Profit Sharing/ 401(k) Council of America
April 1998
Contents
About this paper
Executive summary
Reassessing the traditional model of retirement-income security
Building a framework for retirement-income security
Conclusion
Endnotes
Acknowledgments
The Profit Sharing/401(k) Council of America (PSCA) is a national, non-profit association of 1,200 companies that sponsor profit-sharing/401(k) plans for more than 3 million employees. Member companies range in size from Fortune 100 firms to small, entrepreneurial businesses.
For over 50 years, PSCA has worked to promote defined-contribution plan sponsorship and participation because of its member companies' common belief that profit-sharing/401(k) and related savings and incentive programs:
- provide a vital source of retirement income;
- empower and motivate the workforce;
- strengthen the free-enterprise system; and
- improve domestic and international competitiveness.
Based on its member companies' collective experience in sponsoring retirement benefits and saving and investment programs for millions of Americans, PSCA has prepared this paper, which presents a framework that every American can build upon to ensure his or her own financial security in retirement.
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Traditionally, an individual's financial security in retirement was said to rest on a "three-legged stool" of Social Security benefits, employer-provided retirement benefits and personal savings. However, demographic trends-such as the aging of the baby-boom generation, lengthening life spans and earlier retirement ages-increasingly will strain all sources of retirement benefits.
At the same time, competitive pressures and the needs of a changing workforce make it increasingly difficult for individuals to rely on the employer's traditional role in providing retirement income. In addition, the low U.S. national savings rate threatens the long-term growth of our economy, which in turn will diminish the ability of individuals, employers and government to fund retirement-income programs.
In response to these pressures, the Profit Sharing/401(k) Council of America recommends a new framework for retirement-income security, based upon four principles:
- Individuals must be primarily responsible for their own financial security in retirement.
- American social and political culture must educate and stimulate individuals to save and invest for the long term, particularly for retirement.
- Government must provide an environment that encourages individuals and employers to contribute and invest assets for retirement.
- Employers must have the flexibility to design retirement programs that both assist individuals in meeting their retirement goals and address employers' unique business needs.
This new framework vests principal responsibility for ensuring retirement-income security with the individual, although government and employers will continue to play significant roles. Individuals must assess their own financial situation and then develop and implement a plan that will provide a financially secure retirement. Passively relying on benefits determined by employers or government may expose the individual to inadequate retirement income.
Government can help to expand the retirement-plan system by removing barriers to saving, investment and plan sponsorship. Specifically, it must provide a stable and simplified regulatory environment and make retirement-savings programs available to individuals regardless of their employment status.
Employers will continue to provide meaningful retirement-benefit programs so long as they have the flexibility to design and fund programs that take into account their unique business needs and the needs of a changing workforce. The maturity of the business, the demographics of its employees, the level of competition that it faces, and the complexity and expense of complying with government regulations all influence the decision of what type of retirement program, if any, an employer sponsors.
Finally, our social and political culture must be transformed if the new framework is to succeed. Families, schools, financial and governmental institutions, employers and the media all must educate and encourage individuals to plan for and thrive within this new environment.
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Reassessing the traditional model of retirement-income security
An increasing number of working Americans will not be able to maintain their current standard of living in retirement unless we, as a nation, establish a framework upon which to build retirement-income security. Changes in demographics, lifestyles, the business environment and national savings patterns and concerns over the long-term viability of the Social Security system compel the Profit Sharing/401(k) Council of America to recommend a new approach to retirement-income security that is based upon four principles:
- Individuals must be primarily responsible for their own financial security in retirement.
- American social and political culture must educate and stimulate individuals to save and invest for the long term, particularly for retirement.
- Government must provide an environment that encourages individuals and employers to contribute and invest assets for retirement.
- Employers must have the flexibility to design retirement programs that both assist individuals in meeting their retirement goals and address employers' unique business needs.
Changes in demographics.
Prior to the industrial age, there was no need for retirement programs: people generally worked until they died. But as they moved off farms and into factories, labor became more specialized, and when an employee no longer could do that for which he was trained, he retired. Some employers began offering retirement benefits to ease this transition. And, to provide retirement benefits to greater numbers of people, the federal government established the Social Security system in 1935. These early systems were relatively inexpensive because people at that time were expected to live only until age 62.
