Facing an American Retirement Security Crisis

There are
three main sources of retirement security upon which Americans depend: pensions,
non-financial assets (usually homes), and Social Security. Pensions are
the least broadly distributed asset: only 34.2 percent of Americans 65 and over
earn pension income, while 54 percent have income from assets and over 85 percent
receive Social Security payments.[1] (See Chart 1)

The Great Recession has taken its toll on two of these
resources: pensions and home values. American pensions were some of
the hardest hit in the world, falling in value by over a quarter in 2008.[2] 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 percent drop.[3] 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.[4] (See Chart 2)

As a result,
about half of all Americans are at risk of not having sufficient retirement
income(70-80 percent of pre-retirement income levels), and fully 60 percent of
low-income households are at risk of not having sufficient income to maintain
their pre-retirement standards of living at age 65.[5]

But attributing this grim situation solely to the recession would be
misleading. In 2004, 40 and 53 percent of middle-and lower-income
Americans, respectively, were already at risk of having insufficient retirement
funds, indicating that significant retirement insecurity existed prior to the
Great Recession.[6]

In fact, the poor state of Americans’ retirement security was brought
about by deeper structural problems in retirement savings patterns, due to
several trends, including:

• A troubled transition from defined-benefit to
  defined-contribution plans,
• Widespread underfunding of public pensions, and
• Families relying too heavily on rising home values for
  retirement security.

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 risk onto workers through a movement from
defined-benefit to defined-contribution and 401(k) retirement
plans. Individuals therefore began to bear the full risk of fluctuations
in stock and investment returns. (See Chart 3)

Second, state and local governments, tied to defined-benefit pension
promises, are now experiencing severe underfunding gaps. States have
funded about 80 percent of their pension liability, leaving a $3.32 trillion
funding gap – an estimate which understates the shortfall due to investment
declines from the latter half of 2008.[7] Put another
way, fully 34 states have underfunded their public pensions by at least 20
percent of their gross state product. (See Chart 4)

Ohio and
Rhode Island are in the worst shape, having underfunded their pensions by
almost 50 percent of their gross state product. Novy-Marx and Rauh
conclude that there is a less than a 5 percent chance that the current pattern
of pension fund investments can fulfill obligations to retirees in 15 years.

In addition to pension liabilities, 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.[8] This
underfunding predates the Great Recession.

City governments are also in trouble. 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 employee retirement plan is short by over 100
percent of payroll.[9] Also, 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 percent of payroll, Police by over 300 percent, and
Fire by almost 530 percent.[10]

Third, families’ over-reliance upon ever-rising home values for
retirement security has become devastating with the rupture of the housing
bubble. About 13 million Americans – almost 30 percent of all residential
properties with mortgages – are now in negative or near-negative equity
situations, meaning they owe more on their mortgage than their home is worth.[11] (See Chart 5)

Why is this so damaging for Americans’ retirement security? Home
ownership accounts for the largest proportion of assets for all but the richest
5 percent of the population. The bottom 50 percent had therefore not saved
enough in secure financial assets and pensions to weather the bursting housing
bubble with less damage to their retirement savings.

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
them.

What role is played by the third leg of retirement savings:
Social Security? The bottom two income quartiles (making less than
$18,208) depend on Social Security for over 80 percent of their aged 65+
income, but even the second richest quartile still depends on Social Security
for over 50 percent of its retirement income. (See Chart 6)

Social Security reduces and spreads market risk for individuals, but
provides much less than the 70-80 percent of pre-retirement income needed to
maintain pre-retirement standards of living. It is estimated to replace
less than half of pre-retirement income for the average wage earner with a
continuous work history.[12] But in
reality, workers do not work steadily their entire lives, and Social Security
replaces only about 33 percent of their average wage from the year prior to
retirement.[13] (See Chart 7)

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 but under-funded defined-benefit pensions, what are our policy
options? Strengthening Social Security would be a start.