, reflecting the rapid turnover of their investment
portfolios. It is absolutely amazing, sir, how these portfolios
turn over, because the mutual fund industry, it seems to me on
the data, has become an industry engaged in short-term
speculation rather than long-term investment.
Chairman Miller. This is the activity within the funds that
you might----
Mr. Bogle. Funds buying----
Chairman Miller [continuing]. Invest in as your 401(k) plan
in. You are talking about the internal management----
Mr. Bogle. I am talking about the----
Chairman Miller [continuing]. Of the shares within that
fund.
Mr. Bogle. And just think about this. The average assets of
actively managed funds last year were something in the realm of
$4.8 trillion. And the total transactions, just guess at what
the total transactions, members of the committee and Chairman,
might be in your mind. And I will tell you what it is.
They bought and sold $7.2 trillion dollars with the
securities, trading by and large back and forth with one
another. So the elephant in the room, if you will, is the
ignoring of transaction costs, which have a huge impact,
something like half a percent to 1 percent a year in addition
to that expense ratio, which is--for the fun of it, we will
call 1 percent for the actively managed equity fund.
So now, think about this. And an index fund, of course,
goes for about one-twentieth of that 2 percent, because it--
transaction costs, nor management fees, but overall expenses of
about a tenth of 1 percent compared to 2 percent for the
industry.
Now, think about this when you get to compounding this. And
this is the point which you quote me, sir, accurately. And that
is the miracle of compounding investment returns turns out to
be overwhelmed by the tyranny of compounding cost.
Let us assume, just for the fun of it, counting a stock-
and-bond portfolio together, that it earns over the next 10
years, let us say, 6.5 percent. That is phenomenal return. If
we assume 2.5 percent inflation, just a guess, but probably not
one with which most people in the room would disagree, that
leaves you with a 4 percent real return on a balanced
investment portfolio, of which costs are consuming 2 percent.
Costs are taking half of the real return.
But of course, given that formulation, it is much worse
than that, because if you compound 2 percent and 4 percent over
an investment lifetime, call it 50 years, you find that costs
have consumed 75 percent of the return of the investment.
So you, the investor, who puts up 100 percent of the
capital and takes 100 percent of the risk gets 25 percent of
the market return. That just doesn't seem right to me, sir.
Chairman Miller. Well, I obviously agree with you. You
know, I have always been stunned at whenever you allocate these
costs, and people can argue whether 1.5 percent or 2 percent or
what is fair and all the rest. And then the internal
transaction costs that are taking place within the investment
programs that people purchase, the only source of all of that
revenue is my retirement.
You know, American families make a decision. And it is very
difficult for the huge middle-class families in this country,
that huge class of people, to make a decision after all of
their other obligations, to also save. And yet, that is the
source by which all of these trillions of dollars in
transactional fees and others is from. Nobody else is
contributing that.
There was a while, and it was fairly common, that we shared
that with the employer. But now the employers have figured out
that that should be offloaded more and more onto the employees
if they are managing the funds and on individuals.
And so, you know, I am very jealous. I know how hard people
in my district work to create a little bit of savings. And I
know, as Dr. Munnell has pointed out, how small their total
savings are. And if you combine that with what Dr. Baker said
in terms of what they thought was going to be an equity account
that they had, but they made choices, some good, some bad.
We are talking about a population that is in a desperate
situation. And I don't think we can tell the next generation of
savers that they would want to put their savings at that same
risk with respect to cost. Somehow we have got to figure out
that the idea of these savings makes sense to the American
public to make the determination that they want to participate.
But the struggle, the incredible struggle and the energy
put into fighting against that transparency is just really
quite phenomenal, you know, really quite phenomenal. But we
will continue on down this path.
I just would like to ask, if I might, Dr. Munnell, one
question in this round of my questioning. You had mentioned
that you would like something like the Thrift Savings Plan. But
we could be more creative. What are you talking about?
I will come back to you in the second round. But I just
wanted to put that on the table.
Ms. Munnell. There is enormous trade-off between the
contribution people have to make and the rate of return they
earn. And the question is can you ensure people higher returns.
And so we have really been looking into this issue of
guarantees, which is a very tough subject, because what you can
do according to standard finance theory, if the insurer has the
same preference as the market, it is very modest. And insuring
2 percent real rates of return really would have done nothing
over the last 84 years.
And the question is can you somehow construct higher level
of guarantees or different ways of risk-sharing. But it is not
something you want to do casually. But it is really worth
looking into.
Chairman Miller. I see. Okay, I just want to know what the
parameters of that discussion were.
Ms. Munnell. Right.
Chairman Miller. Thank you.
My time has expired. I just want to know, Congressman Hare
finally showed up a little late to this hearing. You would
think that someone who just turned 60 would be here early to
figure it out.
But anyway, happy birthday.
Mr. McKeon.
Mr. McKeon. We did that in lieu of singing happy birthday,
I guess. He may not be so happy when he is done with the
hearing. He is worried.
I really appreciate your testimony. One of the things that,
whenever we talk about this subject, one of the things that
really bothers me is, I think Dr. Munnell you made the point
that sometimes we make bad decisions. I think human nature
seems to be that we always go for the maximum possible return,
thinking that that will always be there.
I remember talking to a golf pro one time. And he said
every shot, it seems like, we hope is going to be the best shot
we ever make. And I think sometimes we plan our future
retirement on that basis. That is, I guess, why gambling
casinos are doing so well. People go there always expecting to
win. And in our retirements, we expect that we maybe can lose a
little bit here, because we are always going to make it up on
the big play.
And I am wondering how much responsibility the federal
government should take in protecting people from bad decisions.
Do we have the ability, being that we are all very intelligent,
smart here, now that we have been elected to Congress, to avoid
all of those bad decisions. And you can see how successful we
have been lately.
Mr. Stevens, my understanding is that the mutual fund
industry holds about half of the assets in 401(k) plans, which
means about half of those assets are held somewhere else. Can
you tell us where the other half are, and how those plans have
suffered as a result of the financial downturn? How bad is how
they have been affected?
Mr. Stevens. Thank you, Mr. McKeon. Yes, it is true. Mutual
funds are an important component of the system. But if you look
broadly, there are different types of retirement plans,
including defined benefit plans who have been hit, as my
testimony describes. But there are also other components of the
401(k) system and of individual retirement accounts, which are
not mutual funds.
We are sometimes frustrated, because we are such a large
component, that we are sometimes identified as the entire
system. But you have to consider, for example, products that
are sponsored by insurance companies, by banks and other
financial institutions that are part of the system as well. It
is one of the reasons frankly that we have emphasized from the
very beginning the need for a disclosure regime that extends to
all investment options that a 401(k) participant might be able
to invest in in their plans.
We have lived under the regime of the Securities and
Exchange Commission throughout our history, since 1940. And I
think whatever deficiencies people might think there are, we
have as comprehensive a set of disclosures on virtually every
subject, more so than any other financial product.
We have been saying for years that we ought to bring the
other components of the system up to something that is
comparable. And that has been a very important part of our
public policy emphasis now for 33 years. It is certainly
gratifying to us to think that that might begin to be the case.
Certainly we are more than happy to talk about mutual
funds. But let us not confuse mutual funds with the entire
defined contribution system.
Mr. McKeon. Thank you.
Dr. Baker, you mentioned something at the end of your
statement about we should have another kind of a defined
benefit of $1,000. And there would be no cost to the
government. How would that work?
Mr. Baker. Well, the point here, and I think I am thinking
along similar lines to Dr. Munnell, that if we established in
effect an expanded defined benefit building on Social Security,
where workers would contribute voluntarily, perhaps with some
strong-arming by some automatic contributions and default--I
should say, default contributions and perhaps subsidies for
low-income workers, that we could have an additional amount put
aside targeting, say, $1,000 a year, which would be a modest
increment to a higher-income worker, but would be fairly large
for, say, a more moderate income worker, where we would
guarantee somewhere perhaps 3 percent being a little more
ambitious than the 2 percent we overturn, that could provide a
very substantial supplement to----
Mr. McKeon. Excuse me. The worker would contribute $1,000.
Mr. Baker. Yes, in the government-managed account, which
would then be invested privately similar to the thrift savings
plan.
Mr. McKeon. And who would guarantee the 3 percent?
Mr. Baker. The government would provide the guarantee. So
the government would be taking some risk. But again, I would
just contrast that to the, in effect, guarantee we have given
to the bond holders of corporations like Bear, Stearns and AIG,
where that is being very costly to the taxpayer. And there were
certainly no commitment on the part of the government to make
those bonds good in advance.
Mr. McKeon. Sometimes we go through periods of growth.
Sometimes we go through periods like we are in right now, where
things really collapse. How would the government guarantee that
3 percent without any risk to the taxpayer?
Mr. Baker. Well, I should not say that it is no risk. But
it is a very, very modest risk. So if you had a portfolio that
was, say, 60 percent equities, 40 percent other, you know,
bonds, mutual funds, that, over a long period, there would be
very limited risk that you would----
Mr. McKeon. How would that vary from Social Security?
Mr. Baker. Well, the difference is that it would be defined
contribution, that people would voluntarily be putting their
money in there. So if they didn't want to do it, they wouldn't
have to.
Mr. McKeon. Whether they put the money in, or whether the
government puts the money in now for Social Security.
Mr. Baker. Well that is, as you know, that is mandated. In
this case, it would be voluntary.
Mr. McKeon. I see. And then all it takes----
Mr. Baker. So again--that is strongly encouraged.
Mr. McKeon. Why not make it mandatory if it is not----
Mr. Baker. Well, again I----
Mr. McKeon. Why not just increase Social Security
deductions?
Mr. Baker. Well, that is something that I think would be
reasonable to consider. But I think, in this case, it is not a
tax. If you do not want to pay it, you don't have to pay it. So
we could have a default.
Mr. McKeon. But then don't we get back to where we are
right now?
Mr. Baker. Well, I think----
Mr. McKeon. Some people are going to live forever, and are
going to hit the big jackpot at some point. And they don't need
to worry about it until, you know, they get to be about 55.
Mr. Baker. Well, in this case, the 3 percent real return
should be consistent with what the financial markets can give
over the long term. When I was saying that there could be some
risk, we could have a prolonged period, as we may have now, of
a down stock market, in which case it would involve some modest
commitment for the government.
Mr. McKeon. A couple of years ago, it would have been
great.
Chairman Miller. I did. And I am--this hearing is going to
end at 12:30. So we will try to limit going over now that Mr.
McKeon and I have gone over.
Mr. McKeon. I yield back.
Chairman Miller. Mr. Payne.
Mr. Payne. Thank you very much. It is a very important
hearing. Just looking over some of the notes that the
cumulative decline in the value of the financial assets as a
result of the current economic crisis cost Americans almost
$2.7 trillion in their retirement savings. As we remember years
ago, the defined contribution plans were really what was in.
And the defined benefit was less popular.
Of course, when employers started to end their defined
benefit plans, the old-type retirement that, you know, I used
to hear my father talk about, we saw a shift, even in the
1980s. 60 percent of workers were covered by defined pension
plans and 17 percent by their defined contribution 401(k)-type.
However, just 20 years later, only 11 percent of the workers
are covered by defined benefit plans. And 56 percent, almost 60
percent, by the defined contribution plans.
Now, if we are having the problem with the market, you
know, I guess my question, maybe Dr. Baker might take it. I
don't believe that policymakers ever intended that the ability
of a worker to retire would depend on whether the stock market
was up or down in a particular year. How can we modify the 401
plan, so that workers' ability to retire is not dependent on
the state of the stock market.
You know, like I said, years ago you had that guarantee
coming out. The check would come each month, like Social
Security, more or less. But how is the future? It looks bleak
right now. My colleague said that we have ups and downs. Look
like this down is pretty down and going to be down for a while,
maybe not out, but a nine count. And maybe like the Dempsey
fight, we are trying to have a long count to not call 10. We
don't want the knock-out.
So what do you think, Dr. Baker?
Mr. Baker. Well again, I agree with you completely that we
have subjected workers to much greater risk than I think any of
us realized and certainly that they realized. And I was making
the point that, in addition to their retirement wealth, they
also had their housing wealth at risk as well.
So that is why I was thinking that, given the
circumstances, I think it does make sense to talk about having
some additional guaranteed benefit that could be available to
workers. Again, it is possible you would want to look to expand
Social Security. I think that is a reasonable thing to
consider.
But I think to allow workers the opportunity to invest
voluntarily in an account that will give them a guaranteed
return, I think would be something that would be of enormous
value to the country's workers at very low risk. Again, I can't
say no risk, sir, but very little risk to the government. I
think it is a case where the trade-offs, I think, are very much
in favor of offering that sort of guaranteed benefit.
Mr. Payne. Thank you very much.
Well, since the chairman is trying to rush through, I will
stop with the one question. All right.
Chairman Miller. I thank the gentleman. His time has
expired.
Mr. Kline.
Mr. Kline. Thank you, Mr. Chairman.
Thank you, lady and gentlemen, for being here with us
today. A tremendously important subject, and of course now we
are all looking at it, I think, much differently even than we
did a year ago.
We all, Mr. Stevens, look at our account statements with
some trepidation now. I make my wife read them myself. It works
in our house.
I am a little bit intrigued. And I am tempted to get in the
whole discussion sort of suggested by Dr. Baker. And that is
doing something to kind of shore up Social Security, which I
think he is suggesting an additional voluntary effort to put
money in, maybe $1,000 that we guarantee by the government.
That is a very interesting idea, and one which I certainly
wouldn't reject out of hand.
But I am very concerned that one of our pillars here that
we are looking at is Social Security, and it is Medicare. And
by every measure by anybody, we are some $50 trillion or more
underfunded in those programs. So I am just kind of reluctant
to turn in that direction very hard.
Because I don't have much time, let me go to Mr. Stevens.
According to the note I have here, and I remember saying this.
Professor Munnell notes that, during this crisis, we have had
about 2 percent I think of 401(k) plan participants have made
hardship withdrawals from their 401(k). Can you tell me,
looking at the industry from your perspective, how does that
number compare historically to plan withdrawals?
Mr. Stevens. Thank you, Congressman. As I indicated in my
testimony, when you actually look at behaviors in the major
record-keeping systems, they are very much at the norm that we
would have predicted historically, very little increase in
hardship withdrawals. People are not massively taking loans
against their accounts. They seem to have an understanding that
these are assets that are there for their retirement with some
kind of mental accounting.
In fact, I would say in general, there is a tendency to
look at 401(k) investors like their children who don't know
what they are doing. And in fact, if you look carefully at
their behaviors, they are much more grown up than sometimes
they are given credit for.
Mr. Kline. They probably let their wife do it too. The
Thrift Savings Plan has been used as an example a number of
times as an investment plan with relatively low expenses. We
have talked about in the last Congress. I just want to sort of
bring us up to date here. Again, going to Mr. Stevens, tell us
how it is possible for the Thrift Savings Plan to operate at
what seems to be very low expenses. And in general, can you
speak to the performance of funds in the TSP during this
crisis?
Mr. Stevens. Yes. Well, as I said, the Thrift Savings
Plan's funds have been hit like all others. There has been no
shelter from the storm in the market. But the TSP really
doesn't compare to the private retirement system. And I think
this is a very important point to make.
The TSP is about seven times larger than the largest
defined contribution plan in the United States. If memory
serves, I think it only has about three payrolls, large
payrolls, that it has got to process. There may be a number of
other smaller ones.
But you compare that with the literally hundreds of
thousands of different payroll systems and therefore record-
keeping requirements that exist in the private sector. You
don't get remotely the economies of scale.
It is also true that virtually none of the compliance and
regulatory and reporting and other burdens that exist for
sponsors of 401(k) plans exists for the federal government.
Those requirements have been waived with respect to the Thrift
Savings Plan. Not so with respect to any employer, no matter
how small. And remember, most of the employers in 401(k)s have
100 employees or less. So we are talking about relatively small
businesses.
And then, you know, it is simply true that some of the
costs of the Thrift Savings Plan are not apparent. I am a
former federal employee. There are federal personnel offices up
and down every department and agency of government who support
the Thrift Savings Plan. And I have never seen an estimate for
what their cost is. And it is not reported as an additional
cost to the saving of the system. You could think of that as
corresponding to any number of activities that have to take
place to support 401(k) plans.
So I think it is even more remote than comparing apples
with oranges and just doesn't provide an appropriate frame of
reference in which to think about cost factors in the 401(k)
system by any means.
Mr. Kline. Thank you very much.
Mr. Chairman, I yield back.
Chairman Miller. Mr. Andrews. And I want to say that the
witness is not just to do on Mr. Andrews' time. But to the
extent you think you want to say something in response, and you
can politely figure out how to do that, you are more than
welcome to do that.
Mr. Andrews.
Mr. Andrews. Thank you.
I thank the panel for very, very good testimony that is
going to help this process considerably. You know, this hearing
would be compelling under any circumstances. But it is
particularly compelling when we look at the real pain and
anxiety that people all across this country are feeling, that
is subsumed in that $2.7 trillion loss of pension assets.
But we are not here to comment on the size of that loss. We
are here because our hypothesis here is that, because the
401(k) system, the DC system, is in need of reform, the loss is
worse that it would have otherwise been. And when things get
better, the recovery won't be as good as it would otherwise be.
So this hearing would be timely whether people had gained $2.7
trillion or lost $2.7 trillion. And that is what I want to
focus on, is those reforms that I think could make the DC
system better.
Mr. Stevens, one thing I want to ask you. On page 5, you
have a graph, which shows declines in asset values. And it
shows that 401(k) plans have declined 10.9 percent. The S&P 500
declined 19.3 percent.
But I do want to understand, though, as you point out that
that includes the contributions that were made to the 401(k)
plans. Correct?
Mr. Stevens. Actually, Congressman, the graph on page 5 is
intended to depict as of the third quarter of 2008.
Mr. Andrews. Yes.
Mr. Stevens. The depreciation that different types of
retirement plans----
Mr. Andrews. But that depreciation takes into account the
contributions that were made to 401(k) plans. It is not simply
their performance net of contributions. Correct?
Mr. Stevens. Yes, I think that is correct.
Mr. Andrews. Okay. So we are really not comparing apples to
apples when we look at the S&P return and the contribution
returns. Let me ask you this question to supplement the record.
If you could supplement for the committee what that number
would be, if you subtracted the contributions were made and
just looked at the performance of the fund as it exists in the
prior period, we would appreciate that. I think that would
clarify the situation.
I notice on page 9, in footnote 19 I believe it is, I am
encouraged by your--see, in law school, they teach you always
to read the footnotes.
Mr. Stevens. They do indeed.
Mr. Andrews. So I am encouraged by the fact that I think
you have extended an opportunity to work with the chairman and
with all of us and the work that we did in the last Congress
when you say: We agree with the approach taken by the bill
reported out of the committee in the last Congress, names the
bill, and similar proposals ensuring the disclosure rules apply
equally to all products offered by 401(k) plans.
I agree with that. And we would invite your participation
as we try to craft good rules that make meaningful disclosure
to all participants about all assets. And we appreciate you
making that comment.
Mr. Bogle, I was taken by much of what you had to say. We
appreciate the tremendous contribution you have personally made
in this area and your firm has made. Your third recommendation,
which is the inclusion of some sort of annuity product as an
option, are you advocating that each plan should be required to
offer an annuity product as an option?
Mr. Bogle. Each plan, I think, certainly should offer it.
And the question is to what extent one should make it
mandatory. The idea of locking in or locking out, I guess one
would say, longevity risk, seems to me to be a fundamentally
good idea.
Mr. Andrews. Do I understand your proposal correctly that
what you are proposing is that certain participants would have
a certain percentage of their assets put in that annuity-type
plan, unless they opted out. Is that your proposal?
Mr. Bogle. That is correct.
Mr. Andrews. Okay. Could you describe to us what the
annuity product would look like and how it might be designed?
Mr. Bogle. Well, like the mutual fund industry, the annuity
industry takes huge amounts of cost. Out of the returns, you
get marketing cost and administrative cost and investment cost.
So most annuities are not particularly attractive to a--so we
need a better system.
I would argue, I think, that--not I think, I know, that
TIAA-CREF, for example, has one of the outstanding annuities in
the country, very low cost. But it stands almost alone, because
the annuities have to support this big marketing system. I
don't see any reason that some governmental or quasi-
governmental agency couldn't provide just an actuarial based
annuity, but without all those costs in it.
And the whole idea is to take the cost out, because that is
so fundamental to everything we do in retirement savings.
Mr. Andrews. Dr. Mussell [sic], would you care to comment
on whether you think that there should be a fixed asset
annuity-type option included in every plan? Do you think that
should be?
Ms. Munnell. I think that we are really going to face, even
if we didn't have this impact of this financial crisis, that we
were going to see a crisis when people retired with 401(k)
balances, because it is really hard to figure out how to drawn
down that money over unknown lifespan. And so----
Mr. Andrews. But do you think we should require such a----
Ms. Munnell. I think it should be a default in 401(k)
plans. It is not as obvious as automatic enrollment. But I
think it is the better option to have the default be an
annuity. And then people can back out.
Mr. Andrews. So I just may ask one more quick question.
There is a subtle difference between a default position and an
option that must be offered, right?
Ms. Munnell. If you just offer it as an option, no one will
take it. People hate annuities. So I think----
Mr. Andrews. Not everyone.
Ms. Munnell. I think you put them in. You let them try.
Mr. Andrews. Okay.
Ms. Munnell. And then if they don't like it, they can go to
their HR people and get out. But that is where you put them.
Mr. Andrews. Thank you very much.
Chairman Miller. Mr. Castle.
Mr. Baker. I think if I could state quickly, I think your
question was whether it should be mandated. And I think we had
agree that every plan should offer that at least as an option.
Mr. Andrews. Okay.
Ms. Munnell. No, I would say something----
Mr. Andrews. Well, I think, yes. I think the Boston College
folks wanted to be a QDIA-type, a default, but not offered as
an option per se. is that what you are saying?
Ms. Munnell. I am saying every plan should have it. And----
Mr. Andrews. Right.
Ms. Munnell [continuing]. Put everybody in it when they
retire. And then people can say oh, this isn't right for me. I
have cancer.
Mr. Andrews. So if you don't pick a vegetable, it has to
brussel sprouts. Okay.
Chairman Miller. Mr. Castle, help us.
Mr. Castle. Good luck. Thank you, Mr. Chairman.
Dr. Munnell and Mr. Stevens, you both mentioned the fact,
something to the effect of we have to shore up or firm up
Social Security. We in Congress say this on a daily basis in
speeches we give or whatever. And then it gets down to the
specifics of how do we do this? I realize that is a little
beyond perhaps the context of this meeting. But you mentioned
it. And I would be curious as to whether you have any specific
ideas about how to so-called shore up Social Security.
Ms. Munnell. Shore up Social Security. People say oh, we
can do some with tax cuts, benefit cuts, and some with tax
increases. Social Security replacement rates are going down
under current law as the normal retirement age goes from 65 to
66 to 67. For people who continue to retire at 62, you are
going to see very low levels of replacement. And they do tend
to retire at 62.
So I think that anything that cuts benefits any further is
really dangerous and is going to put people at risk. But there
is no free lunch. I don't think people are going to grow
ourselves out of it. So that means more revenues in somehow.
And, you know, you put in the estate tax. I would change
the COLA. I would actually index the full retirement age to
longevity, and then maybe put in some more payroll taxes.
But I think it is important to maintain it as the backbone
of our retirement income system. We have seen that we really
need it. And we should do what we have to do to fix it.
Mr. Castle. Thank you.
Mr. Baker. If I could quickly point out the small free
lunch.
Mr. Stevens. I think that I was asked the question as well,
if I could respond.
Mr. Baker. Okay.
Mr. Stevens. We do not have a plan to fix Social Security.
I consider it a bit above our pay grade. I would say that we
have never supported the idea of private accounts in Social
Security. We believe that the Social Security system should
essentially stay the system that our grandfathers knew and
grandmothers. It is the best inflation-adjusted annuity that
anyone will ever, ever receive. And it ought to be maintained
as such.
Among individuals who are over age 65 and who are no longer
working, the bottom 50 percent ranked by income get 86 percent
of their income from Social Security. That is not new. That has
been the same since 1980. And it is very important to maintain
that stability of income and replacement value for the lower
income workers in the United States.
Mr. Castle. Thank you.
Mr. Baker, do you wish to comment on that?
Mr. Baker. Yes, very quickly. Just the sort of pseudo-free
lunch I was going to refer to is that one of the problems
facing the program was that we had an increasing portion of
wage income going over the wage cap as there had been an upward
redistribution of income over the last 30 years.
There is early evidence thus far that that redistribution
is being reversed. In other words, there has been a big
increase in wages for those at middle and bottom. If that
persists, then we don't have enough data yet to say that will
be true. If that persists, that will substantially reduce the
projected shortfall in the program, since more income will be
subject to the tax. A larger portion of wage income will be
subject to the tax.
We don't know that will stay the case. But at least, thus
far, it looks like that was one outcome of this crisis.
Mr. Castle. I hope you are right. Although the crisis makes
me nervous, perhaps that is not going to happen. But let me ask
you another question, Mr. Baker. I think you said that the
Federal Reserve should combat asset bubbles. Is that correct?
And if so, how should the Federal Reserve combat asset bubbles?
Mr. Baker. Well, I did say that. And I think the Federal
Reserve has a variety of tools that it can use. But the first
tool that I would have used if you were going to make me
Federal Reserve Board chair----
Mr. Castle. Yes. We will do that temporarily.
Mr. Baker [continuing]. Would have been to basically use
the bully pulpit of the fed, to use their congressional
testimonies, use their other public speaking opportunities to
call attention to the misalignment of asset prices and the
fundamental realities.
I think it was easy to see that in the case of both the
stock and the housing bubbles. You had very clear evidence that
these prices were out of line.
Yet, if Chairman Greenspan had used his public speaking
opportunities as occasions to point that out, backed it up with
research from the fed, so I don't just mean mumbling irrational
exuberance. I mean, pointing out here is why real estate prices
are out of line with the fundamentals in the market, you will
end badly. If he had used his bully pulpit to do that
repeatedly, I think it could have had a very large impact.
Now, obviously they have regulatory authority. They could
have prevented a lot of the bad mortgages that we saw and that
contributed to this. But first and foremost, I think that bully
pulpit is extremely valuable. And he wasted the opportunity to
use it.
