By John Siciliano
The grab bag of retirement programs that has become the U.S. pension system is getting threadbare. Pension plans are underfunded by $300 billion-plus; many 401(k)s and individual retirement accounts are below their initial investments; and Social Security will start running a deficit around 2017. Yet the focus in Washington is on patching the holes, not looking at the big picture.
We need a well-crafted retirement strategy for all Americans — one that aligns the interests of citizens, government and business. To accomplish this, we need a new federal agency, a Department of Retirement Security, including a semi-private U.S. Investment Management Co. The Department of Retirement Security's sole focus would be the retirement system, rather than having responsibility for the system chopped up piecemeal among different agencies, as it is today. It would entail a radical but sensible restructuring of the way the pension system is regulated.
The Treasury Department has been the master of all tax issues since the founding of our republic. Its focus is fund raising — not saving. It also determines such important but arcane issues as discount rates for defined benefit pension plans. We need an agency that takes the long view on retirement issues — not the short view consistent with ongoing revenue pressures. The Department of Retirement Security would be charged with this responsibility, as well as developing and monitoring the new retirement savings system and other plans designed to encourage long-term savings and investment.
The Department of Labor, the enforcer of the Employee Retirement Income Security Act, pays little attention to developing and modifying the structure underlying ERISA to be effective in today's pension environment. When ERISA was enacted in 1974, the United States was a different place. Today, the DOL is well intended but too often reactive, e.g., concerns over company stock in 401(k) plans post-Enron Corp.'s collapse. A new ERISA construct needs to be developed — but this rightfully belongs in an agency devoted to retirement and should be incorporated into an integrated plan.
Under our current system, most people don't have a clue as to how to choose their 401(k) or IRA investments. During the 1990s boom, most participants plunked a large share of their money into equities and rode the market up and then down, and many are still underwater today. That's why the number of employees in 401(k) plans plunged to 70% in 2002 from 80% in 1999 and the percentage of income set aside also dipped. Post-Enron, Congress has mandated that larger companies hire financial planners to help with these selections.
People need to be guided into fiduciarily correct investments: diversified portfolios, with modest returns, low fees and no sales charges. The ability to outperform markets depends neither on market timing nor on picking stocks. In fact, over 96% of the variation in stock returns is due to risk factor exposure. In other words, how you invest your assets across all asset classes is what determines your returns.
To pave the way for better investment choices by both private and government workers, I would propose a semiprivate U.S. Investment Management Co. under the Department of Retirement Security, similar to the newly created Accounting Oversight Board at the Securities and Exchange Commission. The U.S. Investment Management Co. would:
-- establish investment options considered appropriate from a fiduciary point of view for the private system, for federal employees and for federally sanctioned lifetime savings accounts;
-- develop appropriate standards for pension plans, pension plan trustees and pension plan participants, consistent with the highest standards of governance; and
-- provide investment analytics to the Pension Benefit Guaranty Corp. to ensure that companies covered by PBGC insurance are conforming to prudent investment guidelines.
The PBGC itself should be transformed into a private insurer with premiums sufficient to fund the train wrecks occurring among corporate pension plans. Instead of corporate managements being able to foist their company pension liabilities onto the public PBGC, the new Department of Retirement Security would take legal action on behalf of the PBGC against company executives who fail, whether intentionally or unintentionally, to uphold their fiduciary duties.
Social Security should be converted to a privatized system. The existing "pay-as-you-go" system taxes active workers to pay for the benefits to retired workers. The problem is that the number of retired workers is mounting, benefits are going up and increased payroll taxes reduce new hires. As L. Jacobo Rodriguez, a financial service analyst at the Cato Institute, Washington, noted, "payroll taxes artificially increase the cost of labor and thus have a negative effect on employment and distort the allocation of resources."
The United States should adopt a Chilean-style system, privatized in 1981. Among the features such a U.S. system might have:
-- Participation would be mandatory.
-- Each employee would deposit a fully deductible, fixed amount, e.g., 10% of salary, on a monthly basis up to some income cap.
-- Each person may contribute additionally, up to a certain limit, also tax deductible. Each individual owns his or her account, allowing people to better track their assets as they grow, providing a strong incentive to keep saving.
-- The system would offer disability, survivor and long-term medical insurance, but premiums would not be deductible.
The existing Social Security program would be phased out by freezing benefits for participants over a certain age, e.g., 50, and raising the retirement age for those grandfathered participants. Younger people would convert to the new plan. Assistance to widows and children would be cut from Social Security and dealt with separately within the Department of Health and Human Services.
Nobody wants government acting as a parent. But given our dramatic shift over the last 50 years toward impatient and often imprudent financial behavior in our country, we need to bring our society back to center and provide the tools and structure to advance the important social agenda of saving for retirement.
John Siciliano is director of global institutional services at Dimensional Fund Advisors Inc., Santa Monica, Calif.