Life expectancy has increased dramatically since the establishment of Social Security. Today the average 65 year-old can expect to live another 17.4 years.1
Lengthening life spans will put a greater burden on retirement systems, but this alone might not be enough to threaten Americans' retirement-income security. The greatest challenge to our retirement systems is the imminent retirement of the so-called baby-boom generation (those born between 1946 and 1964). Over the next four decades, 76 million Americans will retire, raising the percentage of the population that is retired to 20 percent.2 Currently, approximately 13 percent of the U.S. population is retired.3 The combination of lengthening life spans and the baby-boom generation's retirement will increase dramatically the ratio of retirees to active employees, which will overwhelm the financial resources of such tax-funded government programs as Social Security, Medicare and Medicaid. To adjust, government may look to substantially increase taxes, drastically decrease benefits, or both.4
At the same time, several trends are reshaping the composition of the American workforce. Employees today are as likely to be female as male. They also spend fewer years working for any one employer and move frequently from job to job and into and out of the workforce. The delivery of retirement benefits to these employees through traditional employer-provided retirement plans is difficult, at best.
Changes in lifestyle.
Lifestyle changes also are affecting savings and investment for retirement. For example, increasing numbers of dual-income families are coming to expect a higher standard of living during their working years because of their combined income. Between 1970 and 1992 the percentage of families with annual income of $75,000 or more (in constant 1992 dollars) more than doubled, from 7 percent to 14 percent.5 These couples' raised expectations about their financial status will carry over into retirement.
The trend toward earlier retirement is having an impact on individuals' financial needs in retirement. Whether it is the result of corporate restructuring or a desire for more leisure time, the median retirement age is declining. In the 1950s, the median retirement age was 67 for men and 68 for women; by 2000 it is expected to be 62 for men and 61 for women.6 As the gap between end of employment and death increases, the cost of retirement increases dramatically, and individuals will need to adjust their financial plans accordingly.
Not every individual expects to retire early, however. Among those who plan to work to normal retirement age, there is increasing interest in scaling back work, instead of making an abrupt change from full-time employment to retirement. In fact, almost 75 percent of individuals between the ages of 51 and 61 say they would prefer to gradually phase down to part-time work, rather than accept full retirement.7
Changes in the business environment.
Demographic and lifestyle changes are not the only factors that must be considered in developing a framework for retirement-income security. The ways that employers do business in an increasingly competitive global marketplace with a changing workforce also will have a profound impact on individuals' retirement-income security. To compete in today's dynamic economy, U.S. employers are reducing workforce size, decreasing operating costs and refocusing human-resource programs. Specifically, employers are controlling wage and benefit costs by making greater use of short-term work arrangements and independent contractors. They also are introducing participative work environments that incorporate individual empowerment and financial incentives for individual performance and company profitability. These trends increase employers' needs for flexibility in designing employee-benefit programs that allow them to build a qualified workforce while remaining competitive.
Changes in national savings patterns.
A final factor that is affecting the accumulation of savings for retirement is a change in national savings patterns. Since the end of World War II, the national savings rate- that is, savings by individuals, businesses and government-has fallen from an average of 7.7 percent of gross domestic product (GDP) between 1945 and 1980 to 1.7 percent of GDP in 1993.8 Our low national savings rate threatens long-term economic growth because our economy depends on savings to provide capital for new businesses, ongoing business operations, capital improvements and government activities. Without a healthy economy, the ability of individuals, employers and government to fund retirement-income programs is diminished.
To adapt to these demographic, life-style, business-environment and savings-pattern changes, we must build a new framework for retirement-income security. The following pages discuss in greater detail each of the four principles upon which that framework should be based.
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Building a framework for retirement-income security
The United States must develop a realistic framework for retirement-income security if Americans are to live with dignity in retirement. This framework must identify the roles that individuals, our society, government and employers should play. Following are the principles upon which the Profit Sharing/401(k) Council of America believes this framework should be built.
Principle 1
Individuals must be responsible for their own financial security in retirement.
Each individual's personal and financial circumstances are unique. While common themes exist, individuals have their own mix of economic goals, family responsibilities, personal expenses, earning power and financial resources. Thus, an individual's financial needs, goals and expectations will be unique during his or her retirement years.