Mr. Castle. Does that pertain to others, like members of
Congress, chair of the committee and the president of the
United States. I mean, it is to just the Federal Reserve in
other words. It is----
Mr. Baker. Absolutely. I mean, this was the most important
problem, economic problem, facing the country over the last 5
or 6 years by far. I mean, everything else that we--and I am
not saying this in retrospect. I was saying this at the time.
Everything else by comparison is really small change.
Mr. Castle. Very quickly, Dr. Munnell, I came in the middle
of your testimony. But I think you talked about another tier of
up to 20 percent before retirement or something of that nature.
In other words, it sounded like a new program. And maybe it was
in your writing, which I haven't read. But can you briefly tell
us what that is all about?
Ms. Munnell. Yes. I firmly believe that just having 401(k)
plans, no matter how good you try to make them, and Social
Security as the only two components of our retirement income
system is not going to provide people with enough money. I
think that people at the low end, who are going to get less
from Social Security going forward, are going to need something
more. And I think that people with 401(k) plans are also going
to need more than just these balances that they have now.
And so I think we need a new tier across the income groups
for everybody, and let the poor old 401(k) plans go back to
what they originally were, which were sort of supplementary
plans, almost play money, for people who had solid coverage to
being with.
They weren't designed for this. And we keep trying to tweak
them to make the work better. And they do work a little better.
But they are still flawed.
Chairman Miller. Mrs. McCarthy.
Mr. Stevens. Mr. Chairman, could I----
Chairman Miller. I am going to move along here. I mean, we
will try to figure out how to get your comments here.
Mrs. McCarthy.
Mrs. McCarthy. I want to thank the panel for the
information. It has been very helpful. One of the things that I
would like to go into a little bit deeper.
Mr. Stevens, I know you basically support financial
literacy programs, which is something that I am trying to work
on Financial Service Committee to get all that in. It has been
a battle for a number of years.
But one of the things that you spoke about was the
importance of relaxing the required minimum distributions rules
individually age 70\1/2\. As you point out, Congress worked in
a bipartisan manner to suspend the rules for 2009. And you are
talking about basically making that permanent or a lock-in for
the losses.
Could you elaborate why Congress should consider an
extension of the minimum distribution or waiver or permanent
raising the age trigger from the current 70\1/2\ and anybody
else that wants to jump in?
Mr. Stevens. Yes, ma'am. Thank you. The 70\1/2\ age at
which required minimum distributions are triggered now has been
the standard for many, many years. In the meantime, life
expectancy has grown. And it seems to us a very reasonable
accommodation to Americans in retirement, who are trying to
manage their assets, to give them more time before they are
required by law to begin drawing down their retirement account
balances.
When we asked people about this, fully 60 percent responded
that the only reason that they were withdrawing from their
retirement accounts was because they had reached that magic
age. And the law required them to do so.
So obviously, there are many Americans who are in a
position where they can husband these assets for a longer
period of time. And given life expectancy and given other
pressures on retirement assets, we ought to help them do so.
Mrs. McCarthy. Does anybody else have an answer to that?
Ms. Munnell. I would support looking at it. But the reason
it is there in the first place is that so these aren't estate
planning tools. So perhaps we can make the age later. But I
think that it would require careful study. And you definitely
want some age.
Mr. Baker. Just very quickly, I think the concern about
locking in losses is perhaps exaggerated, because keep in mind,
you only have to cash out at 6 percent. It is a relatively
small share. I think you would find very few people who will
reach the age of 70, who are invested 100 percent in equities.
In other words, almost all of them would have enough in bonds
or money funds. But they would be able to meet that
distribution requirement without touching their equities.
Mr. Stevens. No, my point was not their locking in losses,
but their having to withdraw from their accounts however they
are invested.
Mrs. McCarthy. I will yield back the balance of my time.
Chairman Miller. Mr. Guthrie.
Mr. Guthrie. Thank you, Mr. Chairman. And thank you for
conducting this meeting. This is extremely important for people
I know of. Now that we have changed the systems, and then they
have changed. And people are now mostly not in defined
benefits. They are approaching retirement age, a lot of people
in that group. So I know this is important, and they are facing
this.
And Mr. Stevens, you were going to make a comment to Mr.
Castle and didn't have the opportunity to make. We ran out of
time. Did you get to make that? If so, I would give you the
opportunity to do so.
Mr. Stevens. I didn't. Thank you very much. No, much of
what you have heard this morning assumes that there was a point
in time when the vast majority of working Americans enjoyed the
benefit of a defined benefit plan. This is a nostalgia we have,
I think, as a country, and understandably, for an age that
never existed.
Before 401(k)s came online, and then rise of the defined
contribution system, only 16 percent of Americans in
retirement, 16 percent, received any payment from a private
pension plan. And the payment in today's dollars represented
$6,000. So the golden age of the gold watch simply never
existed.
So the idea that somehow or other defined contribution
plans came and displaced this wonderful paternalistic system of
defined benefit arrangements is simply not true.
Mr. Guthrie. Anybody else want to comment on that?
Ms. Munnell. Can I just respond to that? I mean, there were
a period in which everyone who had a pension did have a defined
benefit plan. And that has changed to a situation where
everyone has a pension has the defined contribution plan. The
defined benefit plans weren't perfect. But one has really
displaced the other.
Mr. Guthrie. So the comment is, if you had a pension, you
had defined benefit.
Ms. Munnell. Yes.
Mr. Guthrie. But still, 16 percent had pensions, if that
number is correct. The 16 percent is what----
Mr. Stevens. Or the inverse is 84 percent had no form of
pension. And you have to think of what defined contribution has
done to enlarge some pension provision for working Americans.
And that was my point.
Ms. Munnell. Can I just add one comment?
Mr. Guthrie. Sure.
Ms. Munnell. If you take a snapshot of the private sector
work force at any period of time, and this has been true from
the 1970s right to the present, roughly half of the people have
any employer-provided pension of any sort. And in the old days,
1980s, those were defined benefit plans. Today, they are
defined contribution plans.
So the percent of population with anything has not changed.
But the nature of what they have has changed.
Mr. Guthrie. Thank you. One more, and then I guess I will
yield back after this comment.
Mr. Stevens. I think it is important to understand too
that, in the traditional defined benefit system, you had to
spend a long time at a single employer, and then retire from
that employer to get the pension benefit. The reason defined
contribution plans have become so popular really has to do with
the fact that that is not the working model any longer.
Individuals will have seven to eight different employers during
the course of their lifetime. So the DC plan is a better fit,
in our judgment at least, then the conventional DB plan.
Mr. Guthrie. Thank you.
Thank you, Mr. Chairman. I yield back.
Chairman Miller. Mr. Wu. Mr. Wu is not here.
Marcia Fudge. No questions?
Mr. Bishop is not here.
Mr. Sestak, there you are. The gentleman is recognized for
5 minutes.
Mr. Sestak. Thanks, Mr. Chairman.
Mr. Bogle, if I----
Chairman Miller. Why don't you see if you can use Ms.
Hirono's mic?
Mr. Bogle. Congratulations.
Mr. Sestak. Can you hear me now?
Mr. Bogle. Yes, we can.
Chairman Miller. No.
Mr. Bogle. Well, I can.
Chairman Miller. Yes, let us. I don't know why the----
Mr. Sestak. Can you hear me?
Mr. Bogle. Yes, I can.
Mr. Sestak [continuing]. Question has make sure that I
understand it. It seems to me as though what you are most
interested in is trying to spread the risk of investing to the
entire group of investors. And that is kind of your bottom line
that I am taking out of it.
Mr. Bogle. Correct.
Mr. Sestak. You don't seem as interested or feel it is as
apropos to getting to that overall objective by, if I read your
testimony right, by debundling all of the various fees. That is
nice. It is interesting. We would like to know, if we don't
know, that you have an expense ratio. But we really don't know
the 0.5 to 1 percent that is added on because of transaction
costs. You would like to make that apparent.
Further debundling is nice on the margins. What you really
want to do is spread the risk to the market as a whole. Do I
get it right?
Mr. Bogle. Yes. But I would say, sir, only partially right.
And that is with respect to the equity risk, it is
mathematically correct to spread the risk as widely as you can.
And then all investors as a group will win. Where if they are
fighting with each other in the marketplace, which is the way
the markets work, it is like the casino or the racetrack or the
lottery, they are going to lose. So yes, absolutely correct
with respect to the equity.
However, I don't think we have given much attention at all
here today to something we should give a lot of attention to.
And that is one of the things that went wrong, is that we
didn't spend nearly enough time on educating investors about
the risks of stocks and the need to have a bond component of
their retirement plan. And for more years, more decades, maybe
30 years, I don't know how many years, I have been saying
investors ought to be very conscious of a balanced program.
Now, I grew up, since 1951, with Wellington Fund, which is
a balanced fund. And that was my first defined contribution
plan investment in 1951. So I have been at it for a long, long
time. And it has worked great.
But the reality is that, and what I have been saying for at
least three decades, is your bond position should have
something to do with your age, because things happen when you
get older. I don't want to get into all of them at least.
But among the things that happen are you have less time to
recoup bad times. You have more money at stake. And you
probably get a little more jumpy when we get the crazy stock
markets like this one, which is certainly a once-in-a-
generation thing.
Mr. Sestak. So your proposal would be that your federal
retirement board would mandate the shares that go towards the
bond index as opposed to the stock index.
Mr. Bogle. Yes, sir, I do. And however I would, you know,
not make it rigid; maybe a range in bonds. In other words, if
you are 65, you wouldn't be bound to 65 percent. If you are 65
years of age, you wouldn't be bound to 65 percent in bonds. But
maybe somewhere between 50 and 80 percent, depending on your
own requirements.
Mr. Sestak. And----
Mr. Bogle. And just to get a little protection against
these things that happen in this life, that we don't expect.
Mr. Sestak. The last question I had, again for my
edification is, in your great article ``Black Swan,'' you
called it an expectations market. But I think here, in your
testimony, you call it the phantom. My question is, if you
really do move towards an index-type of an approach, hearing
your testimony, you talked about between 1999 and today, we
actually had, I think, a 7 or 8 percent loss on the stock
market when you know, in reality, rather than the 12 percent
that had gone from 1975 to 1999.
How do you remove the, what you called the coop year from
that? I mean, is it because everything is an index fund? Or you
just let those that still want to go over to the non-index that
you still with the----
Mr. Bogle. Well, as a reality, and we in the financial
system I don't think honor that reality very well. And that
reality is that stock returns come and go. But in the long run,
the whole idea of investing in equities, just working on that
part of the portfolio is to capture the returns that are
developed by American businesses, I said in my statement the
dividend yields and the earnings growth; because over 100
years, that is a 100 percent of the return that you get if you
invest in stocks before those costs are taken out.
The problem is the markets go into these crazes of
speculation, irrational exuberance, call them what you will,
where we had two consecutive decades, in the 1980s and 1990s,
where we had the price earnings multiple, which is speculation,
how much people will pay for a dollar of earnings. And it went
from 10 to 20 to 40. And at 40, buying stocks is basically a
bad joke. You can't recover from that.
So we are now coming back. Unfortunately the earnings are
fading away at this moment in time. But that will take are of
itself in time. But we have to focus on investment return and
try and avoid getting captivated by the speculative return. And
yet, in all the data you see from the industry, they just
ignore what I would call the, as I did in my statement, these
phantom returns that markets periodically develop and have been
developing, you know, since--or maybe even before that, maybe
since Ancient Greece as far as I know.
Chairman Miller. Mr. Polis.
Mr. Polis. No additional questions, Mr. Chairman.
Chairman Miller. Ms. Shea-Porter.
Ms. Shea-Porter. There we go. I have a couple of questions.
First, Dr. Munnell, I heard you talking about raising the age
for retirement. And if I heard that correctly, what age were
you proposing?
Ms. Munnell [continuing]. Going to 67. And that means that
people retiring at 62, which is when people retire. It is not
desirable. But it is when they do retire, are going to get less
and less.
And so that is just built in the cake. And it means that,
when you look at Social Security going forward, people are
going to get less than they think. The replacement rates are
really going to be going down over time. So it matters
enormously what is on top of Social Security. And I just want
to repeat again and again, it is my view is that 401(k) plans,
even fixed-up 401(k) plans, are never going to provide people
with enough additional money. And we need another tier between
Social Security and 401(k) plans, so people will have enough in
retirement.
Ms. Shea-Porter. Okay. And do you support raising the cap
on Social Security so that people at higher incomes pay on the
dollars like those in the lower incomes do?
Ms. Munnell. Oh, I think you can raise the cap somewhat.
But I think that it is really important that there is some link
between contributions and benefits. I think it really
strengthens political support for the program. So do it. Yes,
it can go up somewhat. But do it cautiously.
Ms. Shea-Porter. Okay, so raising the ages is the direction
you are looking at. I also wanted to ask you about this new
plan. Why not put everybody into the TSP? Would that work, if
you want this new layer there, then everybody gets enrolled in
the same plan that we use?
Ms. Munnell. I think there are just two issues that are
important here. I think that, for this additional tier, I think
it is important that it is basically a private sector activity.
I think we have got Social Security, which will provide a good
base. It is pay as you go. It is publicly run.
I think you want to diversify your risk. Pay-as-you-go
systems have demographic risks. Funded systems have capital
risks. And I think you want some of each.
And so I think the TSP is a good model in terms of index
funds, low-cost. But I think that any private sector firm that
could meet those should be able to compete for the available
monies.
Ms. Shea-Porter. Okay, thank you.
And Dr. Baker, I heard you talking about the housing
bubble. Is there anything else you wanted to add about your
testimony that you hadn't been asked before?
Mr. Baker. Well, I guess I would just emphasize the point
that, for most middle-income Americans, most of their wealth in
retirement is going to be reflected in their house. And I think
we had wrongly led many people to believe that that was a
secure asset.
And I think it is very apparent to people today that it is
not, which to my mind raises the argument to increase the
strength of the argument for providing some sort of defined
benefit plan in addition to Social Security, because people do
need some security in retirement. And not only are they risking
it with their 401(k) accounts, but they were also risking it
with their house as well.
Ms. Shea-Porter. So looking 15 or 20 years out for a couple
who is just buying a home, your message to them would be plan
to live in your house and enjoy your house. But make sure that
you have something else that it is not going to be the
traditional cash cow that it was at the end.
Mr. Baker. Well, simply that there is risk, yes. I mean,
certainly we hope that housing values will, you know,
eventually stabilize and that they will at least rise in step
with the inflation as they have done historically. But people
have to recognize that there is a big element of risk there. We
can't guarantee that your house price will appreciate. And
clearly, there always was that regionally. So many people, even
during normal market times, took a big hit on their home
values.
But certainly you can have very erratic movement, as we see
in house prices. So it is not the rock bed of your retirement.
Ms. Shea-Porter. Okay, thank you. And I yield back.
Chairman Miller. Thank you.
Mr. Altmire.
Mr. Altmire. Thank you, Mr. Chairman.
I want to ask Mr. Stevens to get specific about a couple
things. One is you outlined a number of proposals to improve
the 401(k) system. And you have mentioned specifically in your
testimony increasing automatic features into plans, increasing
investor education, ensuring Social Security is on sound
footing, as we have discussed, and others. And I want to ask
you, can you prioritize some of those for us?
Mr. Stevens. Well, it seems to me that, since Social
Security is the bedrock upon which all retirement planning in
the United States has got to rest, that as a confidence-
building measure in Americans' ultimate retirement security,
that is a good place to start.
I would say that there are very specific things that we can
do about the 401(k) system. And as I indicated, we strongly
support the chairman's leadership on improved disclosure and do
want to work with the committee as you continue to consider
those issues in this Congress. It is important, at long last,
that 401(k) participants get the kinds of disclosures that will
help them in their investment decision making.
That in a sense is a step towards improved education,
information and the like that is a broader national priority. I
would think, in light of the downturn in the markets, that a
similar step that we could take now has to do with required
minimum distributions.
Undoubtedly, there are people who are reaching the age of
70\1/2\ or thereabouts who are saying, boy, I would like these
assets to be with me a bit longer. But I have got to take them
out of my account. And so just as we did in sympathy to their
plight in 2009, we ought to look at what more we can do.
I think that the committee has the opportunity to seriously
consider the rapid acceptance of these auto features that were
characteristic of a pension protection act. But I think
universally are now acclaimed as having, not only gotten many
more people covered by 401(k)s, but increased the level of
their contributions. The behavioral economics behind them, it
seems to me, are demonstrating their validity.
And at some point, perhaps in the not-too-distant future,
it is worth considering that we essentially make a plan that is
offered by an employer an opt-out, not an opt-in arrangement.
That could cover many more people.
And then finally the toughest thing, Congressman, is how
you get more of those 50 percent who aren't covered by a plan
in their workplace into the system. That raises many, many
larger and more difficult considerations. But that certainly is
something that the Congress ought to work on, because there
clearly are people who do not have the opportunities we would
like them to, to invest and to save whatever they are able to
for retirement.
Mr. Altmire. And similar to that, you mentioned in your
testimony and again in the Q and A, that 401(k) plan is so
successful in your opinion, because it integrates both
consistent contributions and long-term investing, which is what
you said in your testimony. Can you elaborate on that? And are
you trying to make the point that savers should take advantage
of the benefits of dollar cost averaging, which means acquiring
more shares during market downturns, like we are in now?
Mr. Stevens. Yes, thank you. And it is actually the point I
was trying to make in response to the question from Congressman
Andrews. On page 6 of my written testimony, you have a
depiction of what happens in a market downturn for consistent
participants in 401(k) accounts.
Yes, their account balances do dip. But because 401(k)
combines the power both of consistent savings and potential
returns on investing, what you see is that the participants'
accounts continue to climb at a faster rate than the stock
market.
It is evidence to us, and this is in the context of a
market downturn in recent years that was reasonably
significant, that if you stay the course dollar cost average
and continue to save, and realize the investment potential when
the market recovers, that that is a very, very powerful
mechanism for increasing your retirement wealth. And the
demonstration of that is for us in the chart in that page of my
testimony.
Mr. Altmire. Thank you.
No further questions, Mr. Chairman.
Chairman Miller. Mr. Price.
Dr. Price. Thank you, Mr. Chairman. And I appreciate the
panel's discussion. I apologize for being late and having a
conflict. I have heard some of the testimony back in my office
and read much of it.
Clearly there is an attractiveness to certain returns. If
we remove risk completely, however, we remove reward. I think
all would agree with that. I wonder, Mr. Stevens, if you might
comment on one of my great concerns has been the role of the
federal government, and how the federal government can, I
believe, step over a line that varies, but step over a line,
and then result in decreasing return on investment to all folks
and specifically in 401(k) plans.
For example, the great discussion that has been going on
over the past couple of weeks about the nationalization of
banks. And you see bank stocks decreasing significantly, I
believe, because of that discussion. Do you have any thoughts
as it relates to 401(k) plans and the intrusion of the federal
government in roles like that?
Mr. Stevens. Thank you, Congressman. Let me just give one
example. And it is the issue that concerns us all about the
decumulation phase. It is people who are now in retirement.
They have a stock of retirement assets. And how should they be
managed?
This is certainly an issue that both public policy makers
like yourselves, people who are outside experts, like my
colleagues here, participants in the financial community and
individuals are wrestling with. My concern is that if
government says we have the solution that is ``it is this, it
is nothing but this,'' what happens in the marketplace is all
other experimentation and all other, if you will, innovation,
competition, et cetera, essentially stops.
We spend a lot of time thinking about these things. And
what I believe is that there is no one right solution for
everyone at the point of retirement. Some of my colleagues here
think that we can't trust Americans with their retirement
savings. And we need to force them to do something, so there is
no more risk in their portfolio for the balance of their life.
We talked to the American people in December. Again,
markets were pretty bad. And they told us, overwhelmingly, we
don't want Washington telling us what to do with our
investments.
There is tremendous competition and innovation in the
market by annuity providers, by asset managers, by the two
working in tandem to try to give people tools to manage that
longevity risk. I think we ought to encourage that kind of
innovation in the market. It is what has created the strengths
of the 401(k) system to date.
And so I would think there are conditions in which
competitors ought to be encouraged to meet in the marketplace.
And government has an important role there. Accountability to
the investors, transparency in the system. But let us not
straightjacket it, because ultimately the participants in these
plans and American retirees are going to be the losers.
Dr. Price. Yes. No, there may be some merit to the American
public's concern about the advisability of federal government
control of whatever they can do with their retirement savings.
One of the other lines, I think, that we can pass as a nation
is to increase regulatory burdens so much, that we stifle any
flexibility or ingenuity within the market of pension planning,
401(k) planning.
Do you believe that there is a--what would the consequences
be, I guess, to employees or employers who would voluntarily
choose not to participate, if the regulatory burden increases
to such an extent that they believe that it is a hurdle over
which they can't go?
Mr. Stevens. Well, it is important to remember that this is
a voluntary system. Employers are not required to have 401(k)
plans. They are a benefit that they elect to have and to
provide to their employees. And I think that one of the
persistent problems about moving beyond the 50 percent who are
covered now into smaller and smaller workplaces are the kinds
of burdens that employers have to bear.
It is one of the reasons that a lot of the thinking in the,
sort of, expert community has been dedicated towards
simplifying 401(k)s, making them less burdensome, more
manageable for smaller employers, so that they would have the
wherewithal to adopt a plan and make it available to their
employees.
And I think that is an important objective. It is one of
the specific recommendations that we made in our written
statement.
Dr. Price. Are there specific activities that you believe
that Congress ought to avoid in terms of regulatory imposition
on 401(k) plan?
Mr. Stevens. I think mandating specific investment options
is one important one, attempting to manage from Washington all
of the risk return characteristics that exist in these funds,
and essentially substituting your judgment for the judgment of
the employer who sponsors the plan.
The design of the system was a judgment by Congress that
the employer, as a conscientious fiduciary, held to very high
standards, is in the best position to make those decisions for
his or her work force. And that system has had a lot of
success. And despite the market downturn, we see no reason why
it should be overturned.
Chairman Miller. Mr. Hare.
Dr. Price. I thank you for your responses.
Thank you, Mr. Chairman.
Chairman Miller. Mr. Hare.
Mr. Hare. Mr. Bogle, I apologize. I missed your testimony.
So if I am going over something you have already talked about,
I hope you will bear with me here. It also goes to being 60
years old, evidently.
In your testimony, you called our financial system greedy.
And you pointed out the imbalance between corporations and
hedge fund managers and the investor who feeds at the bottom of
the costly food chain of investing. So I have about three
questions here. And then I will be happy to hear what you have
to say.
What can be done to change this? Do workers have any means
at all to defend themselves, particularly when they reach their
retirement age, and they see that their 401(k) plans are losing
half their value, or find out that their employer cannot pay
out the promises that he or she made? And then finally, what
protections do they need, do you think, from us?
Mr. Bogle. Okay, well, let us start off with that. A great
advantage of 401(k)s compared to defined benefit plans, and
that is you are not at the risk of your employer's financial
security or stability and the risk of bankruptcy.
And if you just take a look, for example, General Motors,
you can describe that as a corporation with a $75 billion
pension plan, surrounded by a few automobiles. And the few
automobiles happen to have a market capitalization of something
in the range of $1.5 billion. Once you get these huge
disparities in the system of competitive capitalism and
creative destruction.
So you could, and I think should, say the decline of the
defined benefit plan in favor of the defined contribution plan
is a plus. Now, the pluses for defined contribution are you can
take it with you when you move jobs. That is very important.
You don't run the risk of corporate failure. That is very
important.
You can make your own asset allocations, something I have
talked about a couple of times here. And that the typical
corporate plan used to be defined benefit plan, around 60
percent stocks was the convention and 40 percent bonds. But
that applied and affected the youngest workers and the oldest
workers. It was a package.
In the defined contribution plan, you can set your own
allocation, gradually building up the bond allocation as you
grow older. And that is a big plus. The big minus to get back
to the first part of your question, the big minus in the
defined contribution plan is it costs about two times or three
times or four times as much as the defined benefit plan,
because we are all paying individually for those services,
instead of collectively.
So how do you get away from that? How do you get a better
system? Well, there are really just two ways. One, wake up the
investor to his own economic interest. This is what we can call
the invisible hand solution.
Now, if we each will just operate in our own best interest,
in our own economic interest, we will gradually move to a very
low-cost, certainly an index system over time. And that is the
way the market has moved over two or three decades now, first
very slowly, and then decently rapidly in recent years. So the
investor has to be aware of owning the market and of keeping
costs down. And that is a very important part of it.
The other solution, and I come back to this, and I
mentioned it in the testimony, is the institutional investors
out there, including the mutual fund managers, really have not
done a very good job of protecting the interest of their
shareholders. Where were all our financial analysts in this
industry when Enron went down. Did they not know what was going
on there? And how about when Citibank and AIG went down?
I don't think our security analysts, our institutional--I
know what they are paid all that money for. But they don't
delve very deeply. Why aren't they challenging the corporations
out there, where are you going to get that 8.5 percent return a
year ago? And now, it has got to be, obviously, a lot more than
that to make up for what was lost in that year.
So the institutional investor is, when you think about it--
and this is pretty much known. I mean, read brokerage reports
on money managers that are publicly held. Institutional
investing has become a game of gathering assets. Why? Because
the more assets you have, the bigger your fees are. This is not
a complicated mathematical equation.
And therefore, and I almost hate to stomp on innovation.
But having said that, I would like to stomp on innovation. How
much innovation can we handle? Do we need more securitization?
Do we need more credit default swaps? Do we need more
collateralized debt obligations? Do we need more severing the
link between lenders and mortgage lenders and mortgage
borrowers?
Have those innovations helped us? No, but they sure as heck
have helped the financial system, which has made billions and
billions of dollars out of all those innovations.
So I think, you know, it sounds kind of funny. I am all for
technology, innovation. I am all for mechanical innovation. I
am all for engineering innovation. I am all for building a
better world through innovation. But they ought to take
innovation a little bit lightly when the idea of innovation in
the financial business is to enrich the providers rather than
enrich the beneficiary.
Mr. Hare. Thank you, sir.
Thank you, Mr. Chairman.
Chairman Miller. Mr. Scott.
Mr. Scott. Thank you. Thank you, Mr. Chairman.
Mr. Bogle, you have indicated one of the advantages of the
defined contribution plan is it is separated from the financial
ups and downs of the corporation. Why can't the employee buy a
defined benefit and still have the separation? Why can't that
be in a separate set-aside account?
