The American Retirement Security Crisis: An introduction Lauren Damme Next Social Contract Initiative, New America Foundation
The three legs of retirement security are under strain Americans primarily depend upon three sources for retirement income: pensions, non-financial assets (usually homes), and Social Security. Percentage of Americans 65+ with income from each source Other income SSI/Public Assistance 6.1% 3.2% Pensions are the least broadly distributed asset: only 34.2% of Americans 65+ earn pension income, while 54% have income from assets and over 85% receive Social Security payments. Pension income Asset income Social Security Earnings 20.1% 34.2% 54.0% 85.8% 0% 20% 40% 60% 80% 100% Percentage of persons 65+ with income from each source 2 Source: Congressional Research Service, 2009.
The Great Recession has increased retirement insecurity About half of all Americans are at risk of 70% not having sufficient retirement income due to 60% reduced pension and 50% home values. Fully 60% of low-income households are at risk of not having sufficient income to maintain their pre-retirement standards of living at age 65. 40% 30% 20% 10% Percent of households at risk of not having enough income to maintain their pre-retirement standard of living at age 65, by income group 53% 60% 40% 47% 36% 42% 2004 2007 2009 0% Low Income Middle Income High Income 3 Source: Munnell, A. Center for Retirement Research, 2009.
American pension returns hit hard by the Great Recession American pensions were some of the hardest hit by the Great Recession, falling by over a quarter in 2008. -26.2 Pension funds' real returns in 2008-17.4 Mexico Czech Republic Germany Slovak Republic Spain Norway Switzerland Portugal Austria Denmark Sweden Netherlands Unweighted Average United Kingdom Poland Finland Japan Hungary Canada Belgium Iceland United States Australia Ireland -40.0-35.0-30.0-25.0-20.0-15.0-10.0-5.0 0.0 4 Source: OECD Pensions at a Glance 2009, Figure 1.3.
Dropping home values lead to more underwater mortgages The Federal Reserve has estimated that homeowners lost $7.15 trillion in home equity from the beginning of 2006 to the end of 2009, a 53% drop. Deutsche Bank predicts that the collapse of the housing bubble will lead to 25 million homeowners - half of all homeowners with mortgages - with negative equity, or underwater mortgages, before 2011. 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% A 43 percent drop inhome equity will lead to a housing market in which 48 percent of mortgagors are underwater. Drop in home equity between 2005 and Q4 2008-43% Percent of all homeowners with mortgages who will be underwater before 2011 48% Source: Joint Center for Housing Studies of Harvard University, 2009; Deutsche Bank, 2009. 5
Deeper problems in the retirement system Although exacerbated by the Great Recession, this state of Americans retirement security was brought about by deeper structural problems in retirement savings patterns, due to: A troubled transition from defined-benefit to definedcontribution plans. Widespread underfunding of public pensions. Families relying too heavily on ever-rising home values for retirement security. 6
The shift from defined-benefit to defined-contribution pensions Prior to the recession, private pensions had already become a less steady leg of retirement security for individuals. Since the early 1980s, businesses have shifted pension risks onto workers through a movement from defined-benefit to definedcontribution/401(k) retirement plans. Percentage of private sector workers with pension coverage by pension type, 1980-2006 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 62.42% 60.2% 65.4% 54.07% Private workers whose employer sponsors a plan, aged 25-64, full-time only Defined contribution -- 401(k) --only Individuals therefore bear the full risk of fluctuations in stock and investment returns. 10.00% 0.00% 17.1% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 10.4% Defined benefit 7 Source: Center for Retirement Research, 2009.
Public pensions are severely underfunded State and local governments, tied to defined-benefit pension promises, are now experiencing underfunding gaps. Trillions of Dollars Novy-Marx and Rauh 3 conclude that there is a less than a 5% chance 2 that the current pattern of pension fund 1 investments can fulfill obligations to retirees 0 in 15 years. Underfunding of state public pension plans dwarfs states' publicly traded debt 6 $5.17 5 4 $1.94 $0.94 $3.23trillion underfunding gap Present value of already promised pension liabilities of all 50 states using market-based discount rates Present value of pension assets of 50 states States' current publicly traded debt 8 Source: Novy-Marx & Rauh, Journal of Economic Perspectives, 2009.
