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Fixing the retirement system

According to Laurence D. Fink, chairman and CEO of BlackRock (BLK) Inc. (BLK), the U.S. needs a form of mandatory savings to supplement Social Security because the current defined benefit and defined contribution plans aren't providing sufficient retirement income.

In a speech on May 7 at New York University, Mr. Fink said the U.S. should look at something like Australia's mandatory superannuation system to which employers and employees are required to contribute, although he didn't propose a particular form of plan.

Mr. Fink is not alone in suggesting a mandatory savings plan. Meir Statman, the Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University, in the May/June issue of the Financial Analysts Journal, urges the adoption of a new, mandatory plan, laying out the workings in some detail.

Last fall, Sen. Tom Harkin, D-Iowa, proposed a new type of retirement plan, the Universal Secure and Adaptable (USA) Retirement Funds, designed to make it simple for employers without a pension plan to offer one.

Proposals for a mandatory private pension system to supplement Social Security go back at least as far as 1980 when the President's Commission on Pension Policy, set up by President Jimmy Carter, called for the establishment of a mandatory universal private pension system. This recommendation died in the Reagan administration.

Even in a generally free society, some element of mandatory savings might be essential to minimize the strain on social safety nets by retirees without sufficient retirement income. But creating a new plan to attain those savings isn't necessary or desirable.

Let's first fix the problems with the current system, which include achieving adequate investment performance in unfavorable markets, and getting employees and employers to make adequate contributions to retirement plans.

As Mr. Fink correctly noted in his speech at the Stern School of Business at New York University, “Central banks in the U.S., Europe and now Japan have driven interest rates to historic lows.” Low-interest rate monetary policy “is taking a terrible toll on savers” both with defined contribution plans and employers that offer defined benefit plans.

“Pension plans and individuals have long used traditional government bonds to help fund retirement obligations. That worked for 30 years of falling inflation and interest rates and 8% returns on Treasuries. But it doesn't work today, when the 10-year Treasury yields less than 2%. And the very real risk is that people overallocating to traditional bond funds are going to lose money when interest rates rise and the value of their bonds fall ... This will deprive investors of flexibility ...

“A rise of just one-fifth of one percentage point in interest rates would mean the loss of an entire year's return on current long-dated Treasuries. In other words, the old rules of investing — 60% equities, 40% fixed income and an increasing share of fixed income the closer you got to retirement — won't work today,” Mr. Fink noted.

The challenges to improving the current system will be eased if and when interest rates begin to rise. The surviving defined benefit plans will begin to look far healthier. The drain of huge pension contributions on corporate and state and local finances will ease and employees might feel more inclined to save when they can see a decent return. Better and more consistent educational programs might encourage adequate, regular contributions to defined contribution plans by preparing individuals to assume more responsibility for achieving their retirement income goals.

Mr. Fink suggested employers should step up efforts to encourage greater retirement savings through more education of participants, better corporate matches and enhanced use of auto enrollment. In addition, he said, the money management industry needs to measure its “performance not against benchmarks, but against investors' long-term needs.”

When the economy improves, if the retirement savings crisis does not improve with it, then an element of compulsion through mandated contributions to the current defined contribution plans might be needed.

But what most employers and participants do not need is a new mandatory plan adding to their existing plans. This will simply add to confusion. The rules for existing plans are well established, and many service providers can help small companies establish simple 401(k) plans if such companies are ordered to do so.

By all means look at the systems in other countries to see if they have ideas we can borrow to improve our system, as Mr. Fink suggests. But we must be fully aware of the differences. In Australia, one country Mr. Fink suggested we emulate, the mandatory defined contribution system supplements a heavily means-tested government-provided pension funded out of general revenue. The U.S. pension system supplements Social Security, from which all who contribute receive a benefit.

Let's try to fix the flaws in the current menu of plans, if necessary requiring employers to provide plans and employees to contribute to them. But let's not add another plan design either by junking what we have and replacing current plans, or adding another plan to the mix with the attendant new rules and regulations.

This article originally appeared in the May 27, 2013 print issue as, "Fixing the system".