Mr. Bogle. I am not sure it is possible, actually, to set
up a defined benefit plan individual by individual. You are
dealing with the overall wage profile, future retirement, the
future demands on the company's assets. You are dealing with a
pool of assets. I just, honestly, I haven't thought about it,
sir.
Mr. Scott. Do you think----
Mr. Bogle. I don't see how you can have an individual
defined benefit plan.
Mr. Scott. You could buy as you go an annuity that kicks in
when you are 65 and buy shares or something in an annuity and
make the individual calculations.
Mr. Bogle. Well, you can do that, of course, sir. But you
have to realize, particularly in these days of tremors and
toxic assets in the financial business, that there is no
guarantee that annuity provider is going to be there when it
comes time for your annuity. So I think one has to approach a
single person taking a single risk very differently than, kind
of, collectively dealing with longevity risk and investment
risk.
Mr. Scott. Well, so----
Mr. Baker. Very quick though, just say I think the public
sector could have a role there, if you so chose. So you could
provide a backdrop either to private issuers or to offer it
directly.
Mr. Scott. And this goes to Mr. Bogle's original point. We
are kind of all in this together. If you take it all together,
it is a lot cheaper. We kind of share, spread the wealth. And
if you had a government backup insurance requiring the
insurance companies to be solvent, so that the government isn't
taking that much risk, but we spread that risk, you could end
up with a defined benefit, which I think a lot of people like.
You know what you are going to get. The stock market isn't
going to up and down. You don't have to care.
We heard that, on average, market goes up and down, drops
20 points on average, we are still okay. Well, that is fine,
unless you are a couple of years from retirement. If you are 15
years from retirement, you know, up and down 20 percent,
actually the lower it gets, the cheaper you are buying in. So
that works out fine.
But one of the things that people like about Social
Security is they know what they are going to get. They don't
have to worry about the finances. They don't have to worry
about the company going up and down. They know what they are
going to get.
And when we talk about trying to invent this thing right
above Social Security, again, isn't there some way where we can
take advantage of the fact that we are all together and improve
Social Security rather than what they say reform Social
Security, which means when you get down to it, cut it. You are
either going to increase the retirement age, or you are going
to reduce the COLA. You somehow reduce benefits. Can we improve
Social Security so that we get a little more rather than trying
to reinvent the wheel?
Mr. Bogle. My own opinion is that your ideas about
improving Social Security are the correct ideas. And Social
Security, as other speakers have said, is indeed the bedrock of
our system, a defined benefit plan that we all know and love--I
think love.
The reality is that, when you go beyond that and start
making contributory retirement plans, such as 401(k), the
possibility any defined contribution plan is going to be
limited to a certain portion of the population. To pick a
number out of the air, I don't think more than half of our U.S.
population can add significantly to their retirement income
with something that goes on in additional to Social Security.
It is very hard to save money when you are making an
inflation-adjusted $18,000 a year, which I think is about the
number, the total of the average income adjusted for 1980
dollars today. You know, families just can't do that or
perceive they can't do it. And yet, in that group,
unfortunately, according to David Brooks, they are spending 13
percent of their income on the lottery. And that is not what we
want. We don't want to go there today.
Chairman Miller. Mr. Scott, if I might, I hate to--I told
the witnesses we would be out of there at 12:30. I have Ms.
Woolsey, Mr. Kucinich, Ms. Hirono yet to ask questions. And I
would like to trim everybody down here to 3 minutes, because we
are leaving at 12:30. So you can take 3 minutes or no minutes
or whatever you want to do.
Mr. Scott. Can I forward a question and not get an answer
and----
Chairman Miller. Yes.
Mr. Scott [continuing]. Maybe they could respond in
writing. The present taxation of dividends and capital gains is
at a historic low. If you put your money into a tax-sheltered
account, when you pull out the profits, you are paying regular
income. Could you make some comments about how valuable the
tax-deferred accounts are when actually your tax rate on the
profits might go up.
Chairman Miller. We are going to take those off the air, as
they say. We will submit those questions to you in writing. If
you could get back to the committee, I would appreciate that.
Mr. Bogle. I would be happy to do that.
Chairman Miller. Ms. Woolsey.
Ms. Woolsey. Thank you, Mr. Chairman.
Chairman Miller. For 3 minutes.
Ms. Woolsey. Aren't we glad that Social Security was not
privatized and invested in the stock market right now.
Mr. Bogle. That is an innovation we didn't need.
Ms. Woolsey. That wasn't.
Ms. Munnell. Exactly.
Ms. Woolsey. You are absolutely right. But Social Security,
to me, was intended, from what I understand, to be a floor, a
safety net that people could count on. But they can't live on
it. Who can live on Social Security? And the--who are forced to
live on Social Security, and look how they have to live.
So I am sorry that I missed your testimony. Has there been
a thread among the four of you that is common between all four
of you that would set us in a better direction, so that we can
have our Social Security, and then have a life beyond it?
Ms. Munnell. I think there is a general consensus that we
need to restore balance to Social Security. I would like to
think there is a general consensus that we shouldn't cut back
on Social Security benefits, so that means putting more
resources into the program.
I think where this panel really divides is that can we have
401(k)s as the only supplement to Social Security? Some people
think yes. I think absolutely not. Even if we fix them up, make
them more automatic, we hear all these good things about what a
success the system has been. But we also have really, really
good data on how much money people have in these plans. And the
Federal Reserve just released a new survey showing that people
approaching retirement have $60,000 in these plans.
Now, the system hasn't been in forever. But that is not a
lot of money. And even if you take into account the money that
is rolled over into IRAs, the figure is only a little bit
higher. So there just hasn't been a lot of money in these
plans. I don't think these plans are ever going to be adequate.
And I think we need more retirement saving, a new system.
Ms. Woolsey. Dr. Baker.
Mr. Baker. I would agree with Dr. Munnell that I think we
need some additional account. And I was arguing the case for
having some sort of guaranteed benefit that would be offered on
a voluntary basis by the government, a contributory account. I
was giving $1,000 per worker per year as sort of the target
that we would be looking to as a modest supplement to Social
Security.
Ms. Woolsey. Okay.
Mr. Stevens.
Mr. Stevens. Yes, and just to clarify, we do in fact think
that the 401(k) system can work to contribute an enormous
amount of pre-retirement income. And it is absolutely true, as
Dr. Munnell said, the people that we are talking about today,
with that $60,000 account, or whatever its balance is, have not
been in the 401(k) system by and large through their working
life. That figure also doesn't take into account what other
financial resources they may have, by the way.
When we modeled based upon the EBRI/ICI database, which is
the largest database of actual 401(k) accounts that is subject
to research in the United States. And we asked on the basis of
normal behaviors, not optimal behaviors----
Chairman Miller. Mr. Stevens, we are going to wrap up here.
We are going to take you----
Mr. Stevens. I will, Mr. Chairman. Normal behaviors over a
working life, you can get a very substantial replacement of
your pre-retirement income, which with Social Security, will
mean retirement adequacy.
Chairman Miller. Ms. Hirono for 3 minutes.
Ms. Hirono. Thank you, Mr. Chairman.
I like the idea that we are going to need another tier
besides Social Security and the 401(k)s. And so obviously I
like Dr. Baker's idea. And I was curious to know, Ms. Munnell,
why you thought that this tier that Dr. Baker talked about
should be done by the private sector, since part of the
attraction of what Dr. Baker is suggesting is that there would
be a guaranteed return. And would the private sector be able to
guarantee a return?
Ms. Munnell. I think we would all like to have a guaranteed
return.
Ms. Hirono. A modest return.
Ms. Munnell. It would be very nice to have 20 percent that
you knew that you were going to get for sure. The concept of
guarantees is very hard. You really need a very high guarantee
of return to make it worthwhile. If we had had a guaranteed
return of 2 or 3 percent, it would never have kicked in once
during the last 84 years. And so it would not have had any
impact.
To have had any impact, you really need this very huge
guaranteed return. And the financial literature says you can't
do it, unless you can figure out some way to argue that
government has a different set of preferences than individuals.
So I think guarantees would be wonderful. Risk-sharing of
some sort, like it may be the Netherlands or in Canada, would
be good. But I think we need a second tier above Social
Security that is substantial, that is reliable, that maybe is
not absolutely guaranteed, but is more secure than what people
have in 401(k) plans.
Ms. Hirono. Well, I am not an--but I just don't think that
in this environment, that people are looking for a guarantee of
a 20 percent. You know, if you can get a guarantee of----
Ms. Munnell. No, I was talking six.
Ms. Hirono. Six, okay. Or even six, I think that sounds
like a lot to me. I think there are a lot of employees who
would want to be able to contribute in a voluntary way to a
modest addition to their Social Security. These are not the
folks that are going to get into 401(k)s, et cetera. So, you
know, if the major concern you have is what is the level of
guarantee that will induce people to participate in a voluntary
tier program like this, a second tier program, then I guess,
you know, we can go somewhere with this idea. So thank you.
Chairman Miller. Mr. Kucinich, 3 minutes.
Mr. Kucinich. Thank you.
I would like to address these remarks to the panelists. But
particularly I would be interested to see what Mr. Bogle and
Mr. Baker would have to say about these observations.
I heard your testimony. I have re-read it. And with the
decline in house values, the decline in the value of defined
pension plans, decline in the value of 401(k)s, workers losing
jobs and health care benefits connected with that, and with the
understanding that we have an aging work force, more and more
elderly are in--you know, the work force is aging more other
than work force, and also comprising more of the jobless.
Are we looking at our baby boomer generation, which is
going to be driven into poverty unless we come up with some
corrections in our health care, protecting Social Security and
some kind of annual benefit that is guaranteed? Mr. Bogle, Mr.
Baker.
Mr. Bogle. Okay, let me start by saying that I don't think
we are looking at a benefits-less, poverty kind of a situation.
I know that the markets are kind of unusual. When they are
going up, we think they are going to go up forever. And now
that they are going down, we think they are going to go down
forever. That is not the case.
I mean, value gets created when stocks drop by 55 percent.
Dividend yields are higher. Price earnings multiples are lower.
The ratio of the price of the stock to its tangible book value,
all that plant and equipment, technology, all those things, get
much more attractive.
So having had two great decades for stocks, too great, that
was the phantom return I talked about in my testimony. And then
a terrible decade, which should not surprise anybody. I mean,
this was predictable. I mean, I have speeches I gave at the
beginning of the--not saying that it was going to be this bad,
but saying you can be looking for 2 or 3 percent return on
stocks.
Mr. Kucinich. Mr. Baker, does what goes down must come up?
Mr. Baker. Well, it depends what level you are looking at.
I think in many cases, we were correcting from exaggerated
heights. Certainly that was the case in housing markets. I
wouldn't make any bets on the housing market rising more
rapidly than inflation over, you know, some time to come. In
fact, I hope it would not, because I am not in favor of an
unaffordable housing policy.
In terms of the stock market, I think market stock prices
are depressed. But the fact is, most of the baby boomer cohort
doesn't have very much by way of stock. And they are not going
to be able to accumulate very much in the years they have left
in the work force.
Mr. Kucinich. Unless we make corrections? Are we looking at
a lot of baby boomers put in poverty? That is what I am----
Mr. Baker. I would say yes. And in particular, you have a
lot of people running around this town who want to further cut
the benefits that baby boomers have in the name of generational
equity, which is rather perverse to me.
Mr. Kucinich. Okay.
Thank you, Mr. Chairman.
Chairman Miller. Thank you very much.
Let me again thank the panel for all of your insights here
in answering the questions of the members of the committee. I
think this has been a great kickoff to this continued inquiry
on pension security by the committee that will be led by
Congressman Andrews.
I would like to, without objection, submit for the record
the following documents for this hearing, one by the Investment
Company Institution on 10 Myths about 401(k)s, a statement for
the record by Matthew Hutchison, an independent pension
fiduciary, a statement from the American Society of Pension
Professionals and Actuaries, and a statement from the Profit-
Sharing Council of America to be included in the record, if
there is no objection. Hearing none, so ordered.
[The information follows:]
10 Myths About 401(k)s--And the Facts
401(k)s and the financial crisis
MYTH No. 1: Thanks to the financial crisis, Americans are bailing
out of their 401(k) plans.
FACT: Americans are not abandoning their 401(k)s.
True, 401(k) accounts have been hard-hit by the broad economic
downturn. One large recordkeeper reports that the average balance in
accounts it administers dropped 27 percent in 2008.
But these losses are not driving Americans out of their 401(k)s.
ICI's study of 22.5 million defined-contribution (DC) accounts shows
that only 3 percent of plan participants had stopped making
contributions through October 2008. Only 3.7 percent of plan
participants had taken withdrawals from their participant-directed
retirement plans, including 1.2 percent who had taken hardship
withdrawals. This level of withdrawal activity is in line with past
years' experiences. Recent loan activity is also in line with
historical experience: in 2008, 15 percent of participants had
outstanding loans, compared to 13 to 17 percent with loans in annual
studies since 1996. Most loans tended to be small, amounting in 2007 to
12 percent of the remaining account balance, on average.
Retirement-saving assets are down--in all forms of accounts--
because the stock market is down, not because of any fundamental flaw
in 401(k)s. In fact, thanks to diversification and ongoing
contributions, the average account fared better in 2008 than the S&P
500, which was down 38 percent.
MYTH No. 2: Americans have lost confidence in the 401(k) system.
FACT: Americans of all income groups support 401(k)s.
A comprehensive survey of 3,000 American households, conducted by
ICI from October to December 2008, shows that Americans of all income
groups support 401(k)s. Even among households that don't currently own
DC plans or Individual Retirement Accounts, large majorities support
the tax incentives for these retirement savings plans. More than 80
percent of DC-owning households agreed that the ``immediate tax savings
from my retirement plan are a big incentive to contribute.'' More than
half of the lowest-income households--those making less than $30,000--
say they probably would not invest for retirement at all if they didn't
have a plan at work.
MYTH No. 3: 401(k) savers have suffered much greater losses than
other retirement investors.
FACT: There is no shelter from the market storm: All retirement
plans have seen their assets fall.
All retirement plans--DC plans, defined benefit (DB) plans, state
and local government retirement plans, and IRAs--are long-term savings
vehicles and invest a large share of their assets in equities. Thus,
they all have suffered in the market turmoil. The latest data
available, from the first three quarters of 2008, show that the assets
of private-sector and state and local government DB plans were down 14
percent, and IRA assets were down 13 percent. Assets of 401(k) plans
fell somewhat less, by about 11 percent, and 403(b) plan assets were
down 10 percent over the first three quarters of 2008. Over the same
period, the S&P 500 total return index was down 19 percent.
401(k)s' role in retirement
MYTH No. 4: Before 401(k)s, most workers had defined benefit plans
offering guaranteed, risk-free benefits.
FACT: Defined benefit pensions never were universal or risk-free.
In 1981, before the creation of 401(k)s, not one in five retirees
received any benefits from a private-sector pension. For those who did,
their median benefit was $6,000 a year in today's dollars. The golden
age of the golden watch never existed.
MYTH No. 5: DB plans are fairer to workers and would protect them
from the market turmoil.
FACT: Today's lower-income workers get better coverage--and more
portable benefits--thanks to DC plans.
Today, lower-income workers are more likely to be covered by 401(k)
or other DC plans than by DB plans: 19 percent of working age
households earning less than $25,000 have a DC plan, versus only 7
percent with a DB plan. For working age households earning $25,000 to
$34,999, 42 percent have DC plans, versus 17 percent with DB plans.
Although defined benefit plans will and should continue to be an
important component of the private-sector retirement plan system, they
are not the answer to the insecurity created by today's markets. As
noted, DB plan assets have fallen along with all other retirement
assets. And DB plans expose workers to other forms of risk, such as the
risk that the sponsor will freeze workers' benefits (by freezing the
plan, terminating the plan, or going out of business) or that a worker
will lose or change jobs without accruing significant DB benefits. For
today's typical worker--who will hold seven or more jobs in his or her
career--DB plans can be a poor fit.
401(k)s and fees
MYTH No. 6: Participants in 401(k) plans pay exorbitant fees, up to
5 percent of assets.
FACT: The numbers bandied about by critics of the 401(k) system
vastly exaggerate the fees that most plans charge.
In fact, the fees that employers and participants pay are very
reasonable. ICI and Deloitte Consulting LLP recently compiled a
detailed survey of fees paid by 130 plans of various sizes, and using
various recordkeeping models. The survey found that the median all-in
fee--covering investment, recordkeeping, administration and plan
sponsor and participant service expenses--was 0.72 percent of total
assets in 2008. In dollar terms, based on the average account size, the
median fee per participant was $346 a year. While fees vary across the
market, 90 percent of all plans surveyed had an all-in fee of 1.72
percent or less.
Half of all 401(k) assets are invested in mutual funds. ICI
research shows that 401(k) investors concentrate their assets in low-
cost mutual funds. The average asset-weighted total expense ratio
incurred by 401(k) investors in stock mutual funds was 0.74 percent in
2007, substantially less than the industry-wide asset-weighted average
of 0.86 percent.
MYTH No. 7: The cost of 401(k)s invested in mutual funds is
substantially understated because funds don't disclose trading costs--a
hidden and excessive fee.
FACT: Funds follow SEC rules on disclosing trading costs--and fund
managers have strong legal and market incentives to minimize those
costs.
All investment products--commingled trusts, separate accounts,
exchange-traded funds (ETFs), mutual funds, and others--incur both
explicit and implicit costs in buying, holding, and selling portfolio
securities. Brokerage commissions are the most obvious and easily
calculated trading cost. Other trading costs--market impact costs and
opportunity costs--cannot be measured as easily or accurately.
The Investment Advisers Act of 1940 requires all mutual fund
managers to seek ``best execution'' of trades, a standard that requires
close attention to total trading costs. Further, trading costs directly
affect a fund's performance--the most important consideration that most
investors use to judge funds. So fund managers have strong legal and
market incentives to minimize these costs.
The SEC has examined disclosure of trading costs repeatedly and has
concluded that the portfolio turnover rate, which measures how often a
fund ``turns over'' its securities holdings, is the best proxy for
trading costs. Recent changes to mutual fund disclosure rules make the
disclosure of portfolio turnover more prominent in fund prospectuses.
Mutual funds also make available to investors, including retirement
plans, detailed information on their total brokerage commissions and
trading policies.
ICI research shows that 401(k) investors in mutual funds tend to
own funds with low turnover rates. The asset-weighted turnover rate
experienced in stock mutual funds held in 401(k) accounts was 44
percent in 2007, compared to 51 percent for all stock funds.
MYTH No. 8: The mutual fund industry opposes disclosure of 401(k)
fees.
FACT: Mutual funds have more comprehensive disclosure than any
other investment option available in 401(k) plans, and have strongly
supported improved disclosure.
Under the securities laws, mutual funds must and do provide robust
disclosure of fees and other information of importance to their
investors. ICI and its member funds have advocated for better
disclosure in retirement plans for more than 30 years. In 1976--at the
dawn of the ERISA era and before 401(k) plans even existed--ICI sent a
letter to the Department of Labor arguing that participants in
participant-directed plans should receive ``complete, up-to-date
information about plan investment options.'' ICI has continued to
advocate that participants in all plans receive key information--not
just on fees, but also including data on investment objectives, risks,
and historical performance--for all products offered in 401(k) plans.
ICI strongly supports the comprehensive fee disclosure agenda the
Department of Labor is pursuing.
401(k)s and smart investing
MYTH No. 9: Participants should base their choices among investment
options in their 401(k) plan solely on the options' fees.
FACT: Fees are only one factor participants should weigh in meeting
their savings goals.
The most important task for a 401(k) participant is to construct a
diversified account with an asset allocation appropriate for the
participant's savings goals. Fees and expenses are only one piece of
necessary information and should always be considered along with other
key information, including investment objectives, historical
performance, and risks. The lowest-fee options in many plans often are
those with relatively low long-term returns (for example, a money
market fund) or higher risk (such as employer stock). Most employees
will fare poorly if they invest solely in these low-fee options without
regard to the risks or historical performance.
Participants must be told that fees are only one factor in making
prudent investment decisions--and must be shown the importance of other
factors by presenting fees in context. For example, any disclosure
associated with employer stock also should describe the risks of
failing to diversify and concentrating retirement assets in shares of a
single company (especially when that company is also the source of an
employee's earned income).
MYTH No. 10: 401(k) savers should only invest in index funds
because they are always superior to actively managed funds.
FACT: Index funds are a good option--but aren't necessarily a
``one-stop'' solution.
Mutual funds were the first to make index investing broadly
available to individual investors more than three decades ago, and
today there are hundreds of index mutual funds available in the market.
Index funds are innovative investments that are appropriate for many
investors in many situations.
But index funds are not necessarily a ``one-stop'' solution for
retirement investing. Index funds vary widely in their choice of index,
which leads to widely varying risks and returns. No one index fund is
right for all investors in all markets.
Index funds are hardly immune from market downturns. One of the
largest indexed investments, the Federal Thrift Savings Plan's C Fund,
which attempts to track the S&P 500 index, was down 37 percent in 2008.
The TSP's indexed I Fund, which attempts to track the Morgan Stanley
Capital International EAFE Index, was down 42 percent.
Actively managed funds, like index funds, can be excellent
investments. The returns that investors receive on either kind of fund
will depend heavily on the mix of actively managed and index funds that
is considered, as well as the period over which returns are measured.
For example, ICI examined the top 10 mutual funds (in terms of 401(k)
assets) in 1997, which included some actively managed funds and some
index funds. Over the 10-year period to 2007, an investment made at
year-end 1997 in those actively managed funds would have earned a
higher return (6.82 percent, net of fees) than a comparable investment
made in the index funds (5.83 percent, again net of fees).
Employers recognize the benefits of both forms of investing when
they select menus of investment options for 401(k) plans. A survey by
the Profit Sharing/401k Council of America found that 70 percent of
plans offered a domestic equity index investment option in 2007. These
are decisions properly left to plan sponsors--fiduciaries who are held
to ERISA's stringent standards.
______
Prepared Statement of Matthew D. Hutcheson, Independent Pension
Fiduciary
five steps to restoring trust in the 401(k) system
Introduction
It is widely accepted that 401(k) and similar arrangements are the
way most Americans will invest for retirement. Therefore, it is
incumbent upon us all to be absolutely certain there are no unnecessary
obstacles (whether intentional or unintentional) to its long-term
success.
The 401(k) concept is excellent. It has always had great potential,
but that potential was sacrificed on Wall Street's altar of greed,
corruption, and the 401(k) industry's harmful business model. It is not
too late for the 401(k), but that will require a complete and
unequivocal shift in public thinking. In other words, the public--
including elected representatives, and regulators--must cast off the
marketing-induced stupor that has befallen them.
It is with a deeply felt commitment to the success of our private
retirement system that this statement is shared with the Committee.
There are reasons the 401(k) is failing. If those reasons are
understood and acted upon, the 401(k) can be saved. This statement will
explain those reasons and what is required to correct and restore the
viability of the 401(k) for generations to come. If all six of the
steps described herein are not implemented, the 401(k) system will be
doomed to mediocrity--and, more likely, continuing failure.
Step 1: Elevate stature of 401(k) to the original level contemplated by
statute
``Give a dog a good name and he'll live up to it.'' \1\
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\1\ Attributed to Dale Carnegie
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While the 401(k) as a concept is excellent, the way the plan has
been interpreted, marketed, delivered, implemented and operated is not.
The 401(k) is suffering because many people inside and outside of the
401(k) and financial services industry view its purpose incorrectly. It
is seen as a financial product, not a delicate retirement-
incomegenerating system deserving of fiduciary protections and care.
Many believe that 401(k) plans are nothing more than financial
planning or simple savings tools. That is incorrect. 401(k) plans are
true retirement plans, with all the attendant obligations and
implications. They must be viewed and operated as such for the system
to begin to restore the public trust.
From a statutory perspective, a 401(k) plan is as much a retirement
plan as a traditional pension plan. Until the 401(k) plan, and the
system that it operates within is elevated to the intended stature of a
``pension benefit plan'' under ERISA section 3(3) (which is why 401(k)
plans are reported as a pension benefit plan on form 5500), society and
the 401(k) and financial services industry will continue to view the
401(k) as being of ``lesser'' importance and stature. Behavior and
attitudes toward the 401(k) will follow accordingly.
The 401(k) needs a fine reputation to live up to, and that can only
happen if all Americans begin viewing it not as just another financial
product, more like E*Trade than ERISA, but as an income-producing
mechanism, as correctly stated under ERISA, with the ability to
financially undergird society as it ages.
Step 2: Create the right types of safe harbors and incentives
``Faced with this statutory and regulatory riddle, the Department
of Labor (``DOL'') and now, Congress, support various investment advice
schemes that allow plan sponsors to seek fiduciary relief under ERISA
section 404(c). Although these schemes have the potential to resolve
the ERISA section 404(c) dilemma, their structural flaws only create
more problems--for example, they allow investment advisors to self-deal
and operate despite conflicts of interest. And so the riddle of ERISA
section 404(c) continues.'' \2\
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\2\ Chicago-Kent Law Review. ERISA Section 404(c) and investment
advice: What is an Employer or Plan Sponsor to do? Stefanie Kastrinsky.
Page 3 May 16, 2005.
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The conventional 401(k) system is not founded solely upon
principles that will yield favorable results for participants and
beneficiaries. Ironically, there are regulatory incentives to produce
mediocre or poor results. Nothing has produced more chaos and confusion
in the 401(k) system than Department of Labor section 2550.404c-1,
commonly referred to as ``404(c).'' 404(c) is not just one of many
problems with the 401(k) system. It's the problem.
We wouldn't let our loved ones get on an airplane that does not
strictly adhere to principles of aeronautical science and physics. And
we certainly wouldn't knowingly let our loved ones ride in an airplane
with a missing wing or a visibly cracked fuselage. That airplane will
surely fall short of its destination; and that fact would be obvious
long before takeoff. Yet we have a system that permits our loved ones
to do just that with 401(k) plans operating within the meaning of
Department of Labor regulation 404(c). In many cases, participants
merely guess about which funds to invest in, and they often guess
wrong. It is commonplace for incomplete or sub-optimal portfolios to be
randomly selected. Without even realizing it, participants choose the
wrong funds, or the wrong combination of funds, or the most expensive
funds--thereby unnecessarily sacrificing years of potential retirement
income. To continue the analogy, they choose a portfolio that is not
``flight-worthy.'' Sadly, they will discover that reality far too late
in life, and find that their only option is to work harder and longer--
perhaps well into their 70's or even beyond.
