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Posted 6/21/2002
Economist James Poterba feels we have exchanged one set of risks for another. Related resources MSN Money's Retirement Planner can help you enjoy your golden years. Do you need a 401(k) Quick Check? How much money will you need to retire? Find out! |
Social Security can't keep up with your 401(k) The shift away from defined-benefit plans means the retiree of tomorrow has different risks to deal with. But here's why one economist thinks these plans will play a bigger role than Social Security in the future. By Scott Burns Through his office window in MIT's Alfred P. Sloan building, you can see the rise of Beacon Hill, the Charles River and its sailboats, and the salt-and-pepper-shaker stonework of the bridge that carries the "T" over the river and into Boston. The view, a central image in the movie "Good Will Hunting," may be the canonical view of Boston.
I've come to visit James Poterba, a startlingly young professor of economics, because he has devoted much of his research career to studying the issues of saving and retirement. My goal is to learn what the big picture looks like to a leading researcher. Shift to defined-contribution plans "We are currently seeing a dramatic shift in how households prepare for retirement. While we still have the three-legged stool of Social Security, private pensions and personal saving, all three are undergoing reform and change. "In 1975, about three-quarters of all retirement-plan money went into defined-benefit plans, where the employee is promised a lifetime income that is dependent on his income and work history. Those plans produced a guaranteed income in nominal dollars. Today, more than half the money is going into defined-contribution plans. In these plans, the retiree has the value of the account at retirement. "That shift creates a host of issues. One is the shift of responsibility from the firm to the individual. Others are whether the employee should join the plan, how much should be contributed, how assets should be allocated and how the money is to be withdrawn. "This has produced concern that some people are facing much more risk (than they were facing under the previous system of defined-benefit plans). I think that's a misapprehension." When I asked him to explain, he observed that the defined-benefit pension system had risks that people often overlooked. "An employee in a defined-benefit plan, for instance, could (need to) change jobs. (This works to reduce lifetime benefits.) In addition, the employer can change the plan." Basically, Poterba feels we have exchanged one set of risks for another. Today's defined-contribution plan system is likely to grow into a very significant pool of assets for retirees. How significant? "If today's retiree were to sell his Social Security benefits, he'd get about $100,000. By comparison, the average 401(k) balance is only $10,000 over all retirees. But if we continue the growth of 401(k) plans out to 2025, Social Security will still be worth $100,000, while 401(k) plans will also be worth about $100,000. "That suggests defined-contribution plans will play a much more important role in the future." When you consider that Social Security is the largest source of income for most retirees, "important role" is a major understatement. The numbers You can see the change by examining his research. Working with Steven F. Venti and David A. Wise, Poterba used survey data to project the growth of 401(k) assets for each income decile. It was then compared to the "wealth" implied by a lifetime income from Social Security. Although lower-income workers don't fare as well as higher-income workers, 401(k) participants with a 50/50 bond/stock portfolio would, on average, accumulate $113,400 in assets at retirement age by 2025. Average Social Security wealth would be only $103,400. Projecting another 10 years further, they found the average retiree would accumulate $151,000 in assets compared to $103,400 in Social Security wealth (all figures were adjusted for purchasing power to 1992 dollars). Projected mean 401(k) assets at retirement age by 2025 Figures reflect projected account balances based on survey data. Investments in 100% stock portfolios could produce larger assets, while 100% bond investments could produce smaller assets. An (a) indicates where the 401(k) assets exceed Social Security wealth.
What does it all mean? We've got a good engine for retirement -- but if you go beyond the averages, it needs some serious tuning for lower-income workers. 
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