Although retirement income may be available from many sources, the sources and the amounts received from each vary by individual. Therefore, individuals must assess their financial situation and then develop and implement a plan that will provide a financially secure retirement. Passively relying on benefits determined by employers or government most likely will expose the individual to inadequate retirement income.
Many individuals already recognize their responsibility for ensuring their financial security in retirement and are taking steps to achieve their retirement-income goals. According to a recent survey, 68 percent of Americans aged 25 to 64 believe that they are primarily responsible for their retirement security.9 The recognition of that responsibility is leading individuals to start saving at an earlier age than their parents did-people aged 45 to 64 report that they first began to prepare for retirement at age 35, while those aged 25 to 44 say that they first began to prepare at age 26.10 Further, a recent nationwide poll found that 21 percent of Americans are "not too confident" and 12 percent are "not at all confident" that they will have enough savings to retire.11 The best way for individuals to allay those fears is to develop and implement personal financial plans to reach retirement-income goals.
To develop their plan, individuals first must define their goals. Specifically, they have to realistically project all their expenses in retirement-particularly those related to health care-to ensure that these expenses will not overwhelm their savings. They also need to identify potential sources of income-for example, personal savings, employer-provided retirement plans, government programs such as Social Security, continued employment or inheritances. Then they must develop a plan of action that will result in having enough income during retirement to meet expected expenses.
The plan should include the amount to be saved, the investment strategy that will be used to meet income goals in retirement and the investment vehicles that will be used to implement the investment strategy. It also may include decreasing current expenses, increasing the amount saved through employer-sponsored or individual retirement plans, changing investment strategies to increase rates of return or choosing to work for an employer that allocates a larger share of the compensation dollar to long-term savings programs.
Implementing the plan will require individuals to keep their long-term goals in sight. They continually will have to monitor and adjust their spending, saving and investment strategies to take advantage of or to defend against changing personal financial situations and broader market conditions.
Individuals cannot accomplish all this on their own. Families, schools, employers, government and the media must help individuals to recognize their responsibility for retirement planning and then provide the information, tools and resources needed to support that plan.
Principle 2
American social and political culture must educate and stimulate individuals to save and invest for the long term, particularly for retirement.
Just a few decades ago, there was little difference between the median retirement age and the average life expectancy. Today, because of trends toward earlier retirement and longer life spans, the average American can expect to spend approximately one-fifth of his or her life in retirement. However, our financial attitudes, culture and institutions have not yet adjusted to this incredible change and are jeopardizing retirement-income security. In the United States, for example, individuals save on average just 5 percent of their after-tax income for retirement and non-retirement purposes, while in Germany they save 12 percent and in Japan they save 15 percent.12
This situation is exacerbated by current personal and public policy decisions to borrow financial resources from the future to pay for present needs. To ensure retirement-income security, American social and political culture must educate and stimulate individuals to save and invest for the long-term, particularly for retirement.
We must build a lifetime framework for financial planning that begins at home with parents teaching their children the importance of saving. Schools, the media, financial institutions, employers and the government must work to continually reinforce and build on this message throughout an individual's life by demonstrating the benefits of long-term savings and investment. Individuals also will need a variety of tools and resources to help them achieve their retirement-income goals. These resources may include newsletters, magazines, books, videotapes, financial-planning software, seminars and personal consultations.
To be effective, this educational process must cover all aspects of an individual's financial situation. This includes such fundamental information as the benefits of saving, the proper use of credit, the long-term effects of compounding interest, the effects of inflation on investment returns, the need to prepare financially for unforeseen emergencies and the financial impact of taxes. As individuals become more financially sophisticated, they will require more detailed information, such as how much retirement income they will need to meet their lifestyle goals, the advantages and disadvantages of different investment vehicles and strategies, and the need to balance long-term and short-term financial goals.
All of this education will not be effective, however, unless government provides an environment that encourages long-term savings and investment.
Principle 3
Government must provide an environment that encourages individuals and employers to contribute and invest assets for retirement.
For individuals to be financially secure in retirement, government must provide an environment that encourages accumulation of retirement assets through individual and employer contributions. In 1921, Congress began encouraging savings and investment for retirement by authorizing tax-advantaged treatment of contributions and earnings in qualified employer-sponsored retirement plans. In the 1960s and '70s, it created tax-advantaged opportunities for individuals, including the self-employed, to save for retirement by authorizing the use of individual retirement accounts (IRAs) and Section 401(k) and Keogh plans.