Section 404(c) was not originally meant for 401(k) plans anyway. It
was intended for Defined Benefit Plans with after-tax mandatory
employee contribution requirements or the precursor to the 401(k)--the
Thrift Savings plans that some employers sponsored in addition to a
traditional Defined Benefit Plan. Since the benefits provided under a
traditional Defined Benefit Plan were protected by employer funding and
the PBGC, it mattered far less if a participant made poor decisions
with their after-tax mandatory or Thrift Savings account. The number of
participants affected by 404(c) prior to the creation of the 401(k) is
not known--but likely insignificant. Perhaps most 401(k) participants
today participate in a plan with a section 404(c) provision. The
drafters of ERISA could not have foreseen how 404(c) would damage a
system that did not yet exist. ERISA section 404(c) existed prior to
the 401(k), and its corrosive effects could not have been known.
In 1991, final regulations under 404(c) were issued by the
Department of Labor as a provision that 401(k) plans could utilize.
That regulation was ill-conceived. By issuing those regulations, the
Department of Labor consigned the 401(k) to mediocrity or worse. It
should have been clear that 404(c) should be the exception, not the
rule--as there were pre-existing laws in place that gave participants
the right to a well diversified, prudent portfolio.
The application of 404(c) to 401(k) plans opened the floodgates to
the chaos in speculation and deviation from sound economic and
financial principles--placing the burden of ``flight-worthiness'' on
the passenger and taking it away from trained professionals at the
airline or the FAA, as it were.
If trust in the 401(k) system is to be restored, the strangle-hold
of 404(c) must be broken. That will prevent participants from making
incorrect decisions based on emotion, ignorance, greed, or all of the
above. It will place investment decision-making back where it belongs--
with prudent fiduciaries.
If 404(c) is allowed to remain, it should require a beneficiary
waiver before a participant may choose to disregard the portfolios put
in place by professional fiduciaries because the result will almost
certainly be less favorable for both the participant and the
beneficiary. If both agree, so be it. However, a prudent portfolio
constructed by an investment fiduciary should be the standard
established by law, and it should be accompanied by a safe harbor.
Congress should consider clarifying for the courts that complying
with 404(c) requires affirmative proof that all of its requirements
have been satisfied. That of course is impossible, because there is no
way to determine whether plan participants are ``informed.'' It is the
``informed'' requirement that gives 404(c) legitimacy, not the offering
of a broad selection of funds. The Courts have missed that point
entirely. Since it is impossible to know who is truly informed and who
is not, even after extensive efforts to provide investor education,
404(c) is simply not viable in a system where the overwhelming
population of American workers persists in its failure to grasp the
elementary differences between a stock and a bond.\3\ Again, 404(c)
could perhaps be the exception, but it is a mistake of massive
proportions to have permitted it to become the rule.
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\3\ Dave Mastio, ``Lessons our 401(k)s Taught us. How much do
Americans know about investing for retirement? What investors don't
know.'' http://www.hoover.org/publications/policyreview/3552047.html
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``Many Americans, alas, know little about stocks, bonds, and
retirement. This is the conclusion reached by none other than the
companies and organizations that would benefit most from a system of
private accounts. The Vanguard Group, the National Association of
Securities Dealers, the Securities Industry Association, the Investment
Protection Trust, Merrill Lynch, Money magazine, and the Securities and
Exchange Commission have all done studies or issued reports that reach
the same general conclusion. To make matters worse, much of the
research over the past five years has focused on the knowledge of
individuals who already own stock and are thus presumably more familiar
with the workings of financial markets; the research has still found
severe financial illiteracy.'' \4\
---------------------------------------------------------------------------
\4\ Ibid
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Beyond the requirement that participants be ``informed,'' virtually
everyone in the 401(k) industry knows that only a tiny fraction of any
plan actually complies with the long list of requirements. Section
404(c) is a waste of time, money, and it is also the cause of many
billions of dollars wasted each year that otherwise would have been
legitimately earned by professionally constructed and managed
portfolios. When employers see a safer route (less fiduciary risk) that
also has the promise of better results, the system will begin to heal
and public trust will be restored.
An employer that sponsors a 401(k) plan should be assured by a
clear, unequivocal statutory safe harbor for appointing a professional
independent fiduciary, acting pursuant to sections 3(21) or 3(38) of
ERISA, or both. That will do more to protect the plan sponsor from
fiduciary risk than anything else, and it is consistent with the duty
of loyalty in a way that participants do not currently enjoy. Such a
safe harbor would reduce or eliminate conflicts of interest. Results
would improve through professional application of sound economic and
financial principles. No longer would America's employers have to wear
two hats and grapple with divided loyalties to their shareholders and
their 401(k) plan participants. Such a safe harbor would restore order
to the system.
Creating better safe harbors and other incentives that give plan
sponsors confidence and a sense of security for having done the right
thing the right way will wean the 401(k) from concepts that have only
confused and frustrated an otherwise excellent program with potential
for long-term success.
Step 3: Participants have a right to know the expected return of their
portfolio
``If [investment] returns could not be expected from the investment
of scarce capital, all investment would immediately cease, and
corporations would no longer be able to produce their sellable goods
and services. The truth is that we invest, not with an eye to making
speculative gains, but because we have an expectation of a specific
return over time.'' \5\
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\5\ ``Investment Risk vs. Unprincipled Speculation'' Journal of
Pension Benefits (c)Wolters Kluwer Law and Business. Volume 16, Number
2, Winter 2009. Page 76.
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Every week, thousands of enrollment meetings are held in the lunch-
rooms of corporate America. Those enrollment meetings seek to explain
to participants why they should enroll in their company's 401(k), and
which investment options are available to them.
That is fine, with one exception. Most of the paperwork and
enrollment materials will provide participants with useless information
about the type of investor they are. Participants will take a 5 minute
quiz, and that quiz will tell the participant that they are a
``conservative'' investor, or a ``moderate'' investor, or perhaps an
``aggressive'' investor. Perhaps a particular list of funds with
suggested ratios for which to allocate new contribution dollars will be
associated with each investor type.
There are two fundamental flaws with that approach.
First, whether a participant has a conservative or an aggressive
investor profile is dependent on emotion; how much market volatility
they can stomach. A participant's tolerance for market turbulence is
not static. It can change day-to-day. For example, if a participant
with an aggressive profile gets in a car accident, their profile may
immediately switch to conservative. That is an emotional profile that
does not tie well to the economics of prudent, long-term investing.
Second, the emotion of identifying an investor profile does not
help the participant understand the interplay between new funding
(ongoing contributions/deposits to the plan) and future retirement
income streams that can be expected (not to be misunderstood as
``guaranteed.'')
Therefore, the most important thing a participant needs to know is
not their emotionally determined ability to endure market turbulence,
but rather the long-term economic output of the participant's
portfolio. This is called the ``expected return.'' Knowing that, a
participant cannot truly understand how much money they should be
contributing to the plan, when coupled with any employer generosity, if
any, to achieve a future income-replacement goal.
The expected return is the most fundamental concept of investing
because if those with capital to invest could not expect a return, that
capital would be invested elsewhere--or not at all. The concept of
expected return is perplexingly absent in the current 401(k) system and
is not understood by participants or fiduciaries. That misunderstanding
can easily be corrected.
It should be mandated by law that all participants be told what the
expected return is for the actual portfolio they are in. That way, the
one thing that participants can control--the amount they contribute to
the plan--is a decision made in light of the expected return of the
portfolio they will invest in so their decision is both informed and
founded upon a process that is likely to yield favorable results.
Participants may not be able to afford what they wish they could
contribute based on the expected return of their portfolio. For example
their portfolio may have an expected return of 5%, and to comfortably
retire they may learn that they will need to contribute twice as much
as they can afford in order to get there. That is an understood reality
of life that many face each day when purchasing goods and services.
However, participants should at a minimum know the economic
characteristics of their portfolio so they can choose to get more
education in order to earn more, work longer, spend less on other
things, or a combination thereof.
Consider how different things would be if we stopped inducing
emotional decisions in participants and began given them solid,
reliable information based on modern principles of economics and
finance.
Step 4: Transparency
Our retirement savings system and its participants deserve
protection. The bedrock of any mechanism as delicate as the 401(k)
should be clarity and transparency.
The debate over whether the cost of a 401(k) plan is reasonable is
pointless without standardized transparency. Can something be
determined reasonable if it cannot first be seen and understood in a
comparative context?
In the case of plans with known economic impact to participants,
perhaps all fees and costs are deemed reasonable when compared to the
industry as a whole, yet simultaneously excessive in light of the
quality or value of services rendered to a specific plan. In other
words, all 401(k) plans could eventually have fees that someone deems
reasonable, but those same fees may be genuinely excessive at the same
time--therefore it is not an either-or scenario.\6\ That conundrum
cannot be resolved in an environment of opacity.
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\6\ See 9th Meigs question for further explanation about the
relationship between ``reasonable'' and ``excessive'' fees and
expenses. http://www.401khelpcenter.com/401k/meigs--mdh--interview.html
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Given the seriousness of the crisis we face, where an estimated $1
trillion in 401(k) assets has been lost in the past few months, we
cannot accept anything less than full and absolute transparency--even
if fees and other charges become very low by today's standard. In other
words, there may come a time when fees are reasonable, non-excessive,
and absolutely transparent. It is in times such as those, transparency
will be no less important or necessary for the purpose of protecting
trust in the system.
Passage of HR 3185 or a fundamentally similar Bill will begin the
process of restoring broken trust. Distilling disclosure of expenses
into an understandable format will deliver value to participants,
beneficiaries, and employers. The gross-to-net methodology, which means
clearly showing gross returns on the investments in a 401(k) account
and also showing the net returns that the participant gets to keep,
makes the most sense. It reveals total investment returns, the net
return to each participant, and by simple subtraction, the actual costs
of delivering those net returns to each participant.\7\ Any other
method obscures both returns and costs from the view of the
participants, plan sponsors, and regulators alike. Gross-to-net
disclosure establishes true transparency, a pre-requisite to restoring
trust in the 401(k).
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\7\ See ``Gross-to-Net'' proposed fee and expense disclosure
reporting grid. http://www.dol.gov/ebsa/pdf/IF408b2.pdf. See also
http://advisor.morningstar.com/articles/
article.asp?s=0&docId=15714&pgNo=2
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Transparency should also be required for new financial products
that are developed in the future, such as fund-of-funds, lifestyle, and
target date funds. Some of those may be well constructed. Some of them
are not. Transparency is required to ensure fiduciaries and plan
participants understand the difference.
Step 5: Retire-ability measurements
As stated earlier, the 401(k) has not been managed to produce
future retirement income. Rather, it has been managed like merely
another of an array of ordinary financial products. Thus, the ability
of conventional 401(k) plans to produce financially secure retirees is
not a primary discussion item of fiduciaries and committee members in
their meetings.
Many factors go into creating a successful program, each having
differing importance and weight at different stages of a participant's
progression from entry into the workforce to retirement. Also,
participants at different ages are affected differently by plan
provisions or economic conditions.
For example, younger participants with smaller account balances are
most affected by matching or other employer contributions. Older
participants with larger account balances are most impacted by fees and
other charges. Employers and fiduciaries must understand what helps
participants, what hurts them, and when those effects are most likely.
If 401(k) plans are to thrive, employers and fiduciary committees
must engage in regular proactive and thoughtful assessments of the
``retire-ability'' qualities of their plan, while taking into account
the demographics of the plan participants as a whole.
Society requires more that ever a more astute body of fiduciaries
who understand that improved future retirement income for individuals
also enables an improved future economy for all. Higher retirement
incomes can help stabilize the economy, sustain tax revenues necessary
to deliver essential government services and provide economic
opportunity for the rising generation.
Employers must not fear the question, and then answer honestly,
``Will our employees be able to retire at their chosen time? If not,
what can we do to improve their chances?''
Summary
1 Return to Roots--Congress can make it unequivocally clear that
plan sponsors need to understand 401(k) plans must not as mere
financial planning tools, but rather the a pension benefit mechanism
that produces retirement income that will be the financial undergirding
mechanism of society.
2 Safe Harbors & Incentives--Congress can create meaningful safe
harbors and incentives that give employers confidence to proceed in
managing their 401(k) plans in accordance with modern principles of
economics and finance--thus improving results. Congress can remove or
suppress harmful elements of the conventional system, such as
Department of Labor regulation 404(c). That regulation, 404(c), is the
lead in the paint, the salmonella in the peanuts, the goose in the jet
engine of the retirement system. Fix it, and you will fix the root
cause of the problems that plague the 401(k).
3 Expected Returns--Congress can require that participants be given
the expected return (economic characteristic) of the portfolio in which
their funds are invested. Unlike knowing the expected return of a
portfolio, the emotional risk profile most 401(k) participants are
given to help them choose investments is not useful in calculating
future retirement income nor is it helpful in making appropriate
portfolio changes. The expected return is already required by case law
to be known and understood by fiduciaries. That same information should
also be made known to participants.
4 Pass HR 3185--Congress can pass HR 3185 or its fundamental
equivalent to clarify plan expenses by a simple gross-to-net
calculation in order to help employers and plan participants make
better decisions, and also to restore trust and confidence in the
system. No system as important as the 401(k) should have any lingering
questions about fee or expense transparency. Thus, the passage of HR
3185 or its equivalent is at a minimum, urgent.
5 Retire-Ability Measures--Congress can encourage employers to look
beyond the robotic fund selecting process that has become synonymous
with being a 401(k) committee member and to look more deeply at how
their plans are designed to produce financially secure retirees. And
participants can be provided tools to assess their projected retirement
dates and expected income levels.
Conclusion
There are problems with how the 401(k) has been delivered; that
goes without saying. That does not mean we need to accept what has not
worked and protect the status quo. No one is suggesting that employers
guarantee benefits. It is proposed, rather, that 401(k) plans be
managed like the retirement-income-producing mechanism they were always
intended to be. It is because the benefits delivered by a 401(k) are
not guaranteed that we should demonstrate particular care and
compassion. Participants are entirely vulnerable, and deserve better
protections. Protecting the interests of participants will require a
sweeping shift in thinking toward a system that enables (1) A fiduciary
level of care; (2) Improved safe harbors and incentives; (3) Disclosure
of expected investment returns; (4) Transparency via actual gross-to-
net disclosure; and (5) Measurements of each participant's ability to
retire at targeted dates and income levels. The benefits of these five
reforms to the 401(k) system will reach more than fifty million working
Americans. Without this shift in thinking and behavior, including
abandoning the misused 404(c) provisions, the 401(k) will fail to
deliver on its original promise. There is hope for the 401(k) to
rebuild savings and regain the trust of American workers, but it must
be operated as ERISA originally contemplated; like a ``pension
benefit'' plan.
______
------
Prepared Statement of the Profit Sharing/401k Council of America (PSCA)
The Profit Sharing / 401k Council of America (PSCA), commends
Chairman Miller for convening a series of hearing to examine the
employer provided retirement plan system. PSCA, a national non-profit
association of 1,200 companies and their six million employees,
advocates increased retirement security through profit sharing, 401(k),
and related defined contribution programs to federal policymakers. It
makes practical assistance available to its members on profit sharing
and 401(k) plan design, administration, investment, compliance, and
communication issues. Established in 1947, PSCA is based on the
principle that defined contribution partnership in the workplace fits
today's reality. PSCA's services are tailored to meet the needs of both
large and small companies, with members ranging in size from Fortune
100 firms to small entrepreneurial businesses.
The market crisis must be addressed
401(k) plan participants, working in partnership with employers,
can successfully manage normal market risks and cycles and accumulate
ample assets for retirement. However, they cannot succeed without
efficient and transparent capital markets.
The drop in 401(k) account balances in 2008 was not caused by a
defect in the 401(k) system or by ignorant participants. These plans
are caught in the same financial crisis that has paralyzed business and
financial organizations throughout the world. 401(k) participants have
suffered along with everyone else. Inadequate enforcement, misguided
policy, reckless conduct, and unethical behavior in the capital markets
are the problem, not 401(k) plans. We urge the Committee, and Congress,
to direct their efforts to ensuring that a similar market collapse
never again occurs. 401(k) participants, as well as all other
investors, will then be able to move confidently forward, knowing that
saving and investing for the long term will pay off as expected.
The Department of Labor reports that in 2006, the latest year
available, participants and employers contributed over $250 billion to
401(k) type plans. The plans continue to improve, benefitting from a
regulatory structure that permits flexible plan design and innovation.
Automatic enrollment and target date funds were rare five years ago,
but they are quickly becoming dominant plan design features. PSCA urges
Congress to fix the markets and continue to work together with plan
sponsors and providers to continually improve the very successful
401(k) system
Contrary to several published reports, real current data indicates
that 401(k) participants are remaining resolute. They are not stopping
contributions or increasing their loan activity. Hardship withdrawals
have increased slightly, but the percentage of participants taking a
hardship distribution remains well below two percent.\1\
Defined contribution plans work for employees, employers, and America
Employers offer either a defined benefit or defined contribution,
and sometimes both types, of retirement plan to their workers,
depending on their own business needs. According to the Investment
Company Institute, Americans held $15.9 trillion in retirement assets
as of September 30, 2008, the latest available date.\2\ On June 30,
2008, retirement assets totaled $16.9 trillion and they were $18
trillion on September 30, 2007. Government plans held $3.9 trillion.
Private sector defined benefit plans held $2.3 trillion. Defined
contribution plans held $4.0 trillion in employment based defined
contribution plans, including $2.7 trillion in 401(k) plans, and $4.1
trillion in IRAs. Employer-based savings are the source of half of IRA
assets. Ninety-five percent of new IRA contributions are rollovers,
overwhelmingly from employer plans. Annuities held $1.5 trillion.
There are questions about the ability of the defined contribution
system to produce adequate savings as it becomes the dominant form of
employer provided retirement plan. Some claim America is facing a
retirement savings crisis. To answer this question, a baseline for
comparison is required. The Congressional Research Service reports that
in 2007, 22.8% of individuals age 65 and older received any income from
a private sector retirement plan. The median annual income from this
source was $7,200.\3\ This income stream represents a lump-sum value of
$90,000, assuming the purchase of a single-life annuity at an 8%
discount rate. Individuals age 65-69 had higher median annual income
from a private sector retirement plan, $9,700 ($121,250 lump sum
value), but only 19.6% of those age 65 or older received any income
from this source. Overall, however, the elderly are not impoverished.
In 2007, 9.7% of Americans 65 and older had family incomes below the
federal poverty rate, the lowest rate for any population group. How
will the next generation of retirees fare compared to current retirees?
We hear about a negative savings rate in America, with some noting
that Americans are saving less now than during the Great Depression.
Intuitively, something must be wrong with this statistic as the total
amount set aside for retirement has almost tripled in 12 years.\4\ A
2005 analysis by the Center for Retirement Research sheds considerable
light on the matter. They discovered that the NIPA (National Income and
Products Account) personal savings rate for the working-age population
was significantly higher than the overall rate, which was then 1.8%.
Working-age Americans were saving 4.4% of income, consisting almost
exclusively of savings in employment-based plans. This does not include
business savings, which, of course, are owned by individuals. Those 65
and older were ``dissaving'' at negative 12% because they were spending
their retirement assets, which are not considered income. The report
accurately predicted that, as baby-boomers begin to retire, they will
consume more than their income and the savings rate as currently
defined would go even lower.\5\
A recent paper from the AARP Public Policy Institute includes the
following finding:
``While the personal saving rate has declined steadily for the past
20 years, aggregate household net worth, including pension, 401(k),
IRA, and housing wealth have increased dramatically. As an indicator of
the adequacy of retirement assets, the personal savings rate, despite
being cited regularly in the media, is not very useful because it
excludes capital gains, which are far more important to changes in net
worth than annual personal saving. The change in household net worth,
and not the saving rate, should be used to indicate changes in
retirement preparation.'' \6\
The Congressional Research Service reports that married households
in which the head or spouse was employed and the head was age 45-54
held median retirement account assets of $103,200 in 2004. Similar
unmarried households held $32,000. An identical married household
headed by an individual age 55 and older held median retirement account
assets of $119,500 in 2004.\7\
While some workers have enjoyed a full working career under a
defined contribution plan such a as profit sharing plan, 401(k)-type
plans in which the employee decides how much to save have existed for
only slightly over twenty years, and most participants have
participated in them for a much shorter period of time. The typical
participant in 2000 had only participated in the plan for a little over
seven years.\8\ Policymakers must be wary of statistics citing average
401(k) balances and balances of those approaching retirement because
they have not saved over their full working career and some balances
belong to brand new participants. For example, a recent Investment
Company Institute report stated that at the end of 2006, the average
401(k) balance was $61,346 and the median balance was $18,986.\9\ The
median age of the participants in the study was 44 and the median
tenure in their current 401(k) plan was eight years. But when the study
looked at individuals who were active participants in a 401(k) plan
from 1999 to 2006 (including one of the worst bear markets since the
Depression) the average 401(k) balance at the end of 2006 was $121,202
and the median balance was $66,650. Long-tenured (30 years with the
same employer) individuals in their sixties who participated in a
401(k) plan during the 1999-2006 period had an average account balance
of $193,701 at the end of 2006. The study does not reflect that many
individuals and households have multiple 401(k)-type accounts or assets
rolled over into an IRA.
In their April 2007 paper, The Rise of 401(k) Plans, Lifetime
Earnings, and Wealth at Retirement, James Poterba, Steven Venti, and
David A. Wise reported the following:
``Our projections suggest that the average (over all persons)
present value of real DB benefits at age 65 achieved a maximum in 2003,
when this value was $72,637 (in year 2000 dollars), and then began to
decline. The projections also suggest that by 2010 the average level of
401(k) assets at age 65 will exceed the average present value of DB
benefits at age 65. Thereafter the value of 401(k) assets grows
rapidly, attaining levels much greater than the historical maximum
present value of DB benefits. If equity returns between 2006 and 2040
are comparable to those observed historically, by 2040 average
projected 401(k) assets of all persons age 65 will be over six times
larger than the maximum level of DB benefits for a 65 year old achieved
in 2003 (in year 2000 dollars).
Even if equity returns average 300 basis points below their
historical value, we project that average 401(k) assets in 2040 would
be 3.7 times as large as the value of DB benefits in 2003. These
analyses consider changes in the aggregate level of pension assets.
Although the projections indicate that the average level of retirement
assets will grow very substantially over the next three or four
decades, it is also clear that the accumulation of assets in 401(k)-
like plans will vary across households. Whether a person has a 401(k)
plan is strongly related to income. Low-income employees are much less
likely than higher-income employees to be covered by a 401(k) or
similar type of tax-deferred personal account plan.''
The Congressional Research Service estimates that a married
household that contributes ten percent of earnings to a retirement plan
for 30 years will be able to replace fifty-three percent of pre-
retirement income. If they save for forty years, they will replace
ninety-two percent of income.\10\ A ten percent savings rate is
realistic given average contribution rates of seven percent and average
employer contributions of three percent. These estimates do not
consider Social Security payments
The lesson is clear--long-term participation in a 401(k) plan will
result in the accumulation of assets adequate to provide a secure
retirement.
These statistics mean little if a worker is not saving for
retirement. One fact is abundantly clear--whether a worker saves for
retirement is overwhelmingly determined by whether or not a worker is
offered a retirement plan at work. In 2008, sixty-one percent of
private sector workers had access to a retirement plan at work and
fifty-one percent participated. Seventy-one percent of full-time
workers had access and sixty percent participated. Seventy-nine percent
of workers in establishments employing 100 or more workers had access
and sixty-seven percent participated. Only forty-five percent of
workers in establishments of less than 100 workers had access to a plan
and thirty-seven percent participated, but for establishments with
between 50 and 100 workers, fifty-eight percent had access and 45
percent participated.\11\ These participation rates are at a single
point in time. They are not indicative of whether or not a non-
participant or their household will choose to participate in a 401(k)
plan for a substantial period of a working career.
DB and DC plans--understanding the risks and rewards
Defined benefit plans and defined contribution plans are very
different, and each plan has strengths and weaknesses. A traditional
defined benefit plan pays a benefit at retirement that is based on a
formula that considers years of service and compensation, (usually
compensation in the last few years of employment). The employer assumes
the investment risk for funding the plan and, accordingly, benefits
from high investment returns.
In a defined contribution plan, the employer commits to a certain
contribution level and the employee is impacted by investment gains and
losses. Proper investment strategies, such as diversification and age-
based asset allocations, can greatly reduce investment risk. Target
date funds and managed accounts permit a participant to delegate these
actions to experts. A risk-averse participant can usually invest in a
very conservative, but low-yielding investment. All DC plan
participants can independently annuitize their retirement assets if
they wish to do so.
Many observers view the different impact of investment risk to
claim, incorrectly, that DB plans are risk-free. DB plans are ``back-
loaded''--the final benefit is strongly determined by earnings in the
final years of employment and years of service. Older employees and
long-term employees benefit most under a DB plan. Individuals who are
involuntarily separated, and those who leave voluntarily, loose a major
portion of their future benefit. Traditional DB plans are not portable
to a new employer. A second major risk is that the employer will decide
to terminate the plan. In both cases, the employee is left only with
their accrued vested benefit, usually payable many years in the future.
If the sponsoring employer becomes bankrupt, benefits may be further
reduced to the PBGC guaranty level. Some defined benefit plans limit
payments to a fixed annual amount, resulting in default and inflation
risk. Finally, a DB plan benefit ends when the participant (or perhaps
a spouse) dies. Those who die early subsidize long-lived participants
and there is no opportunity to pass on wealth.
Both types of plans have risks for participants. The primary
difference is that in the DC plan system the individual can take
responsibility for managing risk. In DB plans, most of the risk is
beyond the control of the individual.
Opportunities for improvement
What does all these data tell us? First, the employer provided
defined contribution system has demonstrated that it can provide asset
accumulation adequate for a secure retirement for participants at all
income levels. The participation rate when offered a plan is
encouraging, but can be improved. There are two areas in which to
concentrate our efforts--lower-paid workers and small business plan
coverage. We also need to increase participation by African-Americans
and some ethnic groups, as revealed by some recent studies. Small
business owners need simplicity and meaningful benefits for themselves
to compensate for the costs of providing a plan to their workers.
