Innovating to sustain America’sworkplace savings system
Robert L. Reynolds
President andChie Executive OfcerPutnam Investments
Edited from a speechgiven to the Tower GroupAnnual Conference onSustainable Innovationin Financial Services,Boston, Massachusetts,on April 14, 2011
This conference has a great theme: “sustainable innovation.” I say that because eventhough “sustainable innovation” may sound like a contradiction in terms, it preciselycaptures the challenge that we face — as a nation. We do need bold innovation innational policy if we want to sustain America’s promise of a better future. We do haveto stop an unsustainable drift toward scal crisis and national decline.My talk this morning — about innovation in workplace savings — actually goes tothe heart of this debate about national solvency. Because innovations in retirementpolicy — especially strengthening workplace savings — can help drive a transition thatour country absolutely has to make. We must move away from old patterns of debt,leverage, and debt-fueled consumption, and toward a new economic model centeredon higher saving, investment, new business formation, and job creation: a solventAmerica that can compete, win, and grow in tough global markets. That’s our challenge.Here’s what drives it.America is aging. Life expectancy is rising. Baby boomers are turning age 65 at therate of about 7,000 per day. Over the next 20 years, the number of Americans over 65will nearly double — from 40 million to 72 million. That’s more than the population of allbut a handful of U.N. member nations.This demographic shift is straining public and private retirement systems across thenation. And unless Social Security, Medicare, and Medicaid are substantially reformed,these three entitlement programs are projected to account for as much as 18% of U.S.gross domestic product by 2045 — a level comparable to the average of the
entire
federalbudget since World War II. At this level of GDP, the government would have to enactmassive tax increases to pay for education, infrastructure, the military, or anything else.
Entitlements as percent of GDP
051015202005 2015 2025 2035 2045
MedicareMedicaidSocial Security
18%
(%)
Average totaltax revenue aspercent of GDP
Sources: GAO Sept. 2004 baseline extended analysis; Bruce Bartlett, Tax Reform Agenda for the 109thCongress 15 (2004). More recent data not available at the time of this presentation.
2
Clearly, we are on an unsustainable course. And yet, even as growing entitlementspending threatens the country’s scal solvency, Social Security replacement rates aredeclining. In 2004, Social Security replaced, on average, nearly 39% of a retiree’s pre-retirement income. However, by 2030, as a result of rising eligibility ages and increaseddeductions for Medicare costs, this gure is projected to decline to about 29%. Moreover,every serious Social Security reform proposal would limit the growth of benets — at leastfor more auent retirees — and raise eligibility ages for most workers. Consequently, adeclining Social Security replacement rate may be more severe, especially for the well-o.
Average replacement rate of pre-retirement income from Social Security
2004 2030
38.7% 29.4%
For earners retiring at age 65. After Medicare Part B deduction (2030 includes higher normal retirement age).Sources: Alicia H. Munnell; 2004. “A Bird’s Eye View of the Social Security Debate”; Center for RetirementResearch at Boston College.
A growing assured income gap
Today’s retirees draw nearly two thirds of their total income from Social Security, denedbenet plans, or both. However, in the future, these income sources will play a much smallerrole for private-sector retirees, and possibly also for public-sector retirees. Future retireesmust save more during their working years and then convert these savings into lifetimeincome — a task that is both trickier and riskier than building a nest egg in the rst place.
Leading to a growing “gap” in assured retirement income
TODAY
WorkincomeTraditionalpensionSocialSecurity
IN 20 YEARS
InvestmentincomeOther retirement incomeGuaranteed incomeWorkincomeTraditionalpensionSocialSecurityInvestmentincome
THEGAP
For illustrative purposes only.
Against this backdrop, it is not surprising that retirement condence — as measured bythe Employee Benets Research Institute (EBRI) — hit a new low in March 2011. For therst time since EBRI began compiling retirement condence data, the percentage ofrespondents indicating they were “not condent” about their retirement was higherthan the percentage saying they were “condent.”
Future retirees will haveto save more while they work, and then master theart o turning lielongsavings into lietimeincome. That’s a task that is both trickier and riskier than building up a nest egg in the frst place.
3
What’s more, roughly 75 million Americans — more than 40% of the total labor force —work for employers that do not oer any type of payroll-deduction savings plan.
Defned-contribution plans are a strong base to build on
We have a strong dened-contribution (DC) workplace saving system that currentlyreaches more than 83 million workers — a number that continues to grow. And thereare 40 million workers covered by dened-benet plans. However, that number is notgrowing. This suggests to me that if we can strengthen the DC system and extend itsreach, we can take huge strides toward meeting the challenge of retirement nance. Andthere is every reason to believe that we can strengthen and extend the DC savings system.
American workers covered by DC plans
384862834042394042427520353802550751001980 1985 1990 1995 2000 2005 2008
DB plansDC plans
(Millions)
Sources: Private Pension Plan Bulletin, Abstract of 2008 Form 5500 Reports, U.S. Department of Labor,December 2010. Collective Bargaining Status of Pension Plans, Total Participants by Type of Plan.
Defned contribution plans have continued to evolve
The DC system has been changing and evolving for over 30 years. Ever since the rstgeneration of 401(k) plans emerged in the 1980s — what I refer to as “WorkplaceSavings 1.0” — we’ve seen innovations such as loan options, daily valuation, multipleinvestment choices, lifecycle funds, and dozens of others. And with the passage of thePension Protection Act of 2006 (PPA), we took a giant step toward making the 401(k)plan — and DC plans generally — America’s
primary
retirement system. PPA endorsedthree game-changing elements of workplace savings-plan design: automatic enroll-ment, savings escalation, and asset allocation guidance. What’s more, PPA gave plansponsors adopting these elements strong legal protection against litigation.As a group, these core elements of plan design marked a qualitative shift, which is why I referto the post-PPA era as “Workplace Savings 2.0.” Today, the evidence of these policy innova-tions is clear: we have essentially solved the challenge of retirement accumulation.Recent research shows that young workers should be able to replace between 40%and 60% of their pre-retirement incomes provided that their DC plans enroll themautomatically, increase their savings from about 6% to 10%, and guide them to age-appropriate asset allocations, mostly through lifecycle funds. And this is beforecounting Social Security, other savings, home equity, life insurance, or any otherassets these workers may have. In other words, these post-PPA auto-enrollmentplans really get the accumulation job done — provided employees start with adeferral of at least 6% and escalate from that level.
PPA endorsed three game-changing elements o workplace savings-plandesign: automatic enrollment,savings escalation, and asset allocation guidance.
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Robert L. Reynolds: Innovating to sustain America's workplace savings system
Edited from a speech given to the Tower Group Annual Conference on Sustainable Innovation in Financial Services, Boston, Massachusetts, on April 14, 2011
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