I am honored to deliver the 2010 Martin Feldstein lecture. It is especially appropriate that I will be discussing the issue of retirement security, because throughout the course of his distinguished career, Martin Feldstein has improved our understanding of the U.S. Social Security system and of retirement policy more broadly.
We clearly are at a pivotal moment in the national discussion on retirement security. Over the past 30 years, the responsibility for funding retirement and the associated risks have shifted from employers to individuals. Today, Americans are recovering from a deep plunge in financial markets and a recession that left people less confident about their ability to achieve financial security.
In discussing the future of retirement security in America, I will examine how we arrived at the current situation, outline a few core features that could be built into a retirement security plan or system, and consider the question that is increasingly asked by researchers: how can we design retirement plans that increase the likelihood of generating an adequate and secure lifetime income?
The Changing Retirement Landscape
The contours of the U.S. retirement system have changed substantially over the past few decades, as the defined benefit pension systems that previous generations relied on for secure retirement income have become increasingly rare. According to the Employee Benefits Research Institute, only 33 percent of employees working for large and medium businesses had access to a defined benefit pension plan in 2008--down from 84 percent 30 years ago. (1) In their place, a patchwork of individual accounts has placed greater responsibility and risk on individual workers.
Initially envisioned as a way for Americans to supplement the pensions made available by their employers, 401(k) plans have instead become most workers' primary means of saving for retirement. As a result, 401(k)-type products have fostered a focus on asset accumulation rather than income in retirement.
The decline in financial markets in 2008 and the ensuing global recession have caused many Americans--especially those nearing retirement--to question whether they will be financially secure after they stop working. Indeed, can they stop working and enjoy anything approaching the standard of living to which they are accustomed?
The evidence is mixed, but for many people the answer seems to be no. Last year, research from McKinsey and Company found that the average American couple will face a savings gap of $250,000 at the time of retirement. (2)
Why has the 401(k) framework failed to adequately prepare workers for retirement? Its shortcomings include:
* Lack of participation among many eligible workers;
* Insufficient employer and employee contributions;
* The failure or inability of many participants to implement an appropriate asset allocation strategy;
* The failure to preserve assets for retirement;
* And a lack of annuitization of accumulated assets in retirement to produce a lifelong income stream.
Fundamentally in the 401(k) context, retirement risk burdens--funding, investment, longevity, and mortality--fall disproportionately, often entirely, upon workers who are not equipped to manage such risks.
On the other hand, employers have benefited over the past three decades by jettisoning defined benefit pensions. For instance, it was only by reshaping their retiree health and savings plans that the big three U.S. auto manufacturers could avoid extinction. And in the public sector, where defined benefit plans are still common, employers are encouraging newly hired workers to select defined contribution retirement options.
While the decline of defined benefit pensions and the rise of defined contribution plans have removed an element of security from most Americans' retirement equation, the resulting individualized retirement system is more closely aligned with the way Americans work today.
With more frequent job changes, including spells of independent work, it makes less sense for Americans to have their retirement savings tied to a single employer.
So, three facts emerge:
* First, defined benefit pension plans proved too expensive for the vast majority of American...