The great 30-year experiment in 401(k) and similar retirement financing schemes that depend on stock market investments has failed. Even before the stock market crisis of 2008, the signs were everywhere that very few workers would be able to accumulate enough wealth through these accounts to insure retirement financial security. As a result, most are looking forward to – or rather becoming resigned to – working longer and seeing their standards of living dramatically decline when they do retire. They will become increasingly dependent on their adult children if they have any. Up until 1980 each generation of workers since the nineteenth century had more retirement security than the previous one. Now each has less. This U-turn in retirement security joins wage stagnation and rising inequality as fundamental class issues facing working people.
For most ordinary people during the nineteenth-century farm economy, retirement as such was sporadic. Many worked and died before entering a distinguishable period of retirement. For the minority who lived beyond their working lives into a period where they could not support themselves through work, most were supported by younger family members in the same farm household. For the upper-class rich it was different. They either had or accumulated during their working lives – if they worked – enough resources to finance their retirements. The labor or incomes of younger members of their families were not required to support them. For upper classes, thus, retirement has never been problematic since they always had financial resources to support themselves. Retirement as a social policy issue concerns people of ordinary and low incomes.
The great dividing line that ushers in modern retirement for working people is when their support shifts from being assumed by younger family members to being organized by governments and employers. In 1883 conservative German Chancellor Bismarck pioneered modern government social insurance with programs to protect workers against sickness, old age, and injury in part to counter the rising influence of the socialist labor movement in Germany. The initial benefits were low, though, and did not cover all workers. By 1935, 34 European nations had followed the German lead and developed some form of national social insurance. In the midst of the Great Depression the federal government of the United States responded to the growing need for a retirement system with the Social Security Act of 1935. Like the European social insurance plans that preceded it, it socialized the original nineteenth-century principle of family responsibility for the elderly. Instead of each family being responsible for just its own elderly – which was clearly an inadequate basis for supporting the entire aged population – all families would be responsible for all of the elderly. Family values were writ large to the whole society.
Social insurance plans to support retirement, such as Social Security, were consistent with the socialist value of solidarity through socialization of support for children, the elderly, the disabled, and others unable to actively participate in the labor force. They also marked progress toward the socialist goal of equalizing living conditions – in this case, between active and retired workers. They, like other reforms within capitalist societies, should be judged not by whether they are explicitly socialist, which they are not, but rather according to whether they are consistent with socialist values and goals. Indeed, conservatives and liberals have often supported such reforms for their own reasons. Neutral-sounding labels such as social insurance and social security enable such heterogeneous ideological coalitions.
Social Security mandates that all active workers and their employers pay taxes into a social security fund that supports all retired workers. It is a formula that has worked remarkably well since its inception, producing the federal government’s most successful and popular domestic program.
Employers also began offering pension systems as job benefits. As with Social Security, current workers and their employers set aside a part of total employee remuneration and used it to pay out benefits to retired workers – a pay-as-you-go formula. Employers saw advantages to offering pension plans because they would reduce employee turnover and its expenses by rewarding loyalty. They also initially saw pensions as being of low expense since the money put aside to pay out retirement benefits would not have to be paid out for a long time. This would lead to a significant long-term problem of under-funding, which is one of the reasons why corporations have found conversions to 401(k) plans as an attractive way out of their obligations.
In technical terms, traditional pensions, whether Social Security or employment-based, differ fundamentally from 401(k) plans and the like. In the first, payroll deductions are collected from the pool of active workers to cover payments to retired workers. These are referred to as defined benefit programs because a predictable retirement income – from either the employer or Social Security – is guaranteed. Under 401(k), on the other hand, individual workers save and invest part of their wages and salaries, with or without employer contributions, in stocks and bonds. The accumulated values of their portfolios are then used to finance their retirement. These are referred to as defined contribution programs since only the contribution is predictable with no benefit amount being guaranteed.
Aside from Social Security, defined benefit pensions have other antecedents in the United States. Revolutionary War and Civil War veterans received defined benefit pensions and a number of large private employers began offering similar defined benefit pay-as-you go pensions before 1920. Defined contribution plans are more recent. Andrew Carnegie initiated the first large-scale one in 1918 with a one million dollar grant to make possible the establishment of the Teacher Insurance Annuity Association (TIAA) for college professors.
In ideological terms, defined benefit plans are progressive reforms within capitalist societies that are consistent with guaranteeing old age support as worker or social rights. Defined contribution plans, to the contrary, are consistent with laissez-faire capitalist principles in that they make support for old age dependent on the market outcomes of personal savings and investments. Not surprisingly, as market fundamentalism gained ascendancy in the 1970s, neoliberal reformers sought to transform the bulk of national retirement plans from defined benefit to defined contribution bases.