Under this favorable environment, opportunities to save and invest for retirement grew. By 1980 there were 488,901 private- sector retirement plans covering 58 million individuals, compared with 169 private plans covering 874,000 individuals in 1920.13
Over those six decades, government implemented a regulatory structure designed to ensure that employer-sponsored plans benefit both highly paid and non-highly paid employees while protecting plan assets against breaches of fiduciary responsibility. However, between 1982 and 1995, Congress passed 10 major pieces of legislation containing provisions that negatively affected the system.14 These include provisions that reduced retirement plan contribution or benefit limits and imposed costly plan-administration requirements. They also eliminated several tax-advantaged retirement distribution options. In addition, Congress and the executive-branch agencies responsible for overseeing retirement plans added layer upon layer of regulation that must be satisfied to qualify retirement plan contributions for tax-advantaged treatment.15 As a result, during the 1980s and into the 1990s, more employer-sponsored defined-benefit pension plans were terminated than were created. In addition, although the number of defined-contribution plans grew from the mid-1970s to the mid-1990s, that growth was restrained.
During the past two years, Congress has demonstrated renewed commitment to improving Americans' retirement outlook. They have made important legislative accomplishments, including passing the Small Business Job Protection Act of 1996 and the Taxpayer Relief Act of 1997. Recent improvements, including the creation of the SIMPLE 401(k) plan and the repeal of the family aggregation rules, make it easier for small businesses to sponsor plans and for greater numbers of workers to save for retirement. To substantially improve Americans' retirement savings situation, Congress must continue its efforts to enact legislation favorable to increasing defined-contribution savings.
As federal spending and budget deficits have grown, government policy-makers increasingly have scrutinized the favorable tax treatment afforded to retirement plans-in some cases, it has viewed retirement-benefit cutbacks as a source of funding for current government operations. The taxes deferred due to private- and public-sector retirement plan contributions represent the federal government's single largest tax "expenditure" each year, according to the Government Accounting Office.16 However, that expenditure is based on government budgets that are devised to cover only five years at a time, which often leads policy-makers to fail to consider the long-term effect that retirement-plan contributions have on government revenues. Government does not lose the revenue it foregoes by permitting tax-deferred employer and employee contributions to retirement plans, it merely defers collecting it until some future date.
Meanwhile, Congress has increased substantially the payroll taxes used to support an expanding Social Security system. Established in 1935, when the American population was much smaller and life expectancies were much shorter, the combined individual/employer payroll tax for Social Security was 3 percent of the first $3,000 of earnings. Today, it is 12.4 percent of the first $61,200 of earnings, with an additional tax of 2.9 percent on all earnings to pay for Medicare. To accommodate the retirement of the baby-boom generation, some experts estimate that the tax rate will have to be raised to about 17 percent of earnings by 2029.17 Policymakers should consider that payroll-tax increases diminish the pool of assets from which individuals and employers can set aside retirement savings.
The government must return to its pre-1980 policy of encouraging individuals and employers to contribute and invest assets for retirement. This shift in policy is of critical importance if our political, economic and social systems are to survive the challenges presented by the combination of lengthening life spans and baby-boomer retirements. Government should help to expand the retirement-plan system by removing barriers to saving, investment and plan sponsorship. Specifically, it must provide a stable and simplified regulatory environment, establish reasonable contribution limits and make retirement-savings programs available to individuals regardless of their employment status and to employers regardless of their size. Most importantly, government must stop using the retirement-savings system as a source of revenue for current operations.
Principle 4
Employers must have the flexibility to design retirement programs that both assist individuals in meeting their retirement goals and address employers' unique business needs.
Today, employer-sponsored retirement plans provide benefits to approximately half the private-sector workforce and hold more than $3 trillion in assets.18 Add the amounts saved and invested through public-sector retirement plans and the assets reach more than $5 trillion.19 Studies have shown that for more than 20 years employer-sponsored retirement-plan contributions and earnings have represented the primary form of savings in the U.S. economy.20
It would be difficult to overstate the impact of retirement-plan asset investment on the U.S. economy. The investment and reinvestment of these assets provide broad and sturdy support to our financial markets (see accompanying table). These funds continuously flow to stocks of new and established companies and to corporate and government debt issues. This investment finances company growth and the development of new products, markets and enterprises, as well as government activities.
|
Growth in percentage of U.S. investment markets held by private employer and state- and local-government sponsored retirement plans.