The growth of automatic enrollment plans will substantially
increase retirement plan participation by lower and middle-income
workers that are most likely to be induced to save by this type of plan
design. Ninety percent of workers that are automatically enrolled
choose not to opt out of the plan.\12\ A 2005 ICI/EBRI study projects
that a lowest quartile worker reaching age 65 between 2030 and 2039 who
participates in an automatic enrollment program with a 6% salary
deferral (with no regard for an employer match) and investment in a
life-cycle fund will have 401(k) assets adequate for 52% income
replacement at retirement, not including social security that provides
another 52% income replacement under today's structure.\13\
The important automatic enrollment provisions in the Pension
Protection Act are already producing results. In the latest PSCA survey
of 2006 plan year experience, 35.6% of plans have automatic enrollment,
compared to 23.6% in 2006, 16.9% in 2005, 10.5% in 2004, and 8.4% in
2003. 53.2% of plans with 5,000 or more participants reported utilizing
automatic enrollment in our survey. A Hewitt survey indicated that 36%
of respondents offered automatic enrollment in 2007, up from 24% in
2006. Fifty-five percent of the other respondents are ``very likely or
somewhat likely'' to offer automatic enrollment in 2007.\14\ More than
300 Vanguard plans had adopted automatic enrollment by year-end 2007,
triple the number of plans that had the feature in 2005. Large plans
have been more likely to implement automatic enrollment designs. In
2007, Vanguard plans with automatic enrollment accounted for 15% of
plans but one-third of total participants. In the aftermath of the PPA,
two-thirds of automatic enrollment plans have implemented automatic
annual savings rate increases, up from just one-third in 2005.\15\
401(k) fees in the erisa framework
Numerous aspects of ERISA (the Employee Retirement Income Security
Act of 1974) safeguard participants' interests and 401(k) assets. Plan
assets must generally be held in a trust that is separate from the
employer's assets. The fiduciary of the trust (normally the employer or
committee within the employer) must operate the trust for the exclusive
purpose of providing benefits to participants and their beneficiaries
and defraying reasonable expenses of administering the plan. In other
words, the fiduciary has a duty under ERISA to ensure that any expenses
of operating the plan, to the extent they are paid with plan assets,
are reasonable.
To comply with ERISA, plan administrators must ensure that the
price of services is reasonable at the time the plan contracts for the
services and over time. For example, asset-based fees should be
monitored as plan assets grow to ensure that fee levels continue to be
reasonable for services with relatively fixed costs such as plan
administration and per-participant recordkeeping. The plan
administrator should be fully informed of all the services included in
a bundled arrangement to make this assessment.
Many plan administrators prefer reviewing costs in an aggregate or
``bundled'' manner. As long as they are fully informed of the services
being provided, they can compare and evaluate whether the overall fees
are reasonable without being required to analyze each fee on an
itemized basis. For example, if a person buys a car, they don't need to
know the price of the engine if it were sold separately. They do need
to know the horsepower and warranty. Small business in particular may
prefer the simplicity of a bundled fee arrangement.
It is important to understand the realities of fees in 401(k)
plans. There are significant recordkeeping, administrative, and
compliance costs related to an employer provided plan that do not exist
for individual retail investors. Nevertheless, because of economies of
scale and the fiduciary's role in selecting investments and monitoring
fees, the vast majority of participants in ERISA plans have access to
capital markets at lower cost through their plans than the participants
could obtain in the retail markets.
The Investment Company Institute reports that the average overall
investment fee for stock mutual funds is 1.5% and that 401(k) investors
pay half that amount.\16\ The level of fees paid among all ERISA plan
participants will vary considerably, however, based on variables that
include plan size (in dollars invested and/or number of participants),
average participant account balances, asset mix, and the types of
investments and the level of services being provided. Larger, older
plans typically experience the lowest cost. Employer provided plans are
often the only avenue of mutual fund investment available to lower-paid
individuals who have great difficulty accumulating the minimum amounts
necessary to begin investing in a mutual fund or to make subsequent
investments. Finally, to the degree an employer provides a matching
contribution, and most plans do, the plan participant is receiving an
extraordinarily high rate of return on their investment that a retail
product does not provide.
A study by CEM Benchmarking Inc. of 88 US defined contribution
plans with total assets of $512 billion (ranging from $4 million to
over $10 billion per plan) and 8.3 million participants (ranging from
fewer than 1,000 to over 100,000 per plan) found that total costs
ranged from 6 to 154 basis points (bps) or 0.06 to 1.54 percent of plan
assets in 2005. Total costs varied with overall plan size. Plans with
assets in excess of $10 billion averaged 28 bps while plans between
$0.5 billion and $2.0 billion averaged 52 bps. In a separate analysis
conducted for PSCA, CEM reported that, in 2005, its private sector
corporate plans had total average costs of 33.4 bps and median costs of
29.8 bps.
Other surveys have found similar costs. HR Investment Consultants
is a consulting firm providing a wide range of services to employers
offering participant-directed retirement plans. It publishes the 401(k)
Averages Book that contains plan fee benchmarking data. The 2008 Ninth
Edition of the book reveals that average total plan costs ranged from
161 bps for plans with 25 participants to 96 bps for plans with 5,000
participants. The Committee on the Investment of Employee Benefit
Assets (CEIBA), whose more than 120 members manage $1.5 trillion in
defined benefit and defined contribution plan assets on behalf of 16
million (defined benefit and defined contribution) plan participants
and beneficiaries, found in a 2005 survey of members that plan costs
paid by defined contribution plan participants averaged 29 bps.
Principles of reform
PSCA supports effective and efficient disclosure efforts. The
following principles should be embodied in any effort to enhance fee
disclosure in employer-provided retirement plans.
Sponsors and Participants' Information Needs Are Markedly
Different. Any new disclosure regime must recognize that plan sponsors
(employers) and plan participants (employees) have markedly different
disclosure needs.
Overloading Participants with Unduly Detailed Information
Can Be Counterproductive. Overly detailed and voluminous information
may impair rather than enhance a participant's decision-making.
New Disclosure Requirements Will Carry Costs for
Participants and So Must Be Fully Justified. Participants will likely
bear the costs of any new disclosure requirements so such new
requirements must be justified in terms of providing a material benefit
to plan participants' participation and investment decisions.
New Disclosure Requirements Should Not Require the
Disclosure of Component Costs That Are Costly to Determine, Largely
Arbitrary, and Unnecessary to Determine Overall Fee Reasonableness.
Bundled service providers should disclose the included services in
detail. However, a requirement to ``unbundle'' bundled services and
provide individual costs in many detailed categories would be arbitrary
and is not particularly helpful and would lead to information that is
not meaningful. It also raises significant concerns as to how a service
provider would disclose component costs for services if they were not
offered outside a bundled contract. These costs will ultimately be
passed on to plan participants through higher administrative fees. The
increased burden for small businesses could inhibit new plan growth.
Information About Fees Must Be Provided Along with Other
Information Participants Need to Make Sound Investment Decisions.
Participants need to know about fees and other costs associated with
investing in the plan, but not in isolation. Fee information should
appear in context with other key facts that participants should
consider in making sound investment decisions. These facts include each
plan investment option's historical performance, relative risks,
investment objectives, and the identity of its adviser or manager.
Disclosure Should Facilitate Comparison But Sponsors Need
Flexibility Regarding Format. Disclosure should facilitate comparison
among investment options, although employers should retain flexibility
as to the appropriate format for workers.
Participants Should Receive Information at Enrollment and
Have Ongoing Access. Participants should receive fee and other key
investment option information at enrollment and be informed
periodically about fees.
HR 3185
PSCA supports legislation that will effectively improve fee
transparency for sponsors and participants. HR 3185, as reported by the
Committee on April 16, 2008, reflects many of our principles and is a
significant improvement over the original legislation. In addition to
numerous minor adjustments to ensure that HR 3185 reflects the
complexity of the retirement plan system, PSCA recommends three key
changes. First, the legislation needs to include a ``matching
proposal'' that specifies that the fiduciary duty to determine that
fees are reasonable is limited in scope to the fees required to be
disclosed under the legislation. The Committee agreed to examine this
issue when Representative Kline offered and withdrew an implementing
amendment during the 2008 mark-up. Second, Congress should abandon the
``unbundling' requirement in the bill and permit both models to compete
in the marketplace. Bundled providers should provide a detailed
description of the services they offer so that plan fiduciaries can
determine that the aggregate fee is reasonable. Finally, the index fund
requirement in the revised bill remains problematic.
endnotes
\1\ Fidelity Reports on 2008 Trends in 401(k) Plans, Fidelity
Investments, January 28, 2009, and Update on Participant Activity Amid
Market Volatility, Vanguard Center for Retirement Research, February
19, 2009.
\2\ The U.S. Retirement Market, Third Quarter 2008, Investment
Company Institute, February 2009.
\3\ Income and Poverty Among Older Americans in 2007, Congressional
Research Service, October 3, 2008.
\4\ The U.S. Retirement Market, Second Quarter 2008, Investment
Company Institute, December 2008.
\5\ How Much are Workers Saving?, Alicia Munnell, Francesca Golub-
Sass, and Andrew Varani, Center for Retirement Research at Boston
College, October 2005.
\6\ A New Perspective on ``Saving'' for Retirement, AARP Public
Policy Institute, February 2009.
\7\ Retirement Savings: How Much Will Workers Have When They
Retire?, CRS Report For Congress, January 29, 2007.
\8\ Rise of 401(k) Plans, Lifetime Earnings and Wealth at
Retirement, James Poterba, Steven F. Venti, and David A. Wise, NBER
Working Paper 13091, May 2007.
\9\ 401(k) Plan Asset Allocation, Account Balances, and Loan
Activity in 2006, Investment Company Institute, August, 2007.
\10\ Retirement Savings: How Much Will Workers Have When They
Retire?, CRS Report For Congress, January 29, 2007.
\11\ Employee Benefits in the United States, March 2008, Bureau of
Labor Statistics, August 7, 2008.
\12\ Hewitt Study Reveals Impact of Automatic Enrollment on
Employees' Retirement Savings Habits, Hewitt Associates, October 25,
2006.
\13\ The Influence of Automatic Enrollment, Catch-Up, and IRA
Contributions on 401(k) Accumulations at Retirement, EBRI Issue Brief
no. 238, July 2005.
\14\ Survey Findings: Hot Topics in Retirement 2007, Hewitt
Associates
\15\ How America Saves 2008, Vanguard
\16\ The Economics of Providing 401(k) Plans: Services, Fees, and
Expenses, 2006, Investment Company Institute, September 2007.
______
Ms. Munnell. Mr. Chairman, could I also ask that an article
that we had on guarantees be included.
Chairman Miller. It is on the level?
Ms. Munnell. Yes.
Chairman Miller. Okay, without objection.
[The information follows:]
------
Chairman Miller. Thank you, again, very much for--oh. And
as previously ordered, members will have 14 days to submit
additional materials for the hearing. And as somebody
submitted--Mr. Scott submitted a question to ask for Mr. Bogle
to follow up on. And we will send that forward. And with that,
the hearing stands adjourned. Thank you.
[Additional submissions by Mr. Miller follow:]
[Internet addresses to the Ariel/Schwab Black Investor
Survey follow:]
http://www.arielinvestments.com/content/view/560/1173/
http://www.arielinvestments.com/content/view/354/1228/
______
Prepared Statement of Mellody Hobson, President, Ariel Investments, LLC
and Chairman, Ariel
Chairman Miller, Ranking Member McKeon, distinguished Members,
thank you for the opportunity to submit this statement for the hearing
``Strengthening Worker Retirement Security.'' My name is Mellody Hobson
and I am the President of Ariel Investments, LLC, a privately owned
Chicago-based money management firm with more than $4.4 billion in
assets under management, founded in 1983 by John W. Rogers, Jr. In
addition to managing separate accounts for corporate, public, union and
non-profit organizations, Ariel Investments also serves as the
investment adviser to the publicly-traded, no-load Ariel Mutual Funds.
Patience serves as the core of our investment philosophy. Ariel
Investments was built around the belief that patient investors will be
rewarded--that wealth can be created by investing in great companies,
selling at excellent prices whose true value would be realized over
time. As such, we believe our long-term performance is driven by our
disciplined and focused approach, our stock selection across industries
where Ariel has proven expertise, our exhaustive investigative research
process and our commitment to investing in quality businesses that are
typically undervalued or ignored.
With the largest generation in American history set to begin
retiring, the country is facing a retirement crisis. Almost half of
Americans today have little or nothing saved. The vast majority have
far short of what they will need. Fewer and fewer Americans today have
jobs offering guaranteed pensions and many public and private pension
systems are underfunded. Many pensions affiliated with financially
troubled companies are also at risk of collapse, and the federal agency
set up to insure them is severely underfunded.
By most estimates, Social Security is in need of supplement and
even under the best of circumstances is inadequate to funding a secure
retirement for working Americans. The typical retiree lives for 17
years after retiring at 65. The typical retired couple spends more than
$200,000 on health care in their old age. Defined contribution plans
(401(k), 403(b), and 453) were never intended to replace traditional
pensions (defined benefit plans) but for more and more people today,
they are the only way of saving for retirement. The problem, however,
is that most people do not save nearly enough and do not manage well
the money they have.
These problems are even more extreme among minorities, who have
less first-hand experience with money management than society as a
whole. I have provided the results of the 2008 Ariel-Schwab Black
Investor Survey and the Ariel-Schwab Black Paper. At Ariel we have
learned that for middle-class African-Americans, the march toward
financial security has been an uphill journey marked by half steps,
pauses and, for some, retreat. Over the last decade, Ariel Investments
and The Charles Schwab Corporation have commissioned annual research
comparing the saving and investing habits of middle- and upper-income
Black and White Americans. The results consistently reveal that Blacks
save less than Whites of similar income levels and are less comfortable
with stock investing which impedes wealth building across generations
and contributes to the growing retirement crisis.
The 11th Annual Black Investor Survey shows White Americans have
more than twice as much saved for retirement as Blacks, but finds
employers well positioned to make a difference. African-Americans are
on equal footing with Whites when it comes to accessing and enrolling
in employer-sponsored defined contribution plans, but save far less
each month and have a considerably smaller nest egg than their White
counterparts, according to the 11th annual Ariel/Schwab Black Investor
Survey. The survey also found that with some help from employers, all
employees, but particularly African-Americans, would be likely to ramp
up their monthly 401(k) savings
This year's survey found that for many younger African-Americans,
saving for retirement is more of a dream than a priority. Both Ariel
and Schwab have made a major investment in financial education for
youth. Through Ariel's foundation, the Ariel Education Initiative, the
company supports the Ariel Community Academy, a Chicago public school
that integrates financial literacy into the school's curriculum.
Charles Schwab Foundation funds Money Matters: Make it Count, an after-
school financial literacy program with Boys & Girls Clubs of America.
I thank the Committee again for taking up this important issue, and
welcome any questions or comments you may have.
______
Prepared Statement of the American Benefits Council
Employer-sponsored 401(k) and other defined contribution retirement
plans are a core element of our nation's retirement system and
successfully assist tens of millions of families in accumulating
retirement savings. While individuals have understandable retirement
income concerns resulting from the recent market and economic
downturns--concerns fully shared by the American Benefits Council--it
is critical to acknowledge the vital role defined contribution plans
play in creating personal financial security.
Congress has adopted rules that facilitate employer sponsorship of
these plans, encourage employee participation, promote prudent
investing, allow operation at reasonable cost, and safeguard
participant interests through strict fiduciary obligations. As a result
401(k) plans are valued by workers who participate in them as important
resources for delivering retirement benefits. Nevertheless,
improvements to the system can certainly be made. Helping workers to
manage market risk and to translate their defined contribution plan
savings into retirement income are areas that would benefit from
additional policy deliberations. An additional area in which reform
would be particularly constructive is increasing the number of
Americans who have access to a defined contribution or other workplace
retirement plan.
The goal should be a 401(k) system that functions in a transparent
manner and provides meaningful benefits at a fair price. At the same
time, we all must bear in mind that unnecessary burdens and cost
imposed on these plans will slow their growth and reduce participants'
benefits, thus undermining the very purpose of the plans. It is
important to understand the facts relating to these plans. The Council
believes the following principles are critical in evaluating any reform
measures in this area:
Defined Contribution Plans Reach Tens of Millions of
Workers and Provide an Important Source of Retirement Savings. There
are now more than 630,000 private-sector defined contribution plans
covering more than 75 million active and retired workers, with another
10 million employees covered by tax-exempt and governmental defined
contribution plans.
Employers Make Significant Contributions Into Defined
Contribution Plans. Many employers make matching, non-elective, and
profit-sharing contributions to complement employee deferrals and share
the responsibility for financing retirement. Recent surveys of defined
contribution plan sponsors found that at least 95% make some form of
employer contribution.
Employer Sponsorship Offers Advantages to Employees.
Employer sponsors of defined contribution plans must adhere to strict
fiduciary obligations established by Congress to protect the interests
of plan participants. Employers exercise oversight through selection of
plan investment options, educational materials and workshops about
saving and investing and professional investment advice.
Defined Contribution Plan Coverage and Participation Rates
Are Increasing. The number of employees participating in these plans
grew from 11.5 million in 1975 to more than 75 million in 2005, and 65%
of full-time employees in private industry had access to a defined
contribution plan in 2008.
Defined Contribution Plan Rules Promote Benefit Fairness.
Congress has established detailed rules to ensure that benefits in
defined contribution plans are delivered across all income groups.
Extensive coverage, nondiscrimination and top-heavy rules promote
fairness regarding which employees are covered by a defined
contribution plan and the contributions made to these plans.
401(k) Plans Have Evolved in Ways That Benefit Workers.
Both Congress and private innovation have enhanced 401(k) plans, aiding
their evolution from bare-bones savings plans into retirement plans.
Among these enhancements have been incentives for plan creation, catch-
up contributions for older workers, accelerated vesting schedules, tax
credits, automatic contribution escalation, single-fund investment
solutions and investment education programs.
Recent Enhancements to the Defined Contribution System Are
Working. The Pension Protection Act of 2006 (PPA) encourages automatic
enrollment and automatic contribution escalation. PPA also provided new
rights to diversify contributions made in company stock, accelerating
existing trends toward greater diversification of 401(k) assets.
Defined Contribution Plan Savings is an Important Source
of Investment Capital. With more than $4 trillion in combined assets as
of March 2008, these plans represent ownership of a significant share
of the total pool of stocks and bonds, provide an important and ready
source of American investment capital.
Defined Contribution Plans Should Not Be Judged on Short-
Term Market Conditions.
Workers and retirees are naturally concerned about the impact of
the recent market turmoil. It is important, however, for policymakers
and participants to judge defined contribution plans based on whether
they serve workers' retirement interests over the long term.
Inquiries About Risk Are Appropriate But No Retirement
Plan Design is Immune from Risk. The recent market downturn has spawned
questions about whether defined contribution plan participants may be
subject to undue investment risk. Yet it is difficult to imagine any
retirement plan design that does not have some kinds of risk. Any
efforts to mitigate risk should focus on refinements to the existing
successful employer-sponsored retirement plan system and shoring up the
Social Security safety net.
The Council has prepared the attached white paper to more fully
develop these principles. We encourage a full and vigorous debate over
ways to improve retirement security for American workers. At the same
time, it is critical that the debate not serve to undermine retirement
security by inadvertently increasing the costs to participants or
discouraging plan sponsorship.
February 5, 2009.
Defined Contribution Plans: A Successful Cornerstone of Our Nation's
Retirement System
Introduction
Employer-sponsored 401(k) and other defined contribution retirement
plans are a core element of our nation's retirement system, playing a
critical role along with Social Security, personal savings and
employer-sponsored defined benefit plans. Defined contribution plans
successfully assist tens of millions of American families in
accumulating retirement savings. Congress has adopted rules for defined
contribution plans that:
facilitate employer sponsorship of plans,
encourage employee participation,
promote prudent investing by plan participants,
allow operation of plans at reasonable cost, and
safeguard plan assets and participant interests through
strict fiduciary obligations and intensive regulatory oversight.
While individuals have understandable retirement income concerns
resulting from the recent market and economic downturns--concerns fully
shared by the American Benefits Council--it is critical to acknowledge
the vital role defined contribution plans play in building personal
financial security.
Defined Contribution Plans Reach Tens of Millions of Workers and
Provide an Important Source of Retirement Savings
Over the past three decades, 401(k) and other defined contribution
plans have increased dramatically in number, asset value, and employee
participation. As of June 30, 2008, defined contribution plans
(including 401(k), 403(b) and 457 plans) held $4.3 trillion in assets,
and assets in individual retirement accounts (a significant share of
which is attributable to amounts rolled over from employer-sponsored
retirement plans, including defined contribution plans) stood at $4.5
trillion.\1\ Of course, assets have declined significantly since then
due to the downturn in the financial markets. Assets in 401(k) plans
are projected to have declined from $2.9 trillion on June 30, 2008 to
$2.4 trillion on December 31, 2008,\2\ and the average 401(k) account
balance is down 27% in 2008 relative to 2007.\3\ Nonetheless, 401(k)
account balances are up 140% when compared to levels as of January 1,
2000.\4\ Thus, even in the face of the recent downturn (which of course
has also affected workers' non-retirement investments and home values),
employees have seen a net increase in workplace retirement savings.
This has been facilitated by our robust and expanding defined
contribution plan system. As discussed more fully below, employees have
also remained committed to this system despite the current market
conditions, with the vast majority continuing to contribute to their
plans.
In terms of the growth in plans and participating employees, the
most recent statistics reveal that there are more than 630,000 defined
contribution plans covering more than 75 million active and retired
workers with more than 55 million current workers now participating in
these plans.\5\ Together with Social Security, defined contribution
plan accumulations can enable retirees to replace a significant
percentage of pre-retirement income (and many workers, of course, will
also have income from defined benefit plans).\6\
Employers Make Significant Contributions Into Defined Contribution
Plans
When discussing defined contribution plans, the focus is often
solely on employee deferrals into 401(k) plans. However, contributions
consist of more than employee deferrals. Employers make matching, non-
elective, and profit-sharing contributions to defined contribution
plans to complement employee deferrals and share with employees the
responsibility for funding retirement. Indeed, a recent survey of
401(k) plan sponsors with more than 1,000 employees found that 98% make
some form of employer contribution.\7\ Another recent study of
employers of all sizes indicated that 62% of defined contribution
sponsors made matching contributions, 28% made both matching and
profit-sharing contributions, and 5% made profit-sharing contributions
only.\8\ While certain employers have reduced or suspended matching
contributions as a result of current economic conditions, the vast
majority have not.\9\ Those that have are often doing so as a direct
result of substantially increased required contributions to their
defined benefit plans or institution of a series of cost-cutting
measures to preserve jobs. As intended, matching contributions play a
strong role in encouraging employee participation in defined
contribution plans.\10\
The Defined Contribution System is More Than 401(k) Plans
The defined contribution system also includes many individuals
beyond those who participate in the 401(k) and other defined
contribution plans offered by private-sector employers. More than 7
million employees of tax-exempt and educational institutions
participate in 403(b) arrangements,\11\ which held more than $700
billion in assets as of earlier this year.\12\ Millions of employees of
state and local governments participate in 457 plans, which held more
than $160 billion in assets as of earlier this year.\13\ Finally, 3.9
million individuals participate in the federal government's defined
contribution plan (the Thrift Savings Plan), which held $226 billion in
assets as of June 30, 2008.\14\
401(k) Plans Have Evolved in Ways That Benefit Workers
Even when focusing on 401(k) plans, it is important to keep in mind
that these plans have evolved significantly from the bare-bones
employee savings plans that came into being in the early 1980s. As
discussed more fully below, employers have enhanced these arrangements
in numerous ways, aiding their evolution into robust retirement plans.
Congress has likewise enacted numerous enhancements to 401(k) plans,
making major improvements to the 401(k) system in the Small Business
Job Protection Act of 1996, the Taxpayer Relief Act of 1997, the
Economic Growth and Tax Relief Reconciliation Act of 2001, and the
Pension Protection Act of 2006. Among the many positive results have
been incentives for plan creation, promotion of automatic enrollment,
catch-up contributions for workers 50 and older, safe harbor 401(k)
designs, accelerated vesting schedules, greater benefit portability,
tax credits for retirement savings, and enhanced rights to diversify
company stock contributions.
There also has been tremendous innovation in the 401(k)
marketplace, with employer plan sponsors and plan service providers
independently developing and adopting many features that have assisted
employees. For example, both automatic enrollment and automatic
contribution escalation were first developed in the private sector.
Intense competition among service providers has helped spur this
innovation and has driven down costs. Among the market innovations that
have greatly enhanced defined contribution plans for participants are:
on-line and telephonic access to participant accounts and
plan services,
extensive financial planning, investment education and
investment advice offerings,
single-fund investment solutions such as retirement target
date funds and risk-based lifestyle funds, and
in-plan annuity options and guaranteed withdrawal features
that allow workers to replicate attributes of defined benefit plans.
These legislative changes and market innovations have resulted in
more employers wanting to sponsor 401(k) plans and have--together with
employer enhancements to plan design--improved both employee
participation rates and employee outcomes.
Long-Term Retirement Plans Should Not Be Judged on Short-Term Market
Conditions
Workers and retirees are naturally concerned about the impact of
the recent market turmoil. It is important, however, for policymakers
and participants to evaluate defined contribution plans based on
whether they serve workers' retirement interests over the long term
rather than over a period of months. Defined contribution plans and the
investments they offer employees are designed to weather changes in
economic conditions--even conditions as anxiety-provoking as the ones
we are experiencing today. (Market declines and volatility are, of
course, affecting all types of retirement plans and investment
vehicles, not just defined contribution plans.) Although it is
difficult to predict short-run market returns, over the long run stock
market returns are linked to the growth of the economy and this upward
trend will aid 401(k) investors. Indeed, one of the benefits for
employees of participating in a defined contribution plan through
regular payroll deduction is that those who select equity vehicles
purchase these investments at varying prices as markets rise and fall,
achieving effective dollar cost averaging. If historical trends
continue, defined contribution plan participants who remain in the
system can expect their plan account balances to rebound and grow
significantly over time.\15\ That being said, the American Benefits
Council favors development of policy ideas (and market innovations) to
help those defined contribution plan participants nearing retirement
improve their retirement security and generate adequate retirement
income.