Public pensions are severely underfunded States have funded about 80 percent of their pension liability, leaving a $3.32 trillion funding gap.* Fully 34 states have underfunded their public pensions by at least 20 percent of their gross state product. In addition, states are responsible for more than $530 billion in unfunded Other Post- Employment Benefits (OPEB), which includes retiree health and dental insurance, life insurance, and legal services. * This estimate understates the shortfall due to investment declines from the latter half of 2008. State underfunding of public pensions as a percentage of gross state product Delaware Nebraska Tennesee North Dakota North Carolina New York Virginia Florida Texas Massachusetts New Hampshire Vermont Washington Indiana Utah Iowa Michigan Louisiana Nevada Georgia West Virginia Kansas Maryland South Dakota Pennsylvania Wyoming Arizona Idaho California Missouri Alaska Montana Connecticut Oregon Minnesota New Jersey Oklahoma South Carolina Hawaii Arkansas Colorado Maine Kentucky Alabama Illinois New Mexico Wisconsin Mississippi Rhode Island Ohio 0% 10% 20% 30% 40% 50% 9 Source: Novy-Marx & Rauh, Journal of Economic Perspectives, 2009.
Many city governments are also suffering from pension shortfalls For example, as of June 2009, Los Angeles had underfunded its public pension liabilities by $3.53 billion, with an additional $2.43 billion owed in Other Post-employment Benefits (such as healthcare). The city employees retirement plan is short by over 100% of payroll. As of June 2009, New York City public pensions programs had liabilities that exceeded their assets by $39.9 billion with an additional $65.5 billion owed in Other Post-Employment Benefits. The NYC Teachers Retirement System (TRS) is underfunded by over 200% of payroll, Police by over 300%, and Fire by almost 530%. 10
Emphasis on home ownership has led to retirement insecurity Home ownership accounts for the largest proportion of assets for all but the richest 5 percent of the population. But this has led to an over-reliance on rising home values for retirement security. The bottom 50 percent have therefore not saved enough in secure financial assets and pensions to weather the bursting housing bubble. 80% 60% 40% 20% 0% -20% -40% -60% -80% Asset and debt items as a percent of assets by percentile distribution of wealth groups 0-50 50-90 90-95 95-99 99-100 Wealth Percentile Debt Equity in vehicles Equity in home Equity in businesses Financial Assets 11 Source: Kennickell, A. Federal Reserve Board, 2009.
Huge numbers of homeowners are underwater Over 10.7 million Americans are now in negative equity situations, meaning they owe more on their mortgage than their home is worth. National Nevada Arizona Florida Michigan California Georgia Virginia Colorado Ohio Maryland New Hampshire Utah Idaho Illinois Washington, DC Minnesota Tennessee New Jersey Washington Wisconsin Rhode Island Massachusetts Oregon Delaware Missouri Arkansas South Carolina Texas Alaska Kansas New Mexico Nebraska North Carolina Connecticut Kentucky Iowa Indiana North Dakota Alabama Hawaii Pennsylvania Oklahoma Montana New York them. 0% 10% 20% 30% 40% 50% 60% 70% 80% Percentage of mortgages in negative or near-negative equity With home prices unlikely to ever recover, this loss in equity has significantly reduced the retirement security of the lower and middle classes, which are less likely to have pensions and other financial assets to sustain Percentage of negative and near-negative* equity mortgages by state, Sept. 2009 *Near-negative equity defined as properties with mortgages within 5% of a negative equity position. 12 Source: First American CoreLogic, Sept. 2009.
Social Security is the main source of income for most Americans Sources of income of persons aged 65+ by income quartile, 2008. 100% Instead, the two bottom 90% income quartiles (making less than 80% $18,208) depend on 70% Social Security for over 60% 80 percent of their aged 65+ income. 50% The second quartile still depends on Social Security for over 50 percent of its retirement income. Percentage of to otal income, 2008 40% 30% 20% 10% 0% 20% Top Quartile 55% Second Quartile 82% Third Quartile 84% Bottom Quartile Other Income Asset Income Pensions Earnings Public Assistance Social Security 13 Source: Congressional Research Service, 2009
Social Security is too weak to provide retirement security Social Security reduces and spreads market risk, but provides much lower than the 70-80% of pre-retirement income needed to maintain pre-retirement standards of living. Many rely upon Social Security for over 80% of their retirement income, but it replaces less than half of preretirement income for the average wage earner with a continuous work history. In reality, workers do not work steadily their entire lives, and Social Security replaces only about 33% of their average wage from the year prior to retirement. Social Securitybenefitsand percent replacement rates compared to past earnings for workers with continuous work histories, retiring at age 65. $90,000 $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 $16,700 Past earnings Benefits $9,400 54% $37,200 $15,570 40% $58,900 $20,610 34% $87,800 Low Average High Maximum $24,000 28% Earnings level 14 Source: National Academy of Social Insurance, 2007.
A new way forward? Our ownership society, based on defined-contribution pensions and home ownership, fully exposes Americans to volatile markets and has left many vulnerable to the possibility of never being able to retire. With home values unlikely to recover and states and cities in serious financial trouble with promised definedbenefit pensions, what are our policy options? 15