Facing an American Retirement Security Crisis

Policy Paper
May 17, 2010

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.

[1] Purcell, P. Income of Americans aged 65 and over, 1968-2008. Congressional Research Service. November 2009.
[2] Organisation for Economic Co-operation and Development. Pensions at a Glance, 2009. Retirement-Income Systems in OECD Countries. 2009.
[3] Federal Reserve. Flow of Funds Accounts of the United States, Z.1. March 11, 2010. Available at: <http://www.federalreserve.gov>
[4] Deutsche Bank. Drowning in Debt: a look at “underwater” homeowners. Securitization Reports. North America. 5 August 2009.
[5] Munnell, A, Webb, A. & F. Golub-Sass. The National Retirement Risk Index: After the Crash. Center for Retirement Research at Boston College. No. 9-22. Oct. 2009
[6] Ibid.
[7] Novy-Marx, R. and J. Rauh. The liabilities and risks of state-sponsored pension plans. Journal of Economic Perspectives. Vol. 23, No. 4. Fall 2009. Pp 191-210.
[8] Government Accountability Office. State and local government retiree health benefits: Liabilities are largely unfunded, but some governments are taking action. Report to the Chairman, Special Committee on Aging, and the U.S. Senate. Report GAO-10-61. November 2009.
[9] City of Los Angeles Comprehensive Annual Financial Report, 2009. Available at: <http://controller.lacity.org/stellent/groups/ElectedOfficials/@CTR_Contributor/documents/Contributor_Web_Content/LACITYP_009064.pdf>
[10] City of New York Comprehensive Annual Financial Report, 2009. Available at: <http://www.comptroller.nyc.gov/bureaus/acc/cafr-pdf/cafr2009.pdf>
[11] First American CoreLogic. Media Alert: First American CoreLogic releases Q3 negative equity data. September 2009.
[12] Social Security Administration Board of Trustees. Annual report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds. Tables VI.F10, V.C.1, and III.A3. Washington, D.C. 2007.
[13] Ibid.
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