1970 - 1994
1970 1994
Equities 9.4% 28.1%
Taxable bonds 13.7 13.8
Cash securities 0.3 7.1
Source: Employee Benefit Research Institute, Quarterly Investment Report, 4th Quarter 1994 |
Private-employer retirement plans also contribute to the success of the economy in other ways. For example, private and academic studies have found that profit-sharing plans enhance productivity, increase profitability and employment stability and lead to greater job satisfaction and organizational commitment-factors that are crucial to company success in today's competitive business environment.21
Yet these benefits have not come without a cost. Retirement plans represent a large expense that employers incur to attract, retain and motivate employees. Many employers will continue to provide meaningful retirement-benefit programs so long as the government permits plan-type and funding flexibility. Employers need the flexibility to offer defined-benefit pension plans, profit-sharing/401(k) and other types of defined- contribution plans, combinations of both or current compensation only because of the uniqueness of each business' situation. The maturity of the business, the demographics of its employees, the level of competition that it faces and the complexity and expense of complying with government regulations all influence the decision of what type of retirement program an employer sponsors.
As competitive pressures increase, employers are forced to tightly control their compensation and benefit costs. Because of this, many employers-particularly smaller ones-simply cannot afford to offer retirement plans or, if they wish to offer plans, may not be able to guarantee a specific retirement benefit to their employees. For this reason, an employer-based, government-mandated system is not a solution to providing retirement-income security to all Americans. Rather, to increase the number of individuals who have access to employer-provided retirement plans, government should foster an environment that provides a range of options from among which an employer can select those that best suit its unique business situation.
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The traditional model in which individuals, employers and government share in the responsibility for ensuring retirement-income security must be re-evaluated. Ongoing demographic, social and economic changes are so fundamental that we must develop a new framework if Americans are to maintain their pre-retirement standard of living after they retire.
This new framework recognizes that individuals are primarily responsible for ensuring their own financial security in retirement, although government and employers will continue to play significant roles. Government must foster a wide range of alternative approaches to retirement savings and investment. Employers must have the flexibility to design and fund programs that take into account their unique business needs and the needs of a changing workforce.
Our social and political culture must be transformed, as well, if the new framework is to succeed. Families, schools, financial and governmental institutions, employers and the media all must educate and encourage individuals to plan for and live within this new environment.
The Profit Sharing/401(k) Council of America encourages individuals, government, employers and other participants in this new framework to participate in open dialogue to identify coordinated strategies that can be used to achieve retirement-income security for all Americans.
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1 Statistical Abstract of the United States: 1997. Washington: U.S. Bureau of the Census. 1997.
2 Statistical Abstract of the United States: 1994. Washington: U.S. Bureau of the Census. 1994.
3 Ibid.
4 According to the annual trustees' report, O.A.S.D.I. expenses will likely exceed tax income in 2013 and it will become necessary to begin spending the interest earned on the trust fund balance; in 2021 O.A.S.D.I. expenditures will exceed tax income and earnings and it will become necessary to draw on the accumulated assets in the trust fund; in 2032 the O.A.S.D.I. trust fund will be exhausted. 1998 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds. April 28, 1998.
5 Statistical Abstract of the United States: 1994.
6 Saving the American Dream: An Economic and Public Opinion Study. Princeton, N.J.: Merrill Lynch, Pierce, Fenner & Smith Inc. 1994.
7 Hurd, Michael D. The Effect of Labor Market Rigidities on the Labor Force Behavior of Older Workers. Cambridge, Mass.: National Bureau of Economic Research. 1993.
8 Robert Reischauer. Testimony before the Senate Finance Subcommittee on Deficits, Debt Management and Long-Term Economic Growth. June 17, 1994.
9 Planning for Retirement: Are We Leaving it to Chance? 6th Annual Merrill Lynch Retirement Planning Survey. Princeton, N.J.: Merrill Lynch, Pierce, Fenner & Smith Inc. 1995.
