Secure retirement starts to slip away for workers

By DON McINTOSH, Associate Editor

Before 1935, “ending up in the poor house” wasn’t just a figure of speech. The poor house was where the destitute went to die.

Known also as the “poor farm,” the “alms house,” or the “county home,” the “poor house” was begun as an all-purpose American institution in the mid-nineteenth century. At first it housed not just paupers but drunks, madmen and unwed mothers. By the 1920s, reformers had diverted those other groups into special institutions, and the indigent old — those who were no longer able to work and had no family to support them — stayed on as poor houses’ majority residents.

Virtually every county had one. Multnomah County’s poor farm was built in 1911 in Troutdale to replace an earlier one in Portland’s West Hills. That poor farm still stands today, made over as a hotel and brewpub.

“Poor houses were awful places,” said University of Pennsylvania historian Michael Katz. Residents lived without privacy in dirty, disease-ridden quarters, were served bad food and lacked anything to do.

The Census Bureau estimated in the mid-1920s that as many as 150,000 Americans were living in poor houses at any one time. They peaked in population in the 1930s, swelled to overcrowding by an influx of jobless workers driven to destitution by the Great Depression.

And then came Social Security, and everything changed.

Social Security gave life to a new idea about old age — the idea of retirement.

It set an official retirement age — 65, and said that workers who contributed by paying Social Security taxes could receive a benefit in old age. Benefits were small at first, but they provided a foundation that enabled large numbers of workers, for the first time, to be able to live without working when they reached old age.

Unions lobbied to increase Social Security benefits, and at the same time, to supplement Social Security, some unions began to negotiate employer contributions to union-run pension plans.

Craft unions had gotten into various kinds of benefits early on. Like the Masonic and other fraternal orders they sometimes resembled, unions in the 1920s were organized as mutual aid societies. In an age before broad government programs, unions created funds to which workers subscribed by paying dues that would help them in the event of severe economic hardship.

As unions gained in strength, they became a force pressing for more generous retirement benefits.

Anti-union forces struck back in 1947 with the Taft-Hartley law, named for Republican Senator Robert Taft and Representative Fred Hartley, which reversed some of the legal gains unions had won in the 1935 National Labor Relations Act. One of Taft-Hartley's provisions included a prohibition against employers giving anything of value directly to unions. That meant unions could no longer run their own benefit trusts if companies were contributing. Trusts to which employers contributed as part of a collective bargaining agreement would have to be jointly administered by management and labor. That’s why union benefit trusts are sometimes called Taft-Hartley trusts.

The late 1940s Republican Congress frustrated union attempts to expand Social Security, so unions attempted to win at the bargaining table — employer-by-employer and industry-by-industry — what they had been unable to win politically as a universal right: a guarantee of secure retirement.

For 30 years, they made progress. Congress extended Social Security benefits to survivors and the disabled, and increased benefits. And private pensions became more common and more generous, aided by federal tax policies that treated pension contributions separately from wages. Union ranks swelled to 35 percent of the workforce, and union contracts — with guaranteed pensