Retirement in the Year 2024
The following is a speech by Mike Clowes, editorial director of Pensions & Investments and InvestmentNews, to members of the American Society of Pension Actuaries Political Action Committee at the ASPA western conference in Irvine, California, July 28.
I have been asked to speak about the future of pensions and retirement in this country. That's a really tough assignment. Luckily, I found a reverse time capsule--a time capsule into which items were placed in the future to be discovered today. In that time capsule was a videotape of a news program from the year 2024. So I can show you exactly how trends we see developing today will play out. Let me run it for you now.
"Good afternoon, ladies and gentlemen. I'm Walter Crankright. This is an NBCFoxNews Corp. Labor Day Special Report: Retirement 2024.
In a White House Rose Garden ceremony reminiscent of that at which President Gerald Ford signed the famed ERISA pension law 50 years ago today, President Chelsea Clinton signed the Mandatory Private Pension Act of 2024, already commonly known as MUPPA.
MUPPA requires all companies with more than 10 employees to offer those employees a pension plan with a guaranteed minimum pension benefit at least equal to that offered by Social Security.
The minimum pension benefit must be paid as an annuity. Any additional retirement benefit can be paid as a lump sum.
Employees must vest in the guaranteed minimum benefit in no more than three years. Longer vesting periods are permitted for any additional level of benefits, but must be no longer than seven years.
The guaranteed minimum benefit may be provided by a defined benefit plan, or by a defined contribution plan that has a guaranteed minimum floor provision provided in some other way. Any defined benefit plan be fully funded within 10 years of the establishment of the plan, and must be fully funded at the end of each three-year period.
Companies may provide excess benefits either by a defined benefit plan or a defined contribution plan. Contributions to a defined benefit plan are fully deductible from corporate earnings until the benefits are 150 percent funded on an accrued benefit obligation basis and are 50 percent deductible after that. Excess benefits, if provided in a defined benefit form, must be at least 90 percent funded at the end of each 10-year period.
If companies provide excess benefits through a defined contribution mechanism the contributions are only 50 percent deductible.
The new law is seen as the greatest advance in retirement provision for private-sector employees since the passage of ERISA.
As Congressional leaders of both parties and labor leaders watched, President Clinton signed the law with replicas of the same pens used 50 years ago by President Ford to sign ERISA.
And some observers noted that the signing of MUPPA came 43 years after the concept was first proposed by President Jimmy Carter's Presidential Retirement Commission in 1981, a report that was immediately shelved by the Reagan Administration.
A mandatory private pension system seemed unnecessary at the beginning of the Reagan Administration. The number of corporate defined benefit plans was increasing, and such plans were becoming better funded as companies raced to meet ERISA's funding standards. ERISA, it should be remembered, required corporate defined benefit plans to be fully funded over no more than 30 years whereas previously companies funded over periods as long as 100 years.
Defined benefit plans seemed affordable to most corporations in the early 1980s because high interest rates made the future liabilities look small, and because the stock market was rising slowly but steadily. In addition, defined benefit plans allowed owners and top executives to fund substantial pensions for themselves on a tax-deferred basis. So where did MUPPA come from?
The number of defined benefit plans peaked in 1985 at approximately 112,000 and soon began to decline, driven by FASB 87, OBRA 87 and a Congressional campaign against corporate reversions of surplus assets.
FASB 87 required companies to account for their pension funding, and disclose details about that funding, details many companies did not want to disclose. However FASB 87 probably would not have caused much of a ripple had not OBRA 87 been enacted in December that year.
OBRA, the Omnibus Budget Reconciliation Act of 1987, included a stealth provision that was inserted at the last minute that hurt pension funds. The provision reduced the full funding measure from 150 percent of the projected benefit obligation to 150 percent of the accrued benefit obligation. This was inserted as a revenue raising measure. More companies' plans were fully funded by this measure and so could no longer take a deduction for any pension contribution. Companies properly recognized that this made the pension plan a more dangerous benefit because they could no longer set aside in good times sufficient reserves to get them through the bad times. The chickens have come home to roost with a vengeance in the past three years.
As luck would have it, a less troublesome alternative to the defined benefit plan was being promoted by benefit consultants--the 401(k) plan. It seemed to solve a lot of problems for corporations. First, its costs were more easily controlled, and were much less volatile. Second, there was no liability to be recognized in the financial statements. Third, senior executives could stash up to 15 percent of their pay in the plans, though changes in discrimination rules would affect that in the future.
The next nail in the coffin for defined benefit plans was hammered home in 1991 when Congress passed and President George H. W. Bush signed legislation limiting the pension that could be paid from a tax deferred pension plan to $275,000 a year. This legislation made it impossible for senior executives to benefit significantly from the company defined benefit plan. The situation was worsened two years later when in 1993 President Clinton further reduced the limit to $150,000 a year. Top corporate executives responded by starting or enhancing non-qualified plans for themselves and becoming even less interested in the defined benefit plan, especially at smaller companies. A spate of defined benefit plan terminations or freezes followed. By 2002 the number of defined benefit plans had dropped to 30,600.
The decline would have been even greater but for the fact that thousands of companies found their defined benefit plans were heavily underfunded in 2003 because of a precipitous drop in interest rates and the decline in the stock market. The underfunding meant terminating the plans would have been more expensive than keeping them.
Defined benefit plans were made more onerous in 2005 when the Financial Accounting Standards Board revamped pension accounting, removing the smoothing mechanisms of FAS 87, and eliminating the concept of pension income. Now corporate earnings were more exposed to the ups and downs of the pension fund investments, and hence volatile.
However, by 2006, as long-term corporate interest rates climbed above 8 percent, thousands of companies found their plans again fully funded, despite a stock market decline, and rushed to terminate them. The number of defined benefit plans plunged again, dropping to fewer than 10,000 as corporate executives decided to remove forever the defined pension liability.
They replaced the defined benefit plans with more--or more generous--401(k) plans. Others converted their defined benefit plans into variations of the cash balance plan, which maintained a semblance of a defined benefit but took much of the unpredictability out of the pension liability.
Employees who had enjoyed defined benefit plan protection grumbled when a 401(k) plan was substituted, because the 2001-2003 bear market had shown how vulnerable 401(k) plan benefits were to stock market fluctuations and interest rate movements. But, except in heavily-unionized companies, they had no choice but to accept the changes. And some unionized employers used Chapter 11 bankruptcy proceedings to dispose of their defined benefit plans and overcome union opposition.
By the election of 2012, retirement provision had become an important issue, but the focus was initially on Social Security and Medicare reform, since both were in terrible shape and neither party had had enough votes in both houses of Congress to pass reforms that would pass muster with their constituents. The Republican Party campaigned on the promise of privatizing Social Security, allowing participants to invest all or part of their Social Security contributions in individual accounts. These could be invested in any marketable securities. The transition costs were to be financed by 30-year bonds. Likewise, they proposed setting up medical savings accounts and giving employees tax deductions for buying their own catastrophic medical coverage.
The Democratic Party campaigned on the promise of preserving Social Security and Medicare as they were. However, when the Republican Party demonstrated the increases in Social Security and Medicare taxes required for the Democrats to keep their promises, they again won control of Congress and the White House.
President Jeb Bush soon pushed through the promised reforms. Many individuals, lured by the recent solid stock market returns, set up their self-directed Social Security Accounts and began to invest at least part of the money in stocks. And they began to establish medical savings accounts and to buy catastrophic health insurance.
The stock market continued to perform reasonably well until 2015, when stock prices began to crumble as the impact of the growing numbers of Baby-Boom retirees imposed continuous selling pressure on the market as they converted their equity holdings into income flows. The selling pressure mounted with every passing year, overcoming the stronger earnings reported by many industries servicing the retirees in their increased leisure.
Younger workers, trapped in 401(k) plans, saw the value of their annual contributions eroded by stagnant or declining stock values, and also by rising interest rates that were driven by slow-growing but steady inflation pressure. This pressure was, in turn, driven by shortages of critical services, and even shortages of workers, as a smaller younger generation strove to meet the demands of the huge and growing number of retirees.
