The economic shocks of the last year have shown it is time to address serious shortcomings in our nation's approach to retirement savings. The dramatic decline in financial markets has reduced the value of 401(k) accounts that Americans are counting on to complement Social Security and has led many retirees to realize it is possible to outlive their savings. What's less obvious is that we have the building blocks right now to make sure that doesn't happen, and that workers who participate in retirement plans have enough money to cover basic living expenses for the rest of their lives.
President Obama recently outlined a series of initiatives - from expanding automatic enrollment in 401(k) and other retirement savings plans to making it easier for workers to direct their income tax refunds into their retirement accounts - that will help many people save for a more secure retirement.
At the same time, there is growing awareness of the need for retirement savings plans to translate into some sort of guaranteed income in retirement. 401(k) plans were conceived as supplementary savings, not as a holistic retirement system.
While we're past the days when most Americans worked a lifetime for one company and could expect to be rewarded with a monthly pension, a few changes in the way retirement plans operate will go a long way to strengthening retirement security for the workers who participate in them.
Guarantee a portion of savings as income. The President's financial reform plan unveiled in June urges looking at new ways to generate more income for retired workers. One idea that merits further discussion is converting a portion of savings to a series of monthly payments that continues for the life of the retiree and a surviving spouse or partner, and provides some degree of inflation protection (subject to the claims paying ability of the company providing the payment). In the current downturn, retirees who received income from a fixed annuity were able to rely on it to cover expenses like food and housing even while their market investments lost money. Whatever the mechanism, the goal should be to ensure that Americans receive enough monthly income from a combination of their retirement account and Social Security to cover their living expenses.
Offer no more than 15-20 well diversified investment choices. Defined contribution plans should offer participants an investment menu of no more than 15 to 20 options, including low-cost guaranteed fixed annuities. That number is sufficient to cover a range of asset classes without overwhelming participants. Research shows that more than 20 options can lead to less diversification, which is essential for managing investment risk over the long term.
Ensure that contributions are sufficient to generate real income. Contributions by workers and their employers must be sizeable enough to generate sufficient retirement income, assuming reasonable investment returns over time. Employers contribute on average about three percent of employee wages to today's 401(k) plans, most often by matching contributions from workers. The most common match is $.50 per $1.00 up to the first six percent of pay. Among eligible workers who participate, total contributions average 6 to 7 percent of pay. Yet to build sufficient savings, contributions in the range of 12 percent are needed. The public sector, including many state universities, provides a model with defined contribution plans that frequently feature non-discretionary contribution rates for both the individual and the employer.
Keep an eye on financial companies' fees. Companies that provide investment and other services to retirement plans must operate cost-efficiently, with a focus on minimizing fees and expenses so that retiree income can be maximized. For example, participants in TIAA-CREF, the company I lead, benefit from our structure, which assures that money we make goes to help meet the financial needs of participants on the best terms practicable.
Social Security and traditional pensions also need to be shored up over the long term. But we can and should focus right now on improving the defined contribution plans that are the only retirement plan many Americans will ever have. With forethought, we can have a system flexible enough to benefit individuals as they navigate the modern economy, and that guarantees income so retirees can live out their years in dignity.