Both the Democratic and Republic parties were complicit in this transformation. During the 1977–81 Carter presidency, the bases were laid by reforming the tax code – the Revenue Act of 1978 – creating sections 401(k), 403 (b) and 457 to allow retirement plan contributions to be made with pretax dollars into them. The intended effect was to use tax savings to encourage individuals to participate in defined contribution retirement plans. The initial intention was to facilitate savings for retirement to supplement traditional defined benefit pension plans. Very quickly, though, corporations would begin abandoning the latter in favor of the former. The tax savings were used to encourage individuals to participate in the plans. They had the effect as well of diminishing tax revenues and shrinking future financing for federal social programs, thereby accomplishing another neoliberal goal.
The Carter administration also took steps to transform a significant part of federal employee retirement plans from defined benefit to defined contribution bases. Just as Democratic Party policymakers during the Clinton presidency began the deregulation of financial markets that contributed mightily to the 2008 housing market crash, a previous generation of Democratic Party policymakers paved the way for Republicans to undermine retirement security.
The Reagan Administration was joined by the Thatcher government in the United Kingdom in enthusiastically carrying out the neoliberal transformation of retirement. Simultaneously neoliberal advisors trained at the University of Chicago urged the Pinochet dictatorship in Chile to transform its entire defined benefit national retirement system into a defined contribution one – with one notable exception: the military kept traditional defined benefit pensions for themselves.
Reagan’s administration was in no position to completely transform Social Security as had occurred in Chile. It, instead, encouraged the 401(k) transformation of employer-based defined benefit plan and began floating the idea of at least partially privatizing Social Security. The first part of that campaign had long-term success. In 1983, of private sector workers who had retirement plans, 62 percent were defined benefit and 12 percent, defined contribution; by 2007 the ratio had completely reversed: only 17 percent had defined benefit plans while 63 percent had defined contribution ones.1 The second part – privatizing Social Security – failed under the recent Bush presidency, a victim of successful popular resistance. It was no accident that in 2005 Bush cited favorably the Chilean precedent.
For retirees in Chile, the United Kingdom, and the United States, conversion to defined contribution retirement plans has been nothing short of disastrous. In Chile, administration costs by fund managers have absorbed as much as one-third of workers’ contributions. In the United Kingdom by the 1990s it was clear also that administrative costs were high and that future benefits would be low. By 2004 many workers were moving back into state programs. It took the 2008 crisis, when 401(k) values dropped by an average of 25 percent, for most Americans to also realize that their retirement security had evaporated.
Before the 2008 market crisis a prescient minority in the United States, though, were already becoming increasingly nervous about whether they would have sufficient 401(k) accumulations to afford to retire. But in a classic case of blaming the victim, the financial services industry pinned the problem on participants not saving enough. This of course is a self-serving argument since the more money people put into these accounts, the more commissions the financial services industry is able to attain from managing them. But even those who have lived as frugally as possible and put the maximum allowable into the accounts have found that they still do not have enough to maintain their pre-retirement standards of living in retirement. The problem lies with the nature of 401(k)s, not in the supposed lack of prudent savings habits of their participants.
There are two reasons why the 401(k) approach to retirement security failed. First, its basic assumption was that people would be able to save enough through investments to finance their retirements. This is not possible for people with ordinary incomes who also have to pay for increasingly expensive homes and children’s college educations. What can be afforded with a realistic amount of retirement saving will only finance a retirement standard of living that is much lower than that of the working years. It is true that some participants have been able to beat the odds through skilful or lucky investments and come out ahead. It is also true that some gamblers beat the house, but most don’t.
Second, the shift from guaranteed pensions to 401(k) and similar accounts created a tremendous boon for the financial services industry that siphoned off commissions from the accounts. The 401(k)s do a good job of supporting that industry but not of supporting retirement. The American public has subsidized the expansion of the financial services industry with its retirement savings.
What works for supporting retirement is the original social insurance approach. Instead of attempting to create private wealth, workers pay into a collective fund that supports retirees. Like all insurance, some gain more than they contribute and some less. Workers who die just after retiring gain less. But what such retirees “lose” goes into supporting other retirees. The short-lived subsidize the long-lived. The overall class of retirees neither loses nor gains. With 401(k) accounts, on the other hand, if retirees die early, the leftover funds go to heirs, most often younger family members who are still in the labor force and not needing of retirement support. The superiority of the social insurance approach is that it is dedicated purely to supporting retirement instead of creating private wealth.