It is important to note that in the face of the current economic
crisis and market decline, plan participants remain committed to
retirement savings and few are reducing their contributions. Rather,
the large majority of participants continue to contribute at
significant rates and remain in appropriately diversified investments.
One leading 401(k) provider saw only 2% of participants decrease
contribution levels in October 2008 (1% actually increased
contributions) despite the stock market decline and volatility
experienced during that month.\16\ Another leading provider found that
96% of 401(k) participants who contributed to plans in the third
quarter of 2008 continued to contribute in the fourth quarter.\17\
Research from the prior bear market confirms that employees tend to
hold steady in the face of declining stock prices, remaining
appropriately focused on their long-term retirement savings and
investment goals.\18\
Demonstrating the importance of defined contribution plans to
employees, a recent survey found that defined contribution plans are
the second-most important benefit to employees behind health
insurance.\19\ The same survey found that 9% of employees viewed
greater deferrals to their defined contribution plan as one of their
top priorities for 2009.\20\
Defined Contribution Plan Coverage and Participation Rates Are
Increasing
Participation in employer-sponsored defined contribution plans has
grown from 11.5 million in 1975 to more than 75 million in 2005.\21\
This substantial increase is a result of many more employers making
defined contribution plans available to their workforces. Today, the
vast majority of large employers offer a defined contribution plan,\22\
and the number of small employers offering such plans to their
employees has been increasing modestly as well.\23\ In total, 65% of
full-time employees in private industry had access to a defined
contribution plan at work in 2008 (of which 78% participated).\24\
Small businesses that do not offer a 401(k) or profit-sharing plan are
increasingly offering workers a SIMPLE IRA, which provides both a
saving opportunity and employer contributions.\25\ Indeed, as of 2007,
2.2 million workers at eligible small businesses participated in a
SIMPLE IRA.\26\
The rate of employee participation in defined contribution plans
offered by employers also has increased modestly over time \27\--with
further increases anticipated as a result of automatic enrollment
adoption. Moreover, participating employees are generally saving at
significant levels--levels that have risen over time.\28\ Younger
workers, in particular, increasingly look to defined contribution plans
as a primary source of retirement income.\29\
There are understandable economic impediments that keep some small
employers, particularly the smallest firms, from offering plans. The
uncertainty of revenues is the leading reason given by small businesses
for not offering a plan, while cost, administrative challenges, and
lack of employee demand are other impediments cited by small
business.\30\ Indeed, research reveals that employees at small
companies place less priority on retirement benefits relative to salary
than their counterparts at large companies.\31\ As firms expand and
grow, the likelihood that they will offer a retirement plan
increases.\32\ Congress can and should consider additional incentives
and reforms to assist small businesses in offering retirement plans,
but some small firms will simply not have the economic stability to do
so. Mandates on small business to offer or contribute to plans will
only serve to exacerbate the economic challenges they face, reducing
the odds of success for the enterprise, hampering job creation and
reducing wages.
Some have understandably focused on the number of Americans who do
not currently have access to an employer-sponsored defined contribution
plan. Certainly expanding plan coverage to more Americans is a
universally shared goal. Yet statistics about retirement plan coverage
rates must be viewed in the appropriate context. Statistics about the
percentage of workers with access to an employer retirement plan
provide only a snapshot of coverage at any one moment in time. Given
job mobility and the fact that growing employers sometimes initiate
plan sponsorship during an employee's tenure, a significantly higher
percentage of workers have access to a plan for a substantial portion
of their careers.\33\ This coverage provides individuals with the
opportunity to add defined contribution plan savings to other sources
of retirement income. It is likewise important to note that
individuals' savings behavior tends to evolve over the course of a
working life. Younger workers typically earn less and therefore save
less. What younger workers do save is often directed to non-retirement
goals such as their own continuing education, the education of their
children or the purchase of a home.\34\ As they age and earn more,
employees prioritize retirement savings and are increasingly likely to
work for employers offering retirement plans.\35\
Defined Contribution Plan Rules Promote Benefit Fairness
The rules that Congress has established to govern the defined
contribution plan system ensure that retirement benefits in these plans
are delivered across all income groups. Indeed, the Internal Revenue
Code contains a variety of rules to promote fairness regarding which
employees are covered by a defined contribution plan and the
contributions made to these plans. These requirements include coverage
rules to ensure that a fair cross-section of employees (including
sufficient numbers of non-highly compensated workers) are covered by
the defined contribution plan and nondiscrimination rules to make
certain that both voluntary employee contributions and employer
contributions for non-highly compensated employees are being made at a
rate that is not dissimilar to the rate for highly compensated
workers.\36\ There are also top-heavy rules that require minimum
contributions to non-highly compensated employees' accounts when the
plan delivers significant benefits to top employees.
Congress has also imposed various vesting requirements with respect
to contributions made to defined contribution plans. These requirements
specify the timetable by which employer contributions become the
property of employees. Employees are always 100% vested in their own
contributions, and employer contributions made to employee accounts
must vest according to a specified schedule (either all at once after
three years of service or in 20% increments between the second and
sixth years of service).\37\ In addition, the two 401(k) safe harbor
designs that Congress has adopted--the original safe harbor enacted in
1996 and the automatic enrollment safe harbor enacted in 2006--require
vesting of employer contributions on an even more accelerated
schedule.\38\
Employer Sponsorship of Defined Contribution Plans Offers Advantages to
Employees
As plan sponsors, employers must adhere to strict fiduciary
obligations established by Congress to protect the interests of plan
participants. ERISA imposes, among other things, duties of prudence and
loyalty upon plan fiduciaries. ERISA also requires that plan
fiduciaries discharge their duties ``solely in the interest of the
participants and beneficiaries'' and for the ``exclusive purpose'' of
providing participants and beneficiaries with benefits.\39\ These
exceedingly demanding fiduciary obligations (which are enforced through
both civil and criminal penalties) offer investor protections not
typically associated with savings vehicles individuals might use
outside the workplace.
One area in which employers exercise oversight is through selection
and monitoring of the investment options made available in the plan.
Through use of their often considerable bargaining power, employers
select high-quality, reasonably-priced investment options and monitor
these options on an ongoing basis to ensure they remain high-quality
and reasonably-priced. Large plans also benefit from economies of scale
that help to reduce costs. Illustrating the value of this employer
involvement, the mutual funds that 401(k) participants invest in are,
on average, of lower cost than those that retail investors use.\40\
Recognizing these benefits, an increasing number of retirees are
leaving their savings in defined contribution plans after retirement,
managing their money using the plan's investment options and taking
periodic distributions. With the investment oversight they bring to
bear, employers are providing a valuable service that employees would
not be able easily or inexpensively to replicate on their own outside
the plan.
Employers also typically provide educational materials about
retirement saving, investing and planning, and in many instances also
provide access to investment advice services.\41\ To supplement
educational materials and on-line resources, well over half of 401(k)
plan sponsors offer in-person seminars and workshops for employees to
learn more about retirement investing, and more than 40% provide
communications to employees that are targeted to the workers'
individual situations.\42\ Surveys reveal that a significant percentage
of plan participants utilize employer-provided investment education and
advice tools.\43\ Although participants can obtain such information
outside of the workplace, it can be costly or require significant
effort to do so, yielding yet another advantage to participation in an
employer-sponsored defined contribution plan.
Recent Enhancements to the Defined Contribution System Are Working
Recent legislative reforms are improving outcomes for defined
contribution plan participants. The Pension Protection Act of 2006
(``PPA''), in particular, included several landmark changes to the
defined contribution system that are already beginning to assist
employees in their retirement savings efforts.
Employee participation rates are beginning to increase thanks to
PPA's provisions encouraging the adoption of automatic enrollment. This
plan design, under which workers must opt out of plan participation
rather than opt in, has been demonstrated to increase participation
rates significantly, helping to move toward the universal employee
coverage typically associated with defined benefit plans.\44\ And more
employers are adopting this design in the wake of PPA, in numbers that
are particularly notable given that the IRS's implementing regulations
have not yet been finalized and the Department of Labor's regulations
were not finalized until more than a year after PPA's enactment.\45\
One leading defined contribution plan service provider saw a tripling
in the number of its clients adopting automatic enrollment between
year-end 2005 and year-end 2007,\46\ and other industry surveys show a
similarly rapid increase in adoption by employers.\47\ Moreover, many
employers that have not yet adopted automatic enrollment are seriously
considering doing so.\48\
Employers are also beginning to increase the default savings rate
at which workers are automatically enrolled,\49\ which is important to
ensuring that workers have saved enough to generate meaningful income
in retirement. Studies show that automatic enrollment has a
particularly notable impact on the participation rates of lower-income,
younger, and minority workers because these groups are typically less
likely to participate in a 401(k) plan where affirmative elections are
required.\50\ Thus, PPA's encouragement of auto enrollment is helping
to improve retirement security for these often vulnerable groups.
PPA also encouraged the use of automatic escalation designs that
automatically increase an employee's rate of savings into the plan over
time, typically on a yearly basis. This approach is critical in helping
workers save at levels sufficient to generate meaningful retirement
income and can be useful in ensuring that employees save at the levels
required to earn the full employer matching contribution.\51\ Employers
are increasingly adopting automatic escalation features.\52\
In PPA, Congress also directed the Department of Labor (DOL) to
develop guidance providing for qualified default investment
alternatives, or QDIAs--investments into which employers could
automatically enroll workers and receive a measure of fiduciary
protection. QDIAs are diversified, professionally managed investment
vehicles and can be retirement target date or life-cycle funds, managed
account services or funds balanced between stocks and bonds. There has
been widespread adoption of QDIAs by employers and this has helped
improve the diversification of employee investments in 401(k) and other
defined contribution plans.\53\ Congress also directed DOL in PPA to
reform the fiduciary standards governing selection of annuity
distribution options for defined contribution plans, and the DOL has
recently issued final regulations on this topic.\54\ As a result,
fiduciaries now have a clearer road map for the addition of an annuity
payout option to their plan, which can give participants another tool
for translating their retirement savings into lifelong retirement
income.
Defined Contribution Plans Provide Employees with the Tools to Make
Sound Investments
As a result of legislative reform and employer practices, employees
in defined contribution plans have a robust set of tools to assist them
in pursuing sound, diversified investment strategies. As noted above,
employers provide educational materials on key investing principles
such as asset classes and asset allocation, diversification, risk
tolerance and time horizons. Employers also provide the opportunity for
sound investing by selecting a menu of high-quality investments from
diverse asset classes that, as discussed above, often reflect lower
prices relative to retail investment options.\55\ Moreover, the vast
majority of employers operate their defined contribution plans pursuant
to ERISA section 404(c),\56\ which imposes a legal obligation to offer
a ``broad range of investment alternatives'' including at least three
options, each of which is diversified and has materially different risk
and return characteristics.
The development and greater use by employers of investment options
that in one menu choice provide a diversified, professionally managed
asset mix that grows more conservative as workers age (retirement
target date funds, life-cycle funds, managed account services) has been
extremely significant and has helped employees seeking to maintain age-
appropriate diversified investments.\57\ As mentioned above, the use of
such options has accelerated pursuant to the qualified default
investment alternatives guidance issued under PPA.\58\ These investment
options typically retain some exposure to equities for workers as they
approach retirement age. Given that many such workers are likely to
live decades beyond retirement and through numerous economic cycles,
some continued investment in stocks is desirable for most individuals
in order to protect against inflation risk.\59\
One potential challenge when considering the diversification of
employee defined contribution plan savings is the role of company
stock. Traditionally, company stock has been a popular investment
option in a number of defined contribution plans, and employers
sometimes make matching contributions in the form of company stock.
Congress and employers have responded to encourage diversification of
company stock contributions. PPA contained provisions requiring defined
contribution plans (other than employee stock ownership plans) to
permit participants to immediately diversify their own employee
contributions, and for those who have completed at least three years of
service, to diversify employer contributions made in the form of
company stock.\60\ And today, fewer employers (23%) make their matching
contributions in the form of company stock, down from 45% in 2001.\61\
Moreover, more employers that do so are permitting employees to
diversify these matching contributions immediately (67%), up from 24%
that permitted such immediate diversification in 2004.\62\
The result has been greater diversification of 401(k) assets. In
2006, a total of 11.1% of all 401(k) assets were held in company
stock.\63\ This is a significant reduction from 1999, when 19.1% of all
401(k) assets were held in company stock.\64\
New Proposals for Early Access Would Upset the Balance Between
Liquidity and Asset Preservation
The rules of the defined contribution system strike a balance
between offering limited access to retirement savings and restricting
such saving for retirement purposes. Some degree of access is necessary
in order to encourage participation as certain workers would not
contribute to a plan if they were unable under any circumstances (e.g.,
health emergency, higher education needs, first-home purchase) to
access their savings prior to retirement.\65\ Congress has recognized
this relationship between some measure of liquidity and plan
participation rates and has permitted pre-retirement access to plan
savings in some circumstances. For example, the law permits employers
to offer workers the ability to take loans from their plan accounts
and/or receive so-called hardship distributions in times of pressing
financial need.\66\ However, a low percentage of plan participants
actually use these provisions, and loans and hardship distributions do
not appear to have increased markedly as a result of the current
economic situation.\67\ To prevent undue access, Congress has limited
the circumstances in which employees may take pre-retirement
distributions and has imposed a 10% penalty tax on most such
distributions.\68\
In 2001, as part of the Economic Growth and Tax Relief
Reconciliation Act (EGTRRA), Congress took further steps to ease
portability of defined contribution plan savings and combat leakage of
retirement savings. EGTRRA required automatic rollovers into IRAs for
forced distributions of balances of between $1,000 and $5,000 and
allowed individuals to roll savings over between and among 401(k),
403(b), 457 and IRA arrangements at the time of job change.\69\
As a result of changes like these, leakage from the retirement
system at the time of job change has been declining modestly over
time--although leakage is certainly an issue worthy of additional
attention.\70\ Participants, particularly those at or near retirement,
are generally quite responsible in handling the distributions they take
from their plans when they leave a company, with the vast majority
leaving their money in the plan, taking partial withdrawals,
annuitizing the balance or reinvesting their lump sum
distributions.\71\ In sum, policymakers should acknowledge the careful
balance between liquidity and preservation of assets and should be wary
of proposals that would provide additional ways to tap into retirement
savings early.
Defined Contribution Plan Savings is an Important Source of Investment
Capital
The amounts held in defined contribution plans have an economic
impact that extends well beyond the retirement security of the
individual workers who save in these plans. Retirement plans held
approximately $16.9 trillion in assets as of June 30, 2008.\72\ As
noted earlier, amounts in defined contribution plans accounted for
approximately $4.3 trillion of this amount, and amounts in IRAs
represented approximately $4.5 trillion (much of which is attributable
to rollovers from employer-sponsored plans, including defined
contribution plans).\73\ Indeed, defined contribution plans and IRAs
hold nearly 20% of corporate equities.\74\ These trillions of dollars
in assets, representing ownership of a significant share of the total
pool of stocks and bonds, provide an important and ready source of
investment capital for American businesses. This capital permits
greater production of goods and services and makes possible additional
productivity-enhancing investments. These investments thereby help
companies grow, add jobs to their payrolls and raise employee wages.
Inquiries About Risk Are Appropriate But No Retirement Plan Design is
Immune from Risk
The recent market downturn has generated reasonable inquiries about
whether participants in defined contribution plans may be subject to
undue investment risk. As noted above, the American Benefits Council
favors development of policy proposals and market innovations that seek
to address these concerns. Yet it is difficult to imagine any
retirement plan design that does not have some kind or degree of risk.
Defined benefit pensions, for example, are extremely valuable
retirement plans that serve millions of Americans. However, employees
may not stay with a firm long enough to accrue a meaningful benefit,
benefits are often not portable, required contributions can impose
financial burdens on employers that can constrain pay levels or job
growth, and companies on occasion enter bankruptcy (in which case not
all benefits may be guaranteed).
Some have suggested that a new federal governmental retirement
system would be the best way to protect workers against risk. Certain
of these proposals would promise governmentally guaranteed investment
returns, which would entail a massive expansion of government and
taxpayer liabilities at a time of already unprecedented federal budget
deficits. Other proposals would establish governmental clearinghouses
or agencies to oversee retirement plan investments and administration.
Such approaches would likewise have significant costs to taxpayers and
would unnecessarily and unwisely displace the activities of the private
sector. Under these approaches, the federal government also would
typically regulate the investment style and fee levels of retirement
plan investments. These invasive proposals would constrain the
investment choices and flexibility that defined contribution plan
participants enjoy today and would establish the federal government as
an unprecedented rate-setter for many retirement investments.
Rather than focusing on new governmental guarantees or systems, any
efforts to mitigate risk should instead focus on refinements to the
existing successful employer-sponsored retirement plan system and
shoring up the Social Security safety net.
The Strong Defined Contribution System Can Still Be Improved
While today's defined contribution plan system is proving
remarkably successful at assisting workers in achieving retirement
security, refinements and improvements to the system can certainly be
made. Helping workers to manage market risk and to translate their
defined contribution plan savings into retirement income are areas that
would benefit from additional policy deliberations. An additional area
in which reform would be particularly constructive is increasing the
number of Americans who have access to a defined contribution or other
workplace retirement plan. The American Benefits Council will soon
issue a set of policy recommendations as to how this goal of expanded
coverage can be achieved. We believe coverage can best be expanded
through adoption of a multi-faceted set of reforms that will build on
the successful employer-sponsored retirement system and encourage more
employers to facilitate workplace savings by their employees. This
multi-faceted agenda will include improvements to the current rules
governing defined contribution and defined benefit plans, expansion of
default systems such as automatic enrollment and automatic escalation,
new simplified retirement plan designs, expanded retirement tax
incentives for individuals and employers, greater use of workplace IRA
arrangements (such as SIMPLE IRAs and discretionary payroll deduction
IRAs), more effective promotion of existing retirement plan options,
and efforts to enhance Americans' financial literacy.
endnotes
\1\ Peter Brady & Sarah Holden, The U.S. Retirement Market, Second
Quarter 2008, INVESTMENT COMPANY INST. FUNDAMENTALS 17, no. 3-Q2, Dec.
2008. This paper reveals that, as of June 30, 2008, total U.S.
retirement accumulations were $16.9 trillion, a 13.4% increase over
2005 and a 59.4% increase over 2002. As noted above, these asset
figures have decreased in light of recent market declines although
assets held in defined contribution plans and individual retirement
accounts still make up more than half of total U.S. retirement assets.
See Brian Reid & Sarah Holden, Retirement Saving in Wake of Financial
Market Volatility, INVESTMENT COMPANY INST., Dec. 2008.
\2\ 2007 Account Balances: Tabulations from EBRI/ICI Participant-
Directed Retirement Plan Data Collection Project; 2008 Account
Balances: Estimates from Jack VanDerhei, EBRI.
\3\ Press Release, Fidelity Investments, Fidelity Reports on 2008
Trends in 401(k) Plans (Jan. 28, 2009).
\4\ 1999 and 2006 Account Balances: Tabulations from EBRI/ICI
Participant-Directed Retirement Plan Data Collection Project; 2007 and
2008 Account Balances: Estimates from Jack VanDerhei, EBRI. The
analysis is based on a consistent sample of 2.2 million participants
with account balances at the end of each year from 1999 through 2006
and compares account balances on January 1, 2000 and November 26, 2008.
See also Jack VanDerhei, Research Director, Employee Benefit Research
Institute, What Is Left of Our Retirement Assets?, PowerPoint
Presentation at Urban Institute (Feb. 3, 2009).
\5\ According to the Department of Labor, there were 103,346
defined benefit plans and 207,748 defined contribution plans in 1975.
In 2005, there were 47,614 defined benefit plans and 631,481 defined
contribution plans. U.S. Department of Labor, Employee Benefits
Security Administration, Private Pension Plan Bulletin Historical
Tables (Feb. 2008). See also Sarah Holden, Peter Brady, & Michael
Hadley, 401(k) Plans: A 25-Year Retrospective, INVESTMENT COMPANY INST.
PERSPECTIVE 12, no. 2, Nov. 2006.
\6\ A joint ICI and EBRI study projected that 401(k) participants
in their late 20s in 2000 who are continuously employed, continuously
covered by a 401(k) plan, and earned historical financial market
returns could replace significant amounts of their pre-retirement
income (103% for the top income quartile; 85% for the lowest income
quartile) with their 401(k) accumulations at retirement. Sarah Holden &
Jack VanDerhei, Can 401(k) Accumulations Generate Significant Income
for Future Retirees?, INVESTMENT COMPANY INST. PERSPECTIVE 8, no. 3,
Nov. 2002.
\7\ Report on Retirement Plans--2007, Diversified Investment
Advisors (Nov. 2007).
\8\ 401(k) Benchmarking Survey--2008 Edition, Deloitte Consulting
LLP (2008).
\9\ In an October 2008 survey, only 2% of employers reported having
reduced their 401(k)/403(b) matching contribution and only 4% said they
planned to do so in the upcoming 12 months. WATSON WYATT WORLDWIDE,
EFFECT OF THE ECONOMIC CRISIS ON HR PROGRAMS 4 (2008).
\10\ According to one study, defined contribution plans with
matching contributions have a participation rate of 73% compared with
44% for plans that do not offer matching contributions. Retirement Plan
Trends in Today's Healthcare Market--2008, American Hospital
Association & Diversified Investment Advisors (2008). Some have
wondered whether employers would reduce matching contributions as they
adopt automatic enrollment since automatic enrollment is proving
successful in raising participation rates. Current data suggest this is
not occurring. For example, from 2005 to 2007 the number of Vanguard
plans offering automatic enrollment tripled. During the same period,
the percentage of Vanguard plans offering employer matching
contributions increased by 4%. How America Saves 2008: A Report on
Vanguard 2007 Defined Contribution Plan Data, The Vanguard Group, Inc.
(2008); How America Saves 2006: A Report on Vanguard 2005 Defined
Contribution Plan Data, The Vanguard Group, Inc. (2006).
\11\ W. Scott Simon, Fiduciary Focus, Morningstar Advisor, Apr. 5,
2007.
\12\ Brady & Holden (Dec. 2008), supra note 1.
\13\ Brady & Holden (Dec. 2008), supra note 1.
\14\ Gregory T. Long, Executive Dir., Fed. Ret. Thrift Inv. Fund,
Statement Before the House Subcommittee on Federal Workforce, Postal
Service, and the District of Columbia (July 10, 2008).
\15\ The average 401(k) account balance increased at an annual rate
of 8.7% from 1999 to 2006, despite the fact that this period included
one of the worst bear markets since the Great Depression. Sarah Holden,
Jack VanDerhei, Luis Alonso, & Craig Copeland, 401(k) Plan Asset
Allocation, Account Balances, and Loan Activity in 2006, INVESTMENT
COMPANY INST. PERSPECTIVE 13, no. 1/EMPLOYEE BENEFIT RESEARCH INST.
ISSUE BRIEF, no. 308, Aug. 2007.
\16\ Jilian Mincer, 401(k) Plans Face Disparity Issue, WALL ST. J.,
Nov. 6, 2008, at D9.
\17\ Fidelity Investments (Jan. 28, 2009), supra note 3. See also
Reid & Holden (Dec. 2008), supra note 1 (noting that only 3% of defined
contribution plan participants ceased contributions in 2008); The
Principal Financial Well-Being Index Summary--Fourth Quarter 2008,
Principal Financial Group (2008) (finding that, in the six months
leading up to its October 2008 survey, 11% of employees increased
401(k) contributions, while only 4% decreased contributions and only 1%
ceased contributions entirely); Retirement Outlook and Policy
Priorities, Transamerica Center for Retirement Studies (Oct. 2008)
(finding that participation rates are holding steady among full-time
workers who have access to a 401(k) or similar employer-sponsored plan,
with 77% currently participating; 31% of participants have increased
their contribution rates into their retirement plans in the last twelve
months; only 11% have decreased their contribution rates or stopped
contributing); Press Release, Hewitt Associates, Hewitt Data Shows
Americans Continue to Save in 401(k) Plans Despite Economic Woes (Nov.
24, 2008) (finding, in a November analysis, that average savings rates
in 401(k) plans have only dipped by 0.2%, from 8.0% in 2007 to 7.8% in
2008).
\18\ See Sarah Holden & Jack VanDerhei, Contribution Behavior of
401(k) Plan Participants During Bull and Bear Markets, NAT'L TAX ASS'N
44 (2004) (citing a number of studies which indicate little variation
in before-tax contributions and a slight decrease in employer
contributions as a percentage of participant pay during the 1999-2002
bear market).
\19\ Principal Financial Group (2008), supra note 17.
\20\ Id.
\21\ Private Pension Plan Bulletin Historical Tables (Feb. 2008),
supra note 5.
\22\ In 2007, 82% of employers with 500 or more employees offered
401(k) plans to their employees, and 19% of these employers offered a
defined contribution plan other than a 401(k) plan to their employees.
9th Annual Retirement Survey, Transamerica Center for Retirement
Studies (2008).
\23\ 59% of employers with between 10 and 499 employees offered
their employees 401(k) plans in 2007, as compared with 56% in 2006.
Transamerica Center for Retirement Studies (2008), supra note 22; 8th
Annual Retirement Survey, Transamerica Center for Retirement Studies
(2007).
\24\ U.S. DEP'T OF LABOR & U.S. BUREAU OF LABOR STATISTICS, BULL.
NO. 2715, NATIONAL COMPENSATION SURVEY: EMPLOYEE BENEFITS IN THE UNITED
STATES, MARCH 2008, tbl. 2 (Sept. 2008).
\25\ As of December 2007, there were more than 500,000 SIMPLE IRAs.
At the end of 2007, $61 billion was held in SIMPLE IRAs. See Brady &
Holden (Dec. 2008), supra note 1; Peter Brady & Stephen Sigrist, Who
Gets Retirement Plans and Why, INVESTMENT COMPANY INST. PERSPECTIVE 14,
no. 2, Sept. 2008.
\26\ Brady & Sigrist (Sept. 2008), supra note 25. See also U.S.
DEP'T OF LABOR & U.S. BUREAU OF LABOR STATISTICS, BULL. NO. 2589,
NATIONAL COMPENSATION SURVEY: EMPLOYEE BENEFITS IN PRIVATE INDUSTRY IN
THE UNITED STATES, 2005 (May 2007) (indicating 8% of private-sector
workers at eligible small businesses participated in a SIMPLE IRA).
