The Evolving Pension System: Trends, Effects, and Proposals for Reform

Foreword

Private pensions play a crucial role in today’s economy. They provide a valuable second tier of retirement income for many retirees, supplementing the basic support provided by Social Security and Medicare, which were never intended to provide for all retirement needs. Private pensions help employers shape orderly personnel and turnover policies. They provide massive amounts of much-needed patient capital to finance long-term investments. Despite these impressive credentials, the private pension system faces numerous problems. Coverage has stagnated at about 50 percent of the labor force for the last thirty years. Employees with low wages and those who work for small businesses have extremely low rates of coverage. Pension rules and regulations have become enormously complex and quite possibly counterproductive. The collapse of Enron showed the dangers of allowing workers to over-invest their retirement funds in their employers’ stocks. Likewise, the drop in the stock market values between 2000 and 2003, coupled with declines in interest rates over the same period, put extreme pressure on pension funding formulas and led to many underfunded plans. The legislation governing all of this activity, the Employee Retirement Income Security Act (ERISA) of 1974, was signed into law in a world that is quite different from today’s. The last thirty years have seen a massive shift away from traditional defined benefit plans, where workers are automatically enrolled, face no direct investment risk, and automatically receive payments vii Foreword 00-3117-5 frontmat.qxd 11/16/05 3:04 PM Page vii based on wages and years of service for the rest of their lives after retirement. Defined contribution plans have arisen in place of traditional defined benefit plans. In defined contribution plans—like the ever-popular 401(k)—workers literally own a financial account that builds in value over time. Although defined contribution plans offer portable and easy-to-understand benefits, they also raise concerns about workers’ ability to make appropriate choices regarding participation, contribution levels, investment allocations, and withdrawals. A related issue is that Social Security and Medicare, the primary government programs for the elderly, face significant financial shortfalls that may well require that benefits in those programs be cut back in the future. If this occurs, it would heighten the role of private pensions in providing for the income and financial well-being of future retirees. For all of these reasons, improving the private pension system should be a top public policy priority. This book is one of two concurrent volumes that take a hard look at pension realities and reform. The contributions in this volume provide a framework for understanding the broad role of pensions in the American economy and paradigms for reform. The first chapters describe trends in the pension system and their causes. Later chapters look at how pensions influence labor markets and wealth accumulation. The last chapters examine options for broad-based reform. The companion volume, Private Pensions and Public Policy, examines more of the “nuts and bolts” of pension reform issues. This project was funded in part by the TIAA-CREF Institute and by Stanford University and its Institute for Economic Policy Research, as well as the American Council of Life Insurance. Brookings thanks them for their generous support. Strobe Talbott President Washington, D.C. December 2005 viii Foreword 00-3117-5 frontmat.qxd 11/16/05 3:04 PM Page viii The Evolving Pension System 00-3117-5 frontmat.qxd 11/16/05 3:04 PM Page ix 00-3117-5 frontmat.qxd 11/16/05 3:04 PM Page x ...