The 401(k) approach was sold with three arguments. Workers would receive much more from them than from traditional pensions; they would “own” their retirements in an ownership society; and they were portable – as workers shifted jobs they could take their retirement savings with them unlike traditional pensions.
The first turned out to be false. Very few have seen higher incomes from 401(k)s than from traditional pensions. The second is true but of little beyond ideological value. Workers “own” something, but it is of less value than what they had before. The third is true. 401(k)s are portable and that is important for an increasingly mobile labor force and a feature that needs to be preserved in any national reform.
In addition to the other problems, since there is ownership of the 401(k) accounts, there is the temptation to raid them, both by their owners and by the financial services industry itself. When participants get into a financial tight spot – loss of jobs, payment of children’s educational expenses, medical bills, or just plain irresponsible spending habits – there is the temptation and ability of siphon off accumulations. The financial services industry is a willing enabler in this practice. There are even banks that issue debit cards that allow you to spend down your accumulations.
Unlike traditional pensions, retirement incomes from 401(k)s are unpredictable. Those who still have traditional pensions are unaffected by the current stock market crisis. Whether the market goes up or down, their retirement benefits remain the same.
The retirement crisis calls for national action. To begin, we must acknowledge what has worked. By far the most successful retirement program in terms of the number of people who have benefited is Social Security. Its basic approach – dedication to financing retirement rather than creating wealth or providing business for the financial services industry – remains sound. Neoconservative critics claim that Social Security is going bankrupt. But even if it were true that eventually expenses would be greater than revenues, that is an easily resolved problem. As any accountant knows, there are two possible ways to get incomes and expenses back in balance – increase revenues or decrease expenses, and there is no requirement that either, or some combination of the two, be done dramatically. Slight incremental increases or decreases will have significant consequences. That is what has always been wrong with the sky-is-falling-in scaremonger argument.
Social Security revenue could be dramatically increased by reforming how it is collected. As Table 1 indicates, for those earning under $100,000, about 79 percent of their Adjusted Gross Incomes (AGI) is from wages and salaries. But for those receiving over $100,000, forms of property income – profits, dividends, interest, rents, etc. – make up increasing shares of AGI. At some point between $300,000 and $500,000 property incomes surpasses wage and salary income. As a result, those who receive more than $100,000 together receive a greater share of national income than under $100,000 earners but they collectively support Social Security less (Table 2).
The higher the income over $94,200 in 2006 – the most recent year for which we have full tax statistics – the greater the proportion of AGI that is shielded from Social Security taxation. There are two reasons for this. First, Social Security taxes (6.2 percent for both the employer and employee) were collected on only the first $94,200 of wage and salary income. Second, no Social Security taxes are paid on property forms of income.
Social Security revenue could be significantly increased by removing the cap on wage and salary income and exposing property income to taxation. Removing the cap, by my calculation, would have added $111.6 billion to the $677 billion collected that year – a 16.5 percent increase that would have been much more than sufficient to ensure solvency (see Table 3). Revenue could have been enhanced a further $91.1 billion if enough of the nonwage income of those receiving over $100,000 was included so that at least 79 percent of their Adjusted Gross Income was exposed to Social Security taxation as is that of those earning less than $100,000.
These reforms would go far beyond insuring the current benefit levels of Social Security. They could and should be the first steps toward expanding Social Security benefits and beginning to phase out employment-based retirement plans, which are increasingly irrational – like employment-based health care benefits – as more workers change jobs during their working lives. The funds currently going into employment-based plans could then be shifted into Social Security.
The substantive goal of retirement policy should be to provide predictable lifetime income for retirees that replaces as much as possible of their pre-retirement incomes and has cost-of-living adjustments to keep up with inflation. The means to get there is to replace the current three-legged stool of retirement – Social Security, employment-based benefit, and personal savings – with a national system in which Social Security accounts for the overwhelming bulk of income, topped off by personal savings.
But confronting that vision is an enormously powerful sector of finance capital that benefits from the current growth of defined contribution plans from which it draws commissions, interest payments, and management fees. Just as health care reform in the United States has been fought by a “medical industrial complex” made up of insurance companies, pharmaceutical corporations, hospitals, and doctors who directly benefit from the current health system at the expense of the general public, serious retirement reform will be fought by a “retirement industrial complex” made up of banks, insurance companies, investment firms, and financial consultants who profit from the growth of defined contribution plans that fail to provide adequate retirement security for their participants.
1. Alicia H. Munnell, Francesca Golub-Sass, and Dan Muldoon, “An Update on 401(k) Plans: Insights from the 2007 SCF,” Center for Retirement Research at Boston College paper, Mar 2009, Number 9-5, p. 2, http://crr.bc.edu/images/stories/Briefs/ib_9_5.pdf