\27\ Among all full-time, full-year wage and salary workers ages 21
to 64, 55.3% participated in a retirement plan in 2007. This is up from
approximately 53% in 2006. Craig Copeland, Employment-Based Retirement
Plan Participation: Geographic Differences and Trends, 2007, EMPLOYEE
BENEFIT RESEARCH INST. ISSUE BRIEF, no. 322, Oct. 2008 (examining the
U.S. Census Bureau's March 2008 Current Population Survey). See also
The Vanguard Group, Inc. (2008), supra note 10 (noting that, out of all
employees in Vanguard-administered plans, 66% of eligible employees
participated in their employer's defined contribution plan); 51st
Annual Survey of Profit Sharing and 401(k) Plans, Profit Sharing/401(k)
Council of America (Sept. 2008) (noting that 81.9% of eligible
employees currently have a balance in their 401(k) plans).
\28\ Participants in plans administered by Vanguard saved 7.3% of
income in their employer's defined contribution plan in 2007. The
Vanguard Group, Inc. (2008), supra note 10. Among non-highly
compensated employees, the level of pre-tax deferrals into 401(k) plans
has risen from 4.2% of salary in 1991 to 5.6% in 2007. Profit Sharing/
401(k) Council of America (Sept. 2008), supra note 27.
\29\ See Transamerica Center for Retirement Studies (Oct. 2008),
supra note 17 (finding that 35% of Echo Boomers, 34% of Generation X,
28% of Baby Boomers, and 7% of Matures consider employer-sponsored
defined contribution plans as their primary source of retirement
income).
\30\ Jack VanDerhei, Findings from the 2003 Small Employer
Retirement Survey, EMPLOYEE BENEFIT RESEARCH INST. ISSUE NOTES 24, no.
9, Sept. 2003.
\31\ Both small employers and workers in small businesses consider
salary to be a greater priority than retirement benefits, but the
inverse is true for the majority of larger employers and workers in
larger businesses. See Transamerica Center for Retirement Studies
(2008), supra note 22 (finding that 56% of employees in larger
businesses consider retirement benefits to be a greater priority, where
54% of employees in smaller companies rank salary as a priority over
retirement benefits). See also Brady & Sigrist (Sept. 2008), supra note
25.
\32\ For example, one survey found that more than half of small
business respondents would be ``much more likely'' to consider offering
a retirement plan if company profits increased. VanDerhei (Sept. 2003),
supra note 30. See also Transamerica Center for Retirement Studies
(2008), supra note 22 (finding that large companies are more likely
than smaller companies to offer 401(k) plans (82% large, 59% small)).
\33\ It should also be remembered that those without employer plan
coverage may be building retirement savings through non-workplace tax-
preferred vehicles such as individual retirement accounts or deferred
annuities.
\34\ See Brady & Sigrist (Sept. 2008), supra note 25.
\35\ Based on an analysis of the Bureau of Labor Statistics'
Current Population Survey, March Supplement (2007), of those most
likely to want to save for retirement in a given year, almost 75% had
access to a retirement plan through their employer or their spouse's
employer, and 92% of those with access participated. Brady & Sigrist
(Sept. 2008), supra note 25.
\36\ Voluntary pre-tax and Roth after-tax contributions must
satisfy the Actual Deferral Percentage test (``ADP test''). The ADP
test compares the elective contributions made by highly compensated
employees and non-highly compensated employees. Each eligible
employee's elective contributions are expressed as a percentage of his
or her compensation. The numbers are then averaged for (i) all eligible
highly compensated employees, and (ii) all other eligible employees
(each resulting in a number, an ``average ADP''). The ADP test is
satisfied if (i) the average ADP for the eligible highly compensated
employees for a plan year is no greater than 125% of the average ADP
for all other eligible employees in the preceding plan year, or (ii)
the average ADP for the eligible highly compensated employees for a
plan year does not exceed the average ADP for the other eligible
employees in the preceding plan year by more than 2% and the average
ADP for the eligible highly compensated employees for a plan year is
not more than twice the average ADP for all other eligible employees in
the preceding plan year. Treas. Reg. Sec. 1.401(k)-2. Employer
matching contributions and employee after-tax contributions (other than
Roth contributions) must satisfy the Actual Contribution Percentage
test (``ACP test''). The ACP test compares the employee and matching
contributions made by highly compensated employees and non-highly
compensated employees. Each eligible employee's elective and matching
contributions are expressed as a percentage of his or her compensation,
and the resulting numbers are averaged for (i) all eligible highly
compensated employees, and (ii) all other eligible employees (each
resulting in a number, an ``average ACP''). The ACP test utilizes the
same percentage testing criteria as the ADP test. Treas. Reg. Sec.
1.401(m)-2.
\37\ A trust shall not constitute a qualified trust under 401(a)
unless the plan of which such trust is a part satisfies the
requirements of section 411 (relating to minimum vesting standards).
See I.R.C. Sec. 401(a)(7).
\38\ See I.R.C. Sec. Sec. 401(k)(12) and (13).
\39\ ERISA Sec. 404. I.R.C. Sec. 401(a) also requires that a
qualified trust be organized for the exclusive benefit of employees and
their beneficiaries.
\40\ Sarah Holden & Michael Hadley, The Economics of Providing
401(k) Plans: Services, Fees, and Expenses, 2007, INVESTMENT COMPANY
INST. PERSPECTIVE 17, no. 5, Dec. 2008.
\41\ See Transamerica Center for Retirement Studies (2008), supra
note 22 (finding that, regardless of company size, almost two-thirds of
employers offer investment guidance or advice as part of their
retirement plan; of those who do not currently offer guidance or
advice, 18% of large employers and 7% of small employers plan to offer
advice in the future); Deloitte Consulting LLP (2008), supra note 8
(51% of 401(k) sponsors surveyed offer employees access to
individualized financial counseling or investment advice services
(whether paid for by employees or by the employer)); Trends and
Experience in 401(k) Plans 2007--Survey Highlights, Hewitt Associates
LLC (June 2008) (40% of employers offer outside investment advisory
services to employees).
\42\ Profit Sharing/401(k) Council of America (Sept. 2008), supra
note 27.
\43\ 46% of plan participants consulted materials, tools, or
services provided by their employers. John Sabelhaus, Michael Bogdan, &
Sarah Holden, Defined Contribution Plan Distribution Choices at
Retirement: A Survey of Employees Retiring Between 2002 and 2007,
INVESTMENT COMPANY INST. RESEARCH SERIES, Fall 2008.
\44\ See, e.g., Measuring the Effectiveness of Automatic
Enrollment, Vanguard Center for Retirement Research (Dec. 2007)
(stating that ``[a]n analysis of about 50 plans adopting automatic
enrollment confirms that the feature does improve participation rates,
particularly among low-income and younger employees''); Deloitte
Consulting LLP (2008), supra note 8 (stating that ``[a] full 82% of
survey respondents reported that auto-enrollment had increased
participation rates''); Building Futures Volume VIII: A Report on
Corporate Defined Contribution Plans, Fidelity Investments (2007)
(stating that in 2006 overall participation rates were 28% higher for
automatic enrollment-eligible employees than for eligible employees in
plans that did not offer automatic enrollment; overall, automatic
enrollment eligible employees had an average participation rate of
81%).
\45\ A recently-surveyed panel of experts expects automatic
enrollment to be offered in 73% of defined contribution plans by 2013.
Prescience 2013: Expert Opinions on the Future of Retirement Plans,
Diversified Investment Advisors (Nov. 2008).
\46\ See The Vanguard Group, Inc. (2008), supra note 10.
\47\ See Deloitte Consulting LLP (2008), supra note 8 (42% of
surveyed employers have an automatic enrollment feature compared with
23% in last survey); Hewitt Associates LLC (June 2008), supra note 41
(34% of surveyed employers have an automatic enrollment feature
compared with 19% in 2005); Profit Sharing/401(k) Council of America
(Sept. 2008), supra note 27 (more than half of large plans use
automatic enrollment and usage by small plans has doubled).
\48\ See Deloitte Consulting LLP (2008), supra note 8 (stating that
26% of respondents reported they are considering adding an auto-
enrollment feature).
\49\ One leading provider has noted an upward shift since 2005 in
the percentage of sponsors that use a default deferral rate of 3% or
higher, and a corresponding decrease in the percentage of sponsors that
use a default deferral rate of 1% or 2%. The Vanguard Group, Inc.
(2008), supra note 10.
\50\ See, e.g., Copeland (Oct. 2008), supra note 27 (noting that
Hispanic workers were significantly less likely than both black and
white workers to participate in a retirement plan); Jack VanDerhei &
Craig Copeland, The Impact of PPA on Retirement Savings for 401(k)
Participants, EMPLOYEE BENEFIT RESEARCH INST. ISSUE BRIEF, no. 318
(June 2008) (noting that industry studies have shown relatively low
participation rates among young and low-income workers); Fidelity
Investments (2007), supra note 44 (stating that, in 2006, among
employees earning less than $20,000, the participation boost from
automatic enrollment was approximately 50%); U.S. GOV'T ACCOUNTABILITY
OFFICE, GAO-08-8, PRIVATE PENSIONS: LOW DEFINED CONTRIBUTION PLAN
SAVINGS MAY POSE CHALLENGES TO RETIREMENT SECURITY, ESPECIALLY FOR MANY
LOW-INCOME WORKERS (Nov. 2007); Daniel Sorid, Employers Discover a
Troubling Racial Split in 401(k) Plans, WASH. POST, Oct. 14, 2007, at
F6.
\51\ See Fidelity Investments (2007), supra note 44 (noting that,
in 2006, the average deferral rate for participants in automatic
escalation programs was 8.3%, as compared to 7.1% in 2005).
\52\ See The Vanguard Group, Inc. (2008), supra note 10 (post-PPA,
two-thirds of Vanguard's automatic enrollment plans implemented
automatic annual savings increases, compared with one-third of its
plans in 2005); Hewitt Associates LLC (June 2008), supra note 41 (35%
of employers offer automatic contribution escalation, compared with 9%
of employers in 2005); Transamerica Center for Retirement Studies
(2008), supra note 22 (26% of employers with automatic enrollment
automatically increase the contribution rate based on their employees'
anniversary date of hire).
\53\ A leading provider states that ``QDIA investments are often
more broadly diversified than portfolios constructed by participants.
Increased reliance on QDIA investments should enhance portfolio
diversification.'' The Vanguard Group, Inc. (2008), supra note 10. See
also Fidelity Investments (2007), supra note 44 (where a lifecycle fund
was the plan default option, overall participant asset allocation to
that option was 19.4% in 2006; where the lifecycle fund was offered but
not as the default option, overall participant asset allocation to that
option was only 9.8%).
\54\ Selection of Annuity Providers: Safe Harbor for Individual
Account Plans, 73 Fed. Reg. 58,447 (Oct. 7, 2008) (to be codified at 29
C.F.R. pt. 2550).
\55\ See Holden & Hadley (Dec. 2008), supra note 40.
\56\ One survey found that 92% of companies surveyed stated that
their plan is intended to comply with ERISA section 404(c). Deloitte
Consulting LLP (2008), supra note 8.
\57\ In 2006, the percentage of single investment option holders
who invested in lifecycle funds--``blended'' investment options--was
24%. 42% of plan participants invested some portion of their assets in
lifecycle funds. The average number of investment options held by
participants was 3.8 options in 2006. Fidelity Investments (2007),
supra note 44.
\58\ In 2007, 77% of employers offered lifecycle funds as an
investment option, compared with 63% in 2005. Hewitt Associates LLC
(June 2008), supra note 41. See also Fidelity Investments (2007), supra
note 44 (noting that, in 2006, 19% of participant assets were invested
in a lifecycle fund in plans that offered the lifecycle fund as the
default investment option, compared with 10% of participant assets in
plans that did not offer the lifecycle fund as the default investment
option).
\59\ See Target-Date Funds: Still the Right Rationale for
Investors, The Vanguard Group, Inc. (Nov. 28, 2008) (noting that ``even
investors entering and in retirement need a significant equity
allocation'' and citing the 17- to 20-year life expectancy for retirees
who are age 65). See also Fidelity Investments (2007), supra note 44
(``In general * * * the average percentage of assets invested in
equities decreased appropriately with age * * * to a low of 45% for
those in their 70s.'').
\60\ I.R.C. Sec. 401(a)(35); ERISA Sec. 204(j).
\61\ Hewitt Associates LLC (June 2008), supra note 41.
\62\ Hewitt Associates LLC (June 2008), supra note 41.
\63\ Holden, VanDerhei, Alonso, & Copeland (Aug. 2007), supra note
15. See also Fidelity Investments (Jan. 28, 2009), supra note 3 (noting
that, at year-end 2008, company stock made up approximately 10% of
Fidelity's overall assets in workplace savings accounts, compared with
20% in early 2000).
\64\ Holden, VanDerhei, Alonso, & Copeland (Aug. 2007), supra note
15. See also William J. Wiatrowski, 401(k) Plans Move Away from
Employer Stock as an Investment Vehicle, MONTHLY LAB. REV., Nov. 2008,
at 3, 6 (stating that (i) in 2005, 23% of 401(k) participants permitted
to choose their investments could pick company stock as an investment
option for their employee contributions, compared to 63% in 1985, and
(ii) in 2005, 14% of 401(k) participants permitted to choose their
investments could pick company stock as an investment option for
employer matching contributions, compared to 29% in 1985).
\65\ See U.S. GOV'T ACCOUNTABILITY OFFICE, GAO/HEHS-98-2, 401(K)
PENSION PLANS: LOAN PROVISIONS ENHANCE PARTICIPATION BUT MAY AFFECT
INCOME SECURITY FOR SOME (Oct. 1997) (noting that plans that allow
borrowing tend to have a somewhat higher proportion of employees
participating than other plans).
\66\ See I.R.C. Sec. Sec. 72(p) and 401(k)(2)(B).
\67\ See, e.g., Reid & Holden (Dec. 2008), supra note 1 (stating
that, in 2008, 1.2% of defined contribution plan participants took a
hardship withdrawal and 15% had a loan outstanding); Fidelity
Investments (Jan. 28, 2009), supra note 3 (noting that only 2.2% of its
participant base initiated a loan during the fourth quarter of 2008,
compared with 2.8% during the fourth quarter of 2007, and 0.7% of its
participant base took a hardship distribution during the fourth quarter
of 2008, compared with 0.6% during the fourth quarter of 2007); Holden,
VanDerhei, Alonso, & Copeland (Aug. 2007), supra note 15 (noting that
most eligible participants do not take loans); Fidelity Investments
(2007), supra note 44 (noting that only 20% of active participants had
one or more loans outstanding at the end of 2006). Most participants
who take loans repay them. See Transamerica Center for Retirement
Studies (2008), supra note 22 (only 18% of participants have loans
outstanding, and almost all participants repay their loans).
\68\ I.R.C. Sec. 72(t).
\69\ See I.R.C. Sec. 402(c)(4). 70 In 2007, among participants
eligible for a distribution due to a separation of service, 70% chose
to preserve their retirement savings by rolling assets to an IRA or by
remaining in their former employer's plan, compared with only 60% in
2001. The Vanguard Group, Inc. (2008), supra note 10; How America Saves
2002: A Report on Vanguard Defined Contribution Plans, The Vanguard
Group, Inc. (2002).
\71\ See Sabelhaus, Bogdan, & Holden (Fall 2008), supra note 43
(stating that retirees make prudent choices at retirement regarding
their defined contribution plan balances: 18% annuitized their entire
balance, 6% elected to receive installment payments, 16% deferred
distribution of their entire balance, 34% took a lump sum and
reinvested the entire amount, 11% took a lump sum and reinvested part
of the amount, 7% took a lump sum and spent all of the amount, and 9%
elected multiple dispositions; additionally, only about 3% of
accumulated defined contribution account assets were spent immediately
at retirement).
\72\ Brady & Holden (Dec. 2008), supra note 1.
\73\ Id. It is highly doubtful that Americans would have saved at
these levels in the absence of defined contribution plans given the
powerful combination of pre-tax treatment, payroll deduction, automatic
enrollment and matching contributions.
\74\ See BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, FEDERAL
RESERVE STATISTICAL RELEASE Z.1, FLOW OF FUNDS ACCOUNTS OF THE UNITED
STATES (December 11, 2008); Brady & Holden (Dec. 2008), supra note 1.
______
------
[Questions for the record sent:]
U.S. Congress,
[Via Email],
Washington, DC, February 26, 2009.
Mr. Jack Bogle, Founder,
Vanguard Group, Malvern, PA.
Dear Mr. Bogle: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
One of our Committee Members had additional questions for which he
would like written responses from you for the hearing record.
Congressman Scott asks the following questions:
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
U.S. Congress,
[Via Email],
Washington, DC, February 26, 2009.
Dr. Dean Baker, Co-Director,
Center for Economic and Policy Research, Washington, DC.
Dear Dr. Baker: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
One of our Committee Members had additional questions for which he
would like written responses from you for the hearing record.
Congressman Scott asks the following questions:
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
U.S. Congress,
[Via Email],
Washington, DC, February 26, 2009.
Dr. Alicia H. Munnell, Director,
Center for Retirement Research at Boston College, Chestnut Hill, MA.
Dear Dr. Munnell: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
One of our Committee Members had additional questions for which he
would like written responses from you for the hearing record.
Congressman Scott asks the following questions:
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
U.S. Congress,
[Via Email],
Washington, DC, February 26, 2009.
Mr. Paul Schott Stevens, President and CEO,
Investment Company Institute, Washington, DC.
Dear Mr. Stevens: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
One of our Committee Members had additional questions for which he
would like written responses from you for the hearing record.
Congressman Scott asks the following questions:
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
U.S. Congress,
[Via Email],
Washington, DC, March 3, 2009.
Mr. Jack Bogle, Founder,
Vanguard Group, Malvern, PA.
Dear Mr. Bogle: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
Two Republican Committee members, Senior Ranking Member McKeon and
Congresswoman McMorris Rodgers, have additional submitted questions for
which they would like written responses from you for the hearing
record.
Senior Republican Member McKeon asks the following question:
1. You testified before the Committee regarding the trading costs
of mutual funds. As we heard at the hearing, approximately half of
401(k) assets are invested in mutual funds. The remainder is invested
in other products, such as separately managed accounts, commingled
trusts, insurance contracts, and exchange-traded funds. Given that
research has demonstrated that a significant driver of trading costs is
the cost of buying and selling securities to accommodate investor
contributions and withdrawals, do not these investments incur the same
types of trading costs as those incurred by mutual funds? Are you able
to provide the Committee with data regarding the trading costs of these
other investments?
Congresswoman McMorris Rodgers asks the following questions:
1. On page 15 of your testimony you outline a new defined
contribution retirement system. Tell me if we had this system in place
five years ago could such a board know about the home mortgage
collapse? If we were discussing the safety of mortgage backed
securities five years ago would you have testified that they are a high
risk or low risk
investment? Would it not follow that there are real risks even for
what may be considered today to be a conservative investment?
2. On page 15 of your testimony you state ``For those who have the
financial ability to save for retirement, there would be a single DC
structure, dominated * * *'' What about those who are unable to save
for retirement?
3. Are you proposing that 401(k)s, IRAs, the government TSP
program, and any retirement saving plans with tax incentives be
abolished for this single Federal retirement system under this Federal
Retirement Board?
4. If one can save for retirement, would the only way to do so that
would get tax benefit would be through this new Federal Retirement
System under the proposal you are advocating?
5. It seems that you are making the argument that since some people
can make the wrong investment decisions for retirement that no one
should be able to have a real control over how their money should be
invested in the future. Is that correct?
6. You propose a Federal Retirement Board; I would imagine that
such a board would have control over trillions of dollars for
investment. What could be done to ensure that these savings would not
be invested to further any political agenda and only ensure a decent
return for the potential retiree?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
U.S. Congress,
[Via Email],
Washington, DC, March 3, 2009.
Dr. Dean Baker, Co-Director,
Center for Economic and Policy Research, Washington, DC.
Dear Dr. Baker: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
Republican Committee member, Congresswoman McMorris Rodgers, has
submitted a question for which she would like a written response from
you for the hearing record.
Congresswoman McMorris Rodgers asks the following question:
1. On page five of your testimony you describe your proposal
modeled on the Thrift Savings Plan as voluntary and on page six give
examples of the benefits that can be received. Dr. Munnell's testimony
describes how low the balances of 401(k)s are today for folks near
retirement. Tell me how many people making the $30,000 you give in your
example do you believe will volunteer to have contributions taken out
of their paychecks even if the government could afford a small match to
the contribution?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
U.S. Congress,
[Via Email],
Washington, DC, March 3, 2009.
Dr. Alicia H. Munnell, Director,
Center for Retirement Research at Boston College, Chestnut Hill, MA.
Dear Dr. Munnell: Thank you for testifying at the Tuesday, February
24, 2009, Committee on Education and Labor hearing on ``Strengthening
Worker Retirement Security.''
Republican Committee Member, Congresswoman McMorris Rodgers, has
submitted questions for which she would like written responses from you
for the hearing record.
Congresswoman McMorris Rodgers asks the following questions:
1. On page four of your testimony you advocate for an additional
tier of retirement savings to support 20 percent of a retiree's income.
You suggest that this be modeled after the Thrift Savings Plan (TSP)
that all federal workers, all Members of Congress and their staff are
in. Furthermore you state ``participation should be mandatory;
participants should have no access to [the] money before retirement.''
Could you tell the Committee where the money would come for these new
accounts? Does the government fund it or does the individual make
contributions?
2. If it is the individual who makes the contributions, can you
tell me where they are supposed to come up with this extra money? In
2006, the average per capita income in Washington State was $38,067.
Please tell the Committee how much you believe should someone in
Washington State making $38,067 be required to contribute?
3. Or if it is the government, do you have any estimates for how
much this will cost the taxpayer? What are your recommendations for
Congress for where we should raise this funding?
4. You advocate for a mandatory TSP program for all. Now I can tell
you that my TSP account has taken a similar hit in the last year along
the lines of what you describe for 401(k)s. If we could go back in time
and make your proposal law how would we be any better off today, other
than folks having less money in their paychecks for these mandatory
contributions? If yes, please quantify how much more money a
contributor would have in an account invested in a Vanguard 401(k) S&P
500 fund and the government's S&P 500 ``C'' fund?
Please send your written response to the Committee on Education and
Labor by COB on Tuesday, March 10, 2009--the date on which the hearing
record will close. If you have any questions, please contact the
committe. Once again, we greatly appreciate your testimony at this
hearing.
Sincerely,
George Miller, Chairman.
______
[Responses to questions submitted follow:]
Mr. Baker's Responses to Questions for the Record
Follow-up Questions from Congressman Robert C. ``Bobby'' Scott
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
There will be some change in the timing of tax receipts as a result
of the accumulations in these accounts. The government is collecting
somewhat less in revenue than would otherwise be the case at present
because workers have the opportunity to shelter a portion of their
income in these accounts.
However, this is being reversed as the baby boom cohort is reaching
ages at which they can withdraw funds from these accounts. This effect
is not likely to be very large, primarily because the accumulations in
these accounts has fallen sharply due to the recent decline in the
stock market. It is unlikely that the withdrawals even in the years
where the peak effects of the baby boomers' retirement is being felt
(2020-2035)will have very much impact on the overall budget. Of course,
the net effect will depend on the extent of new tax exempt
contributions. Insofar as policy encourages more retirement savings in
future decades, then we will feel even less of a boost from the baby
boomers drawing down of their accounts and paying taxes on their
accumulations.
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
Retirees would obviously benefit from not having their withdrawals
subject to tax. If this policy was made as a trade-off for paying
capital gains on investments while they were tax sheltered, then savers
would presumably opt for investments that paid interest or dividends
rather than capital gains. This would allow their accumulations to
increase during their working lifetimes without being taxed, and then
allow them to withdraw their money tax free in retirement. I assume
that this is not the intention of this switch, but it can be assumed
that many savers will try to game any changes in order to get the most
benefit from it.
______
Mr. Bogle's Responses to Questions for the Record
From Senior Republican Member Howard P. ``Buck'' McKeon
1. You testified before the Committee regarding the trading costs
of mutual funds. As we heard at the hearing, approximately half of
401(k) assets are invested in mutual funds. The remainder is invested
in other products, such as separately managed accounts, commingled
trusts, insurance contracts, and exchange-traded funds. Given that
research has demonstrated that a significant driver of trading costs is
the cost of buying and selling securities to accommodate investor
contributions and withdrawals, do not these investments incur the same
types of trading costs as those incurred by mutual funds? Are you able
to provide the Committee with data regarding the trading costs of these
other investments?
You are correct that approximately half of 401(k) assets are held
in investment products other than mutual funds. While data on these
other products are more difficult to find, it would be shocking to find
that their turnover rates are materially different than the rates
reported by actively managed mutual funds, primarily because many, if
not most, asset managers manage these other accounts as well.
Morningstar data, for instance, show that the average actively managed
equity insurance fund has a turnover rate of 83 percent--not far from
the 96 percent rate of the average actively managed equity mutual fund.
(Unsurprisingly, because they are index funds, the average exchange-
traded fund has a much lower turnover rate of 37 percent.)
I also agree that some portion of portfolio transactions (in all
investment products) is attributable to contributions and withdrawals
from investors. However, the record is crystal-clear that this activity
plays only a minor role in the staggering degree of portfolio turnover
we see today.
Examining net cash flow to equity funds and common stock purchases
by equity funds provides a crude if revealing estimate of just how much
of this activity is attributable to investor cash flow. In 1991, net
cash flow to equity funds of $40 billion accounted for only 9 percent
of common stock purchases of $224 billion. By 2007, that share had
fallen to 2.6 percent, as net cash flow of $93 billion was dwarfed by
$3.6 trillion of stock purchases by equity funds. Just last year, stock
purchases and sales by equity funds totaled $6.9 trillion, compared to
average equity fund assets of $5.1 trillion.
The simple fact is that portfolio turnover has risen dramatically.
In my first twenty years in this business, annual turnover averaged 21
percent; in the last twenty years, it has averaged 91 percent. As I
wrote in my statement, the problem with this stunning rise lies in this
mathematical reality: investors as a group earn the market's return,
minus the expenses they incur. Thus, mutual funds trading stocks back
and forth with one another at a furious rate, incurring transaction
costs, does two things: 1) it reduces, by definition, the returns of
investors as a group; 2) it enriches the intermediaries who earn
commissions on each sale and purchase, expenses that detract, dollar
for dollar, from the returns earned by mutual fund investors.