10 Saving the American Dream: An Economic and Public Opinion Study.
11 EBRI Databook on Employee Benefits. Washington: Employee Benefit Research Institute. 1997.
12 Survey of Current Business. Washington: U.S. Department of Commerce, Economics and Statistics Administration, Bureau of Economic Analysis. June 1995; World Tables, 1995. Washington: World Bank Group: International Bank for Reconstruction and Development. 1995; and OECD Economic Surveys 1992-1993 Japan. Paris: Organization for Economic Co-operation and Development. 1995.
13 Private Pension Plan Bulletin: Abstract of 1991 Form 5500 Annual Reports. Washington: U.S. Department of Labor, Pension and Welfare Benefits Administration. Winter 1995; and Trends in Pensions 1992. Washington: U.S. Department of Labor, Pension and Welfare Benefits Administration. 1992.
14 Since 1982, Congress has passed the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the Deficit Reduction Act of 1984 (DEFRA), the Retirement Equity Act of 1984 (REA), the Tax Reform Act of 1986 (TRA '86), the Omnibus Budget Reconciliation acts of 1987, 1989 and 1990 (OMBRA '87, OBRA '89 and OBRA '90), the Unemployment Compensation Amendments of 1992 (UCA '92), the Omnibus Budget Reconciliation Act of 1993 (OBRA '93), and the implementing legislation for the Uruguay Round of the General Agreement on Tariffs and Trade (GATT '94).
15 According to the Small Business Council of America, there were 8,587 changes to Internal Revenue Code subsections between 1981 and 1990. Harold Apolinsky, Need for Ten Year Moratorium (attachment to memorandum from Paula A. Calimafde, Small Business Council of America, to Kathy Kiss, Internal Revenue Service, July 15, 1992). Many of those changes apply to the qualified retirement-plan system.
16 Estimates of Federal Tax Expenditures for Fiscal Years 1998-2002. Washington: Joint Committee on Taxation. 1998.
17 Georges, Christopher. "Bid to Overhaul Social Security Picks Up Support In Congress as System's Guardians Soften Stance." The Wall Street Journal. April 5, 1995.
18 Quarterly Pension Investment Report. Washington: Employee Benefit Research Institute. 4th Quarter 1994.
19 Ibid.
20 Shoven, John B. Return on Investment: Pensions Are How America Saves. Palo Alto, Calif.: Stanford University Center for Economic Policy Research. September 1991. The author's calculations are based on Federal Reserve Flow of Funds Balances Sheets for the United States.
21 See, for example, Douglas L. Kruse's 1993 book, Profit Sharing: Does It Make a Difference? (Kalamazoo, Mich.: W.E. Upjohn Institute for Employment Research). Dr. Kruse's analysis of survey data on the corporate performance of 500 U.S. companies (half with profit sharing and half without) over the period of 1970 to 1991 showed that companies that adopted profit sharing experienced first-year productivity increases of 3.5 percent to 5 percent higher than the companies that did not adopt profit sharing. Further, the companies that established profit-sharing plans were able to sustain higher productivity increases over time.
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PSCA gratefully acknowledges the assistance provided by the following people and organizations during the preparation of this paper.
PSCA's National Retirement-Income Policy Task Force:
Brian Fagan, Director of Benefits Accounting, Ogden Services Corp.
Sheila Forsberg, Manager of Benefits Planning, Motorola
John Greenwell, Principal, Arthur Andersen & Co. S.C.
David A. Hildebrandt, Senior Partner, Dow Lohnes & Albertson
Linda P. Holleman, Senior Vice President, Godwins Booke & Dickenson
Deborah R. Iwig, Vice President-Retirement Benefits, Marriott International
Michael L. Johnston, Actuary/Principal, Hewitt Associates
Robert F. Karsch, Vice President, Bankers Trust Co.
Richard L. Menson, Partner, Gardner Carton & Douglas
Rita D. Metras, Director of Benefits Policy, Pension & Savings Plans, Eastman Kodak Co.
Robert H. Smith, Senior Tax Counsel, Exxon Corp.
Allan W. TeRonde, Vice President, American Grinding & Machine Co.
Pamela Toussaint, Manager of Benefit Delivery, Ameritech
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