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Retirement Planning Holds Challenges, Opportunities

Public Affairs Forum
March 9, 2011

Moderator: Roger, welcome to the Federal Reserve Bank of Atlanta. As CEO of TIAA-CREF, you must see every side of planning for retirement among the four million teachers and researchers you serve. We're really glad to have this opportunity to speak with you about retirement issues.

Photo of Roger FergusonRoger Ferguson: Thank you very much, nice to be here.

Moderator: What are some of the challenges for America's pensions and public pensions in particular?

Ferguson: Well, let's start with the current situation and talk about how to repair it. Currently we see that all three legs of America's retirement system are under stress. Historically, twenty or thirty years ago, many, many workers had a defined benefit plan, up to 85 or 90 percent. Now only about a third of people in the private sector have a defined benefit plan.

The second thing that we certainly know to be true is that the 401k system, which was never meant to be the primary system, had become the primary system for many people for saving for retirement, and as we've already talked about, that's been under a huge amount of stress because of market turmoil. But even before the market stress, it turned out that people were saving far too little. By some studies it seemed as though the average American family had a shortfall of $250,000 in their savings.

We certainly need to get more Americans enrolled in a retirement system of some sort—now, about half of Americans aren't in any retirement system—and we need to encourage them and incent them to save more. The evidence is that between an employer and an employee, the average American needs to have saved 10 to 15 percent of annual salary in order to build a fairly safe and secure retirement.

We really have to make sure that people have the right range of choices in their retirement options. It turns out that in many retirement plans there are far too many choices and people are stymied with too much choice. Sometimes there are too few choices and by definition you have too few choices. The behavioral economists sort of indicate to us that fifteen to twenty choices seems about the optimal number, so we have to give people the right number of choices.

The third element of stress is Social Security. It has been much discussed that in a few years the inflows into Social Security will be less than the outflows from Social Security if one abstracts from the investment returns. And the trustees have already talked about potential stresses and strains going forward in the future. So all three legs of the retirement system have been under stress.

A fourth element that we haven't talked much about is the need to save for health care expenses in retirement. There's been one study that shows that the average couple, age 65 today, may need anywhere from $200,000 to $800,000 of savings just for health care expenses in retirement. That's a daunting number for everybody.

And finally, the new retirement system that I think we need really should provide an option for guaranteed income for life for everybody. The real risk for many, many Americans is that they will outlive their savings. So a guaranteed income option in the form of an inexpensive simple annuity, I think, is the fifth element of a retirement system for the future of America.

Moderator: Do you see any solutions or preferred outcomes from the public pension system squeeze?

Ferguson: Well, the public pension system—the system for people employed in the public sector—is confronting some significant stresses. Three things are happening. First, obviously many state, county, and municipal budgets are under stress and taxes are off because of the economic crisis.

Secondly, we are seeing a number of people starting to retire as an aging population—the baby boomers—this year in 2011 will start to reach sixty-five. So they are starting to reach a retirement age.

And the third thing that is happening is taxpayers are showing a great deal of reluctance to continue to fund some of these systems, and all of these systems, or many of them, are significantly underfunded. So there are a number of challenges confronting the public sector pension plans right now.

It's clear to me that those who are leading the public sector are really going to have to start to think about redefining, repairing, and rebuilding public sector pensions, just as America has to rebuild the entire pension system. In the public sector, I think it's clearly going to be the case that it's going to have to become more of a shared responsibility, probably moving away from defined benefit systems, which have been the norm, towards some form of a hybrid system—bringing in elements of a defined contribution system, having both employers and employees making contributions, with some elements of a defined benefits system—so that public sector workers can have some certainty about what their retirement may look like.

It's also quite clear that all of us are going to have to figure out what tax burden we as taxpayers want to live with in order to deal with the underfunded nature of the public sector pensions. So there's going to have to be some burden sharing, if you will, for sure.

And then the big issue is going to be transition. Those who have been in the public sector for some time and have reasonable expectations of one type of retirement, a defined benefit system, may be in a very different place from the new hires who may find themselves moving into a hybrid DCDB—defined contribution defined benefit—system. So you've got issues of rebuilding and then you've got the issues of the transition.

Moderator: On this issue of burden sharing, what do we say to taxpayers who question why they should pony up money to support the pension obligations of public workers long retired?

Ferguson: That's a very good question. I think that what one says to a taxpayer is, clearly, there are many, many benefits that came from having police departments, fire departments, and public school teachers providing those very important public services. Many individuals went into those roles knowing that their salaries might be somewhat lower than they could otherwise get in the private sector. But on the other hand, their benefits might be more certain. So I think you really have the implicit or explicit social contract that exists between a government and its workers. And at the end of the day, we all understand that governments only have one source of revenue, which is taxes. So that's sort of the story that one has to discuss with the taxpaying public.

On the other hand, the public employees also have to understand that from the eyes of many taxpayers who have seen their defined benefit plans erode, the question of paying taxes for someone else's defined benefit plan—because that person happened to be a public sector employee when private sector employees no longer have the benefit of such guaranteed income—creates some stresses and tensions. So I think there is really a dialogue to be had here in which everyone is educated about the other person's point of view and then, with that general understanding, we move forward to reform the public system in a way that's fair to everybody.

Moderator: Do you see special problems for minorities in saving for retirement?

Ferguson: There are a number of problems for minorities. First, obviously that class of individuals has been more heavily hit by the economic crisis. Here at the Fed in Atlanta and I'm sure across the System, everyone is well aware that the unemployment rate for minorities is higher than the unemployment rate for the rest of America. So their financial wherewithal is not as strong.

Secondly, that population started off with a smaller pool of assets, and so not only have they been heavily hit by unemployment, but they have less of a safety net to fall back on. So there are bigger challenges in terms of their wherewithal to start to save, and I think even a greater skittishness about what to do with their savings because they don't have that safety net to fall back on.

Moderator: The Obama Administration has reached out to you to serve initially on the Economic Recovery Board, and it's now the Jobs and Competitiveness Council. Again, it's a new charge—it's only been in place for a couple of months now—but can you tell me a little bit about what the responsibility of this group is, and what are some of the challenges facing America when it comes to jobs and competitiveness?

Ferguson: The responsibility of this council is both short term and long term. So the first part of the mandate is to ask are there specific government policies that can be put in place, relatively quickly, to help continue the process of bringing the unemployment rate down? And we all know that means creating more private sector jobs.

Then there is a second component, which is in the long term there are many, many strong economies around the world. One of the hallmarks of America's success is that we've been very competitive in terms of productivity and productivity improvements for the last fifteen or twenty years. And so the question is, what should we do going forward? Now, obviously the kinds of solutions that one might recommend will vary. So for the short term, there are questions of corporate tax rate, for example. There are questions of infrastructure and how the federal government might incent more investments in the right kind of infrastructure, as the president has talked about. So those are some of the things we are certainly looking at.

In the longer term, many of the challenges around competitiveness deal with education, and again, the same such issues around infrastructure, which might have long-term impacts. The goal here is to create options for the president to consider and not to hone in on a specific recommendation. It's a very good group. It's a number of CEOs, plus leading academicians—macroeconomists in particular—and a number of individuals who are very sophisticated investors from Wall Street.

Moderator: Today we've been talking to Roger Ferguson, president and CEO of TIAA-CREF. We appreciate your time, Roger.

Ferguson: Thank you very much; it was a pleasure to be here.