From Congresswoman Cathy McMorris Rodgers
1. On page 15 of your testimony you outline a new defined
contribution retirement system. Tell me if we had this system in place
five years ago could such a board know about the home mortgage
collapse? If we were discussing the safety of mortgage backed
securities five years ago would you have testified that they are a high
risk or low risk investment? Would it not follow that there are real
risks even for what may be considered today to be a conservative
investment?
The purpose of the Federal Retirement Board I described would not
to be to predict what will happen in our financial markets and our
economy, were that even possible. Nor would it be to protect plan
participants from the inevitable bear markets they will encounter.
Rather, its purpose would be to oversee our nation's private retirement
savings market, requiring, for instance, that employer-sponsored plans
have the following features:
Automatic enrollment of all employees
Automatic annual increases of participant deferral rates
The use of age-appropriate target retirement funds as
default investment options
Strict limits on loans and withdrawals during the
participant's career
The inclusion of low-cost, broadly diversified total stock
and bond market index funds among the plan's investment options
A low-cost annuity option for participants reaching
retirement age
Full disclosure of all plan-related expenses
Such a system would set plan participants, by default, on the path
toward funding a secure retirement. As I noted in my statement, such a
plan would be far from perfect, but would represent a vast improvement
over the system we have in place today.
2. On page 15 of your testimony you state ``For those who have the
financial ability to save for retirement, there would be a single DC
structure, dominated * * *'' What about those who are unable to save
for retirement?
As I wrote on page ten of my statement, the Federal Retirement
Board I envision might create a public defined contribution plan. Using
both tax incentives and matching contributions from the federal
government, such a plan might enable investors who are currently unable
to save for retirement to set aside a relatively nominal amount
(perhaps $1,000 per year). Invested prudently, at low costs, and with
strict limitations on access during the participant's working years,
such an account would provide a healthy supplement to Social Security
in retirement.
3. Are you proposing that 401(k)s, IRAs, the government TSP
program, and any retirement saving plans with tax incentives be
abolished for this single Federal retirement system under this Federal
Retirement Board?
I am not. Our current retirement system is an amalgam of plans--
each with its own tax incentives, contribution limits, and eligibility
requirements--that makes saving for retirement needlessly complex. What
I suggest is simplifying this system, creating one universal retirement
plan structure, with one set of contribution limits and eligibility
requirements.
An example to clarify the benefits of such a change: In 2009
participants in 401(k) plans can contribute $16,500; individual
retirement accounts (IRAs) limit contributions to $5,000. Thus a worker
whose employer does not offer a retirement plan can save only fraction
of the amount that an employee with access to an employer-sponsored
plan can. Doing away with the needless and seemingly arbitrary
distinctions between retirement plans would seem to be a painless and
common sense step toward enhancing the ability of all workers to save
for retirement.
4. If one can save for retirement, would the only way to do so that
would get tax benefit would be through this new Federal Retirement
System under the proposal you are advocating?
I believe I covered this in the answers above, but to summarize,
the Federal Retirement Board I envision would simplify our nation's
retirement system, establishing a single plan structure with high
limits on contributions and universal eligibility requirements. It
would also establish certain minimum standards for all employer-
sponsored plans, as described in my answer to the first question.
5. It seems that you are making the argument that since some people
can make the wrong investment decisions for retirement that no one
should be able to have a real control over how their money should be
invested in the future. Is that correct?
That is not correct. I have never and would never take the position
that no one should have any control over how their money should be
invested, for retirement or otherwise.
In examining our nation's retirement system, there are a few
undeniable facts:
Most workers do not participate in an employer-sponsored
retirement plan
The median balance of those who do participate--
approximately $15,000 currently--is, by any definition, insufficient to
make even a moderate contribution to retirement funding
A large number of participants make decisions that are
detrimental to their wealth: most cash out their plans when they change
jobs; most contribute far too little to their plans; many have asset
allocations that are highly questionable, either investing too heavily
in stocks as they near retirement age, or investing too conservatively
at a young age.
If left unaddressed, the inadequacy of our nation's retirement
savings will become a crisis. The crisis, in fact, is not that these
workers will be unable to retire, in that retirement implies a
voluntary separation from the workforce. Rather, the crisis will be
that a large segment of our population will have insufficient savings
to maintain even a basic standard of living as they become unable--not
unwilling--to work. Such a crisis would undoubtedly have enormous
social and economic costs.
The plan I have outlined would make relatively minor changes to our
existing system, changes that would use the typical participant's
inertia in their favor by setting them, by default, on a path toward
accumulating the assets necessary to support them in retirement. It
would change our system from one based on the assumption that the
average employee has the interest and ability to take charge of their
retirement savings--assumptions that have left millions of workers
behind--to one based on the assumption that the average employee does
not posses those traits, and takes a number of decisions out of their
hands by default.
6. You propose a Federal Retirement Board; I would imagine that
such a board would have control over trillions of dollars for
investment. What could be done to ensure that these savings would not
be invested to further any political agenda and only ensure a decent
return for the potential retiree?
The Federal Retirement Board I envision would neither control any
investment dollars nor be charged with ensuring a decent return for
potential retirees. Rather, such a Board would oversee a retirement
system that, as I state on page ten of my statement, would remain in
the private sector. As I indicated in my answer to the first question,
such a Board would establish minimum standards for all employer-
sponsored plans.
Additionally, I would like to see the Federal Retirement Board do
away with the confusing myriad of retirement savings plans we currently
have and establish a universal retirement savings structure. I would
also like such a Board to consider using tax incentives and nominal
government-matching contributions to establish a private sector-based
system that would cover the millions of employees who cannot currently
afford to save for retirement.
Additional Follow-up Questions
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
It's hard to overemphasize the benefits of investing in a tax-
sheltered account. Aside from costs, deferring taxes represents the
single best way to maximize portfolio growth over the long term.
Morningstar data show that over the past 15 years, the average domestic
equity fund has earned 5.2 percent annually on a pre-tax basis. After
adjusting for taxes, the return of the average fund tumbles to 3.5
percent--a difference of 1.7 percent per year.
Compounded over an investment lifetime of 40 years, $1 would grow
by $6.60 at 5.2 percent annually, while a 3.5 percent return would grow
$1 by $2.96. In this scenario, the ability to defer taxes would provide
the investor with a 123 percent increase in wealth.
Amazingly, the mutual fund industry, by and large, seems to ignore
the role of taxes. Managers turn their portfolios over at rates that
often exceed 100 percent, generating tremendous tax consequences for
shareholders who hold their funds in taxable accounts. Tax-deferred
accounts, then, provide the protection our industry fails to.
What is not clear is that tax-sheltered accounts actually add to
national savings. A given portion of the money in such accounts would
doubtless have been saved anyway, just as it was before the huge growth
of defined contribution pension plans.
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
All else equal, most advisors would recommend that their clients
hold a highly tax-efficient equity fund (such as a total stock market
index fund) in a taxable account, and hold their bond allocation in a
tax-deferred account. Such a strategy would allow the owner to benefit
from the current lower tax rates on long-term capital gains and
dividends, while deferring taxes on the interest income earned on their
bond investments.
But while such a practice might make sense in theory, it is of
little use for the large segment of investors whose retirement
accounts--containing stocks and bonds--represent the overwhelming
majority, if not the entirety, of their investment portfolio.
And while it is currently inefficient, from a tax perspective, for
investors to pay income tax rates on earnings that would otherwise be
taxed at now-lower long-term capital gains rates, a few facts remain:
Tax policy is ever-changing, and there is no guarantee
that today's comparatively low tax rates on long-term capital gains
will continue into the future.
Investors who own equities in tax-deferred accounts are,
by and large, able to control the timing and amount of their tax
liability. Investors in actively managed equity funds, on the other
hand, lack such control, and are at the mercy of the fund's manager.
It is likely that a retiree taking a distribution from a
tax-deferred retirement plan will be in a lower marginal tax bracket
than he or she was prior to retirement, thus lowering the tax liability
on any distributions.
In sum, I doubt that a large segment of the investor population
spends a great deal of time worrying structuring their portfolios to
achieve the maximum tax efficiency, partly because of a lack of
understanding, partly because it's an ever-moving target, and partly
because restrictions on access and tax considerations prevent assets
from moving from tax-deferred accounts to taxable accounts and back
again as tax policies change.
______
Ms. Munnell's Responses to Questions for the Record
1. Could you please comment on the long-term implications of tax-
sheltered accounts?
Retirement saving conducted through typical employer plans--both
defined benefit pension and 401(k) plans--is tax advantaged because the
government taxes neither the original contribution nor the investment
returns on those contributions until they are withdrawn as benefits at
retirement. If the saving were done outside a plan, the individual
would first be required to pay tax on their earnings and then on the
returns from the portion of those earnings invested. Deferring taxes on
the original contribution and on the investment earnings is equivalent
to receiving an interest-free loan from the Treasury for the amount of
taxes due, allowing the individual to accumulate returns on money that
they would otherwise have paid to the government.
Tax benefits are designed to encourage retirement saving. Tax
benefits are clearly not the only reason why employers sponsor
retirement income plans. At the end of the nineteenth century, long
before the enactment of the Federal Personal Income Tax in 1916, a
handful of very large employers, such as governments, railroads,
utilities, universities, and business corporations, had put in place
defined benefit pension plans. They did so because the pension was a
valuable tool for managing their workforce.
The transition from defined benefit to 401(k) plans, which began in
the early 1980s, has enhanced the importance of the advantageous tax
treatment of pensions. The 401(k) plan is essentially a savings
account. It is much harder to argue that this form of pension, as
opposed to traditional defined benefit plans, is a key personnel
management tool to retain skilled workers and encourage the retirement
of older employees whose productivity is less than their wage. Once
vested, workers do not forfeit any benefits when they change employers.
Nor do 401(k) plans contain the incentives to retire at specific ages
that employers embed in defined benefit plans. The tax preferences
afforded pensions, as a result, have become the major advantage of
employer-sponsored 401(k) plans.
The bottom line is that the tax advantage costs the government
money because it defers the date when taxes are due. This deferral is
equivalent to an interest-free loan. It is useful to question whether
the foregone revenues are effective in achieving the goal of more
retirement saving and whether the incentives are being offered to the
right people.
2. Also, how are retirees being affected by the decision to either
pay income taxes on funds once they are withdrawn from a tax-sheltered
account or to pay capital gains taxes during the life of their
investments?
One often hears the lament that people taking their money out of
401(k) plans are taxed at ordinary income rates, while those investing
in equities outside of 401(k) plans only have to pay capital gains
rates. The lament implies that people with 401(k) plans are bearing a
greater burden. This implication is not correct.
Of course, the value of the preferred tax treatment depends on the
taxation of investments outside of 401(k)s. And the taxation of capital
gains and dividends has been reduced dramatically--particularly in
recent years--making saving outside of 401(k) plans relatively more
attractive and lowering the value of the tax preference. But saving
through a 401(k) is still advantageous from a tax perspective.
The intuition is clearest when considering stock investments inside
and outside of a Roth 401(k). (And although a conventional 401(k) and a
Roth 401(k) may sound quite different, in fact they offer identical tax
benefits.) Assume the tax rate on capital gains and dividends is set at
zero. In both cases, the investor pays taxes on his earnings and puts
after-tax money into an account. In the Roth 401(k) plan, he pays no
taxes on capital gains as they accrue over time and takes his money out
tax free at retirement. In the taxable account, he pays no tax on the
dividends and capital gains as they accrue and takes the money out tax
free at retirement. In short, the total tax paid under the Roth and the
taxable account arrangement is identical.
How close is the assumption of a ``zero'' tax rate to the real
world? Table 1 summarizes the maximum tax rates applied to capital
gains and dividends since 1988. The 1986 tax reform legislation set the
tax rate on realized capital gains equal to that on ordinary income.
The capital gains tax rate became preferential in 1991-1996, not
because it changed but because the rates of taxation of ordinary income
increased. Subsequently, Congress explicitly reduced the tax rate on
capital gains to 20 percent effective in 1997 and to 15 percent
effective in 2003.\1\ Dividends, with the exclusion of $100 or $200,
traditionally have been taxed at the rate of ordinary income. That
pattern was changed effective in 2003 when the rate on dividend
taxation was reduced to 15 percent.
---------------------------------------------------------------------------
\1\ For taxpayers in the 10-percent and 15-percent tax bracket, the
tax rate on capital gains is 5 percent.
TABLE 1.--TOP RATES ON ORDINARY INCOME, CAPITAL GAINS, AND DIVIDENDS, 1988-2005
----------------------------------------------------------------------------------------------------------------
Top rate on Top rate on ``realized'' Top rate on
Year ordinary income capital gains dividends
----------------------------------------------------------------------------------------------------------------
1988-1990\a\.................................. 28 percent 28 percent 28 percent
1991-1992..................................... 31 percent 28 percent 31 percent
1993-1996..................................... 39.6 percent 28 percent 39.6 percent
1997-2000..................................... 39.6 percent 20 percent 39.6 percent
2001.......................................... 39.1 percent 20 percent 39.1 percent
2002.......................................... 38.6 percent 20 percent 38.6 percent
2003-2008..................................... 35 percent 15 percent 15 percent
----------------------------------------------------------------------------------------------------------------
\a\ In 1988-1990, the top rate on regular income over $31,050 and under $75,050 was 28 percent. Income over
$75,050 and under $155,780 was taxed at 33 percent. And any income over $155,780 was taxed at 28 percent.
Source: Citizens for Tax Justice (2004).
Table 2 shows the difference in return between saving through a
401(k) plan and through a taxable account, taking all personal income
taxes into account. The calculations are based on the following
assumptions: 1) the worker earns $100 and wants to save the proceeds;
2) the proceeds are invested for 30 years in equities with a 6-percent
rate--2 percent paid out in dividends and 4 percent in the appreciation
of the value of the stock; 3) the worker is in the maximum tax bracket;
and 4) the worker does not trade the stock during his working years, so
capital gains taxes are due only when gains are realized at retirement.
The bottom line is that while the difference between saving inside and
outside a 401(k) has narrowed, 401(k) saving still produces higher
after-tax returns.
TABLE 2.--NET AFTER-TAX RETURNS FOR TAXPAYERS FACING MAXIMUM TAX RATE IN TAXABLE ACCOUNT\a\
[Percentage]
----------------------------------------------------------------------------------------------------------------
Rate of return
----------------------------------- Difference between 401(k)
Year Taxable Conventional/Roth and taxable account
account 401(k) Plan
----------------------------------------------------------------------------------------------------------------
1988-1990........................................ 3.7 4.8 1.1
1991-1992........................................ 3.5 4.7 1.2
1993-1996........................................ 2.8 4.2 1.4
1997-2000........................................ 3.0 4.2 1.2
2001............................................. 3.1 4.3 1.2
2002............................................. 3.1 4.3 1.2
2003-2008........................................ 3.9 4.5 0.6
----------------------------------------------------------------------------------------------------------------
\a\ Assumes appreciation of 6 percent per year--2 percent from dividends and 4 percent from increase in the
price of the equities.
Source: Author's calculations based on rates in Table 1 and assumptions described in the text.
______
Ms. Munnell's Additional Responses to Questions for the Record
1. On page four of your testimony you advocated for an additional
tier of retirement savings to support 20 percent of a retiree's income.
You suggested that this be modeled after the Thrift Savings Plan (TSP)
that all federal workers, all Members of Congress and their staff are
in. Furthermore you state ``participation should be mandatory;
participants should have no access to [the] money before retirement.''
Could you tell the Committee where the money would come for these new
accounts? Does the government fund it or does the individual make
contributions?
The intent of the proposal is to help insure that people after a
lifetime in the labor market have an adequate income in retirement.
Social Security is scheduled to pay benefits at age 62 to the typical
worker, who earns roughly $40,000 at retirement, a benefit equal to 29
percent of previous earnings. That level of benefit will not be
adequate for tomorrow's workers to maintain their standard of living
once they stop working. If the typical individual can hold off until
Social Security's Full Retirement Age (66 today rising to 67), the
replacement rate increases to 41 percent. Even this higher level of
replacement will not be enough.
Increasingly, the only source of additional retirement income will
come from employer-sponsored 401(k) plans. (People simply do not save
on their own--with the exception of building up equity in their house.)
As of 2007, median 401(k) holdings for individuals 55-64 were $60,000.
After the collapse of the stock market, these balances average about
$40,000. These balances will not provide enough supplementary income
for people to maintain their standard of living over 20 years of
retirement. Hence, tomorrow's workers need an additional tier of
retirement income.
There is no free money. To have more in retirement, people will
have to save more during their working life. Under my plan, the new
tier would generally be funded by the employee. The precise
contribution rate depends on the expected rates of return earned on the
invested assets, but assume a contribution rate of 5 percent. Middle-
income individuals would be expected to make the contribution; low-
income individuals would need help from the government. Again, nothing
is free, so low-income support would require additional tax revenues.
While making people put aside more for retirement is unpleasant,
the alternative--ending up with inadequate income in old age--could be
disastrous.
2. If it is the individual who makes the contributions, can you
tell me where they are supposed to come up with the extra money? In
2006, the average per capita income in Washington State was $38,067.
Please tell the Committee how much you believe should someone in
Washington State making $38,067 be required to contribute?
As suggested in the response above, the contribution rate might be,
say, 5 percent. If you and others believe that people need less than an
additional 20-percent replacement rate in retirement, the contribution
rate could be lower. The key point is that if the typical person in
Washington State does not save more, or work much longer than they do
currently, they will be at risk in retirement.
3. Or if it is the government, do you have any estimates for how
much this will cost the taxpayer? What are your recommendations for
Congress for where we should raise this funding?
The cost to the government would be the contributions for low-
income individuals. The precise cost would depend on how the government
contribution was structured. If the government paid the full
contribution for everyone earning less than $20,000, the annual cost
would be about $25 billion. That should probably be viewed as an upper
bound, since some type of matching arrangement would be more
appropriate and would reduce the cost.
4. You advocate for a mandatory TSP program for all. Now I can tell
you that my TSP account had taken a similar hit in the last year along
the lines of what you describe for 401(k)s. If we could go back in time
and make your proposal law how would we be any better off today, other
then folks having less money in their paychecks for these mandatory
contributions? If yes, please quantify how much more money a
contributor would have in an account invested in a Vanguard 401(k) S&P
500 fund and the government S&P 500 ``C'' fund?
As I indicated in my testimony, it would be nice if we could
structure a second tier that provides some type of guarantee. The
problem is that low rates of guarantee--2 percent or 3 percent
inflation-adjusted--would have done nothing to protect workers over the
last 84 years. The reason is that no retiring cohort would have earned
less than 3.8 percent on a portfolio of equities, so low guarantees
would never have kicked in. Only high guarantees--like 6 percent--would
have had any impact, but standard finance theory says such guarantees
are not possible, as long as the guarantor shares the market's aversion
to risk. But it would be nice to think a little more about guarantees
and risk sharing.
In the absence of an answer on how to provide guarantees, I
conclude in my testimony that perhaps the best we can do is a tier
modeled on the Federal Thrift Savings Plan. The advantage is that the
investment options would include only index funds and the structure
could be target date funds. This arrangement does not eliminate risk,
but target date funds would at least insure that those approaching
retirement do not have two-thirds their assets in equities as they
approach retirement, as was the case in 401(k)s, and that index funds
would keep costs down.
My sense is that it may be possible to design a risk-sharing
arrangement that would offer more security, but it would require
careful thought.
In any case, the message that I wanted to emphasize is that we need
more organized retirement saving. A declining Social Security system
and fragile 401(k) plans will not be enough for future retirees. We
need a new tier of retirement saving, but I certainly do not have all
the answers on how that tier should be designed.
______
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[The statement of Mrs. Mcmorris Rodgers follows:]
Prepared Statement of Hon. Cathy McMorris Rodgers, a Representative in
Congress from the State of Washington
Thank you Chairman Miller and Ranking Member McKeon for holding a
hearing on such an important issue. I want to also thank our witnesses
for being here today to share their perspectives of how the current
economic crisis impacted on workers' retirement savings.
Right now, our economy faces challenges that many of us haven't
seen before in our lifetime. The current downturn in our financial
markets has brought considerable uncertainty, particularly for those
workers nearing retirement. A recently released poll said they worry
they will have to work longer because the value of their retirement
savings has declined. Particularly for those workers whose savings were
held in a risky portfolio and also for those who were not well-
diversified, these are difficult times.
America also faces a crisis with our current defined benefit
pension system. As Rodger Lowenstein points out in his recent book
``While America Aged,'' today we have approximately 38 million senior
citizens. It is predicted that in a generation this number will almost
double to 72 million and that by 2030 one in five Americans will be
over 65. Over 60 million Americans have been promised pensions; however
this number is shrinking. Another concern is that over one third of the
workforce has no savings for retirement or pension at all. Still
another concern is that in the private sector the available pension
plans are underfunded cumulatively by 350 billion dollars. Many
employers, like IBM, Sears and Verizon have frozen their pension plans
to keep their obligations from growing further. Unfortunately, some did
not act quickly enough and have been forced to declare bankruptcy while
others, like the U.S. auto industry teeter on the brink with only
enormous government subsidies keeping them alive.
The Pension Benefit Guarantee Corporation (PBGC) created by the
ERISA law in 1974 is currently responsible for the pensions of 1.3
million people whose pension plans have failed. With 94 of these plans
failing in 2006 alone, the PBGC is deeply in the red with a taxpayer
bailout increasingly likely. Even worse the states and localities that
have promised pensions to first responders, teachers, transit workers
and others are hundreds of billions of dollars behind on their promises
to state pension funds. This is money owed by the taxpayer, and under
the state constitutions this debt is required to be paid. Pensions can
never be defaulted upon and this growing obligation has all the
markings of the next financial crisis since these pensions are the
longest enduring promises that exist.
One General Motors retiree recently passed in 2006 at the age of
111. He had been collecting pension and retiree benefits for 48 years.
When he started work in 1926, there was little thought given to what
they would pay him 80 years later. Pensions have always been the way to
over promise future obligations that would have little effect on the
company or municipality today. I find it ironic that the federal
government was one of the first entities to get out of the pension
business in 1984 as part of a solution then to save the Social Security
system.
At the same time, millions of Americans rely on investments in
planning for retirement. Because of this, a downturn in our financial
markets can have a real impact on workers' retirement security. An
increasing number of workers rely on 401(k)-type savings plans and a
smaller share of workers participate in defined-benefit plans. Today,
630,000 private-sector defined contribution plans cover 75 million
active and retired workers. In addition, there are more than 10 million
employees of tax-exempt and governmental workers who participate in
other plans such as 403(b), 427 and the Thrift Savings Program (TSP).
The financial crisis has also had an impact on defined contribution
assets and this is a great concern to workers and retirees. Assets have
declined from $2.9 trillion on June 30, 2008 to $2.4 trillion on
December 31, 2008. The average 401(k) balance decreased 27 percent in
2008. However, 401(k) balances are still up 140 percent since January
1, 2000. If historical trends continue, plan participants who remain in
the system can expect their plan assets to rebound significantly over
time. A vast majority of these participants have remained committed to
their defined contribution plans.
Congress has made progress in this effort. For instance, we made
sweeping reforms of defined contribution plans in the Pension
Protection Act of 2006 including enhanced pension plan financial
disclosure requirements to participants. However, much more remains to
be done.
I had the opportunity to review the testimony from our witnesses
and I am greatly concerned that may of them are advocating for a new
federal retirement system in addition to Social Security modeled on the
federal TSP that covers all federal workers. It is alarming to see
calls for such a dramatic change due to losses incurred under our
current system. A government retirement savings board that may or may
not require all employees to contribute will lower choices for workers
and create a huge new bureaucracy in Washington, D.C. courtesy of the
American worker.
Employer-sponsored 401(k) plans play a vital role in the retirement
security of tens of millions of Americans. Although the recent economic
downturn represents an historic challenge, it should not be used as an
excuse to tear down or radically overhaul the 401(k) retirement system.
I believe Congress should approve legislation that gives plan sponsors
(typically employers) greater incentives to offer pension plans that
match individual's contributions, offer many options for investment and
give the individuals greater incentives to participate, not create a
one size fits all government program with limited investment options
and mandatory contributions.
I look forward to hearing the thoughts and perspectives of our
witnesses regarding our nation's defined contribution plans.
______
[The statement of Ms. Titus follows:]
Prepared Statement of Hon. Dina Titus, a Representative in Congress
from the State of Nevada
Chairman Miller, Ranking Chairman McKeon, esteemed witnesses, and
fellow Committee members--thank you for coming together today to
examine the challenges workers face as they prepare for retirement. I'm
honored to be a Member of this Committee and I look forward to hearing
the testimony of the esteemed panel of witnesses joining us.
Panelists--thank you for your time and input today.
We all know about the sad state of our nation's economy. The people
of Southern Nevada and the Third Congressional District have been
particularly hard hit by the economic downturn. Unemployment is nearing
10 percent--the highest it has been in 25 years--and it is expected to
get worse. Sadly, Nevada also leads the nation in foreclosure and
bankruptcy rates. These numbers are a stark reminder that we must take
action, and we must take action soon to create reforms that will help
restore savings for Nevadans nearing retirement, that will help
Nevadans save for a secure retirement, and that will safeguard
Nevadans' savings against any future economic crises that may befall
us.
We will hear today from witnesses that will address numerous
problems in today's defined contribution plans, and specifically 401(k)
plans. Some of the witness testimony faults the market, some faults
individuals for not saving adequately or for taking out hardship loans,
some faults greed of financial management corporations, some faults
companies that offer limited plans or cease to match employer
contributions when times are tough. Ladies and gentleman of the
Committee, and esteemed witnesses, I firmly believe that this cannot be
a blame game. We must study in a bi-partisan fashion--bridging the gap
between ``labor'' and ``business''--to find reforms that can benefit
all parties. I do not see these as competing interests and I don't
believe anyone on this Committee, on the panel, or in Nevada can afford
to see them as such.
I am eager to hear the testimony of today's witnesses and to
continue discussions with my fellow Committee members on our best path
forward as Members of Congress and the role we can play as Members of
the House Education and Labor Committee.
______
[A submission by Mr. Andrews follows:]
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[Whereupon, at 12:33 p.m., the committee was adjourned.]