By 2020 individuals had lost faith in the stock market, and in their ability to manage their own investments. Many had seen the volatility of their Social Security balances and the balances of their 401(k) accounts. They wanted certainty. Older employees found as they began to retire that the balances in their retirement accounts were not enough to afford them a decent retirement. Further, they were weary of the financial burden taxes needed to pay off the bonds used to finance the transition to the self-directed Social Security System. In the elections of that year the Democratic Party campaigned on a promise to restore certainty to retirement.
They planned to rescind the self-directed Social Security legislation, and they promised to require employers to offer a retirement plan with a guaranteed minimum benefit.
As a result, in November 2020, President Chelsea Clinton was elected in a landslide, taking with her Democratic majorities in both houses of Congress. After two years of tendentious hearings, during which hundreds of retirees regaled the Congress with stories of how they were reduced to penury because they had invested their self-directed Social Security accounts and their 401(k)s in the stock market, Congress passed the Mandatory Universal Private Pension Act of 2024.
Though the Democrats controlled both houses, they did not hold enough Senate seats to prevent a filibuster, and so the Republicans were able to prevent a completely defined-benefit solution to the private pension crisis. Hence the compromise of a minimum guaranteed pension benefit approach.
The Congress at the same time had passed the Social Security Restoration Act. Ironically, the transition bonds the Republican Congress had directed the Treasury to issue to fund the transition to the self-directed system had largely eliminated Social Security's under funding. And though they had not mentioned it during the campaign, the Democrats significantly increased Social Security taxes and the retirement age to keep it funded.
Younger employees soon grumbled, but since retired voters by now significantly outnumbered them, the Congress was not too concerned.
And there you have it. That's how we found ourselves in the Rose Garden today as President Clinton signed MUPPA.
What was the driving force behind this legislation? Was it the uncertainty of the stock market? Was it poor choices of the nation's private employers trying to cut retirement costs? Was it a misreading of the mood of the electorate by the Republicans?
While all of those things played a part, the real driving force was demographics. There are in the year 2024 only 1.5 workers for each retiree, and that places a large burden on each worker.
What is unspoken by both parties is that MUPPA's costs will no doubt be passed on to employees either in lower wages and benefits, or increased unemployment.
There are still no free lunches. What the Republicans and Democrats have been arguing over for the past 30 years or longer is how to pay for the lunch.
And that, ladies and gentlemen, is the conclusion of our special report; Retirement 2024.
Now back to the present. Does this sound fanciful to you? I don't know if the reverse time capsule and the video are genuine. They could be fakes, but is the scenario impossible?
I have been pondering the problem of retirement income security off and on for the past 30 years. From an economics point of view, I would argue the best retirement income system would be for each worker to save enough during his or her working career to support himself and any non-working spouse in retirement. The role of the government in retirement income provision would be limited to helping those who cannot help themselves, or have suffered misfortune. However, since few workers are forward looking enough save early for retirement by their own volition, even with tax incentives, they would have to be required to do so. No Congress is likely to pass a bill requiring Americans to save, say, 10 percent of their income each year in retirement accounts.
The remaining alternatives, therefore, are a government run supplement to Social Security, or a mandatory employer-provided system. I do not believe the country will accept a government run pension system supplementing Social Security, in part because the taxes would be overt, and employees would object to the high taxes. With an employer-sponsored system, the costs are passed on by employers, usually in lower wages, and these are generally hidden from employees. For that reason I believe we will eventually have a mandatory employer-provided retirement system.
I bounced this idea off a gathering of pension experts in Washington DC in February. All of them had been involved in the passage of ERISA in some way, as Congressional staffers, at the IRS, at the DOL, in the labor movement, lobbying on the employer side etc.
Their response was unanimous: my scenario is plausible. Some even agreed wholeheartedly that the Democrats would try to do exactly what I suggest the next time they come to power.
Thank you for listening.