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Save for Retirement, or Else

Now that the defined benefit plan is in decline, Americans will ahve to take charge of their retirement. How to get employees to participate? How to save Social Security? Robert Pozen, a retirement expert and chairman of MFS, on what needs to be done.

Today, Social Security is the largest source of income for seniors 65 years and older, representing 42 percent of their income, according to the Employee Benefit Research Institute. But, let's face it: It would seem that the U.S. government has promised more to future retirees than it can pay. People are living longer, while in industrialized countries like the U.S., the number of future workers is falling as fertility rates continue to decline.

Ergo the looming crisis: Either taxes will have to rise to meet the obligations or entitlements will have to be cut. (If you're the betting kind, which do you think will happen, more taxes or fewer entitlements?) On top of that, the defined benefit plan is dying out. (Last year, 61 percent of large employers offered traditional pensions, that's down from more than 90 percent 20 years ago, according to Hewitt Associates.) No matter how you slice it, it's clear that in the future, personal savings will become the most important part of a retirees' income. Recently, Robert Pozen, chairman of MFS Investment Management, described what should be done to fix Social Security and entice workers to save.

Registered Rep.: So, how bad is this retirement savings crisis?

Bob Pozen: There is a major crisis in retirement savings. I think the crisis is a combination of several factors. One is that the traditional defined benefit plan is on its way out. So many companies have started to freeze their plans or to convert them, and this new legislation [Pension Protection Act], while it tries to do some good things in terms of bulking up the Pension Benefit Guaranty Corp., requires a level of funding that will probably mean the demise of defined benefit plans. Also, Social Security has a long-term financial deficit with the present value close to $4 trillion.

There doesn't seem to be a lot of political appetite to make the changes necessary to close that deficit. With the fragility of defined benefit plans on the corporate and the government side, there's more and more weight put on defined contribution plans. Those in the U.S. are voluntary unlike other countries, like Hong Kong, where some of these defined contribution plans have mandatory contributions.

RR: And, being a free country, Americans are free not to save.

BP: Americans used to save. And they felt that they could invest in various things, like stocks and then residential real estate, and, since they were getting very good returns, they didn't have to worry about savings. First that was in the stock market, then in the home-equity market. When the stock market bubble burst in 2001 and 2002, well, it hurt a lot of people who had counted on that money for their retirement.

RR: What should we do about getting people to save?

BP: I think there is very little that we can do about corporate defined benefits. That's going to be phased out. I think we could do a lot of things to make Social Security solvent. But, as I said, the reform strategies that have been proposed don't seem to be politically attractive. So, we need to focus on encouraging people to save, to invest properly in their retirement plans and to act sensibly when they take distributions.

Some of the devices in the new law [the PPA] do encourage participation. We have automatic enrollment. It's really opt-out enrollment — they'll get automatically put in unless they opt out. Another positive is this low-income credit, where people with incomes below, I think, $35,000 or $40,000 dollars a year, get matching tax credits up to a certain amount for contributions to IRAs and 401(k)s.

The more radical thing is to say that every employer needs to at least offer an IRA. I mean all they would have to do is hook up with a financial institution and the financial institution could offer an IRA to all these company employees, sort of like a presumptive IRA for everybody.

RR: That's going to be crucial, since Social Security seems to be doomed. So, we're looking at a very high-tax future, aren't we?

BP: Well, I think we know that if nothing happens, if Social Security is not changed at all, that in around 2040 (and people can debate that), we'll either have a benefit reduction of 25 percent or the payroll tax will go up from 12 percent to 18 percent. Now, people always think that's theoretical but that is actually what just happened in Japan. Japan now is in the process of raising its payroll tax from 13 percent to 18 percent, and Japan is about 20 years ahead of us, demographically speaking. Interestingly, it's like a revolt there; there are a lot of people in Japan who simply won't pay in, which is very unusual for Japan.

RR: Europe is facing the same crisis: Too many old people, not enough workers.

BP: When we look at it globally, we're a lot better off than Italy, France and Germany. Instead of more taxes, I think we need a sort of presumptive universal IRA. As for personal retirement accounts, there are too many. Do we really need all of these different programs — 403(b)s, 457s? Why don't we just have one program with one uniform set of rules?

RR: How do you see this playing out? Do you think we're going to avoid a calamity, or are we going to see a depression-style wave of poverty with old people?

BP: For the poorest third, we need to protect the Social Security system. Quite frankly I'm not so worried about the wealthiest third because they're making quite a bit of money. So we should focus on the middle group where, yes, they'll get Social Security, maybe not as much as they had hoped, but they do need some supplemental retirement income. These people aren't wealthy people and, if they want to have a decent income in retirement, that's what they need to do. Save. And I think if we can focus on that middle group, I think we can avoid a lot of old-age people in poverty.

RR: How do you feel about President Bush's idea to privatize Social Security?

BP: I think privatization is a very unfortunate word choice and sort of connotes that the whole system would be dramatically changed. If we first concentrated on how we get the Social Security system to be solvent, it would involve some takeaways from some groups. And then we could think about what benefits we could give that group in terms of personal accounts. If we talked about allowing people to take a portion of the 12.4 percent of their payroll tax that currently goes to fund Social Security, say 2 or 3 percent, and direct that to a personal account, we're not talking about privatization, we're talking about a voluntary choice for a modest portion of their Social Security contributions. And if people don't want to do it, they shouldn't do it. The question is, can this ever get off the ground? It's interesting, I was in China. China now has a personal account for its Social Security system. Employers pay about 20 percent of wages toward a guaranteed schedule of benefits, and employees contribute 8 percent of wages into personal accounts. We see this in Sweden now; they have a personal account. Workers can invest 2.5 percentage points of the 18.5 percent of their income that they must set aside for retirement. So this is not a capitalist or socialist thing. This is done in a variety of different countries of different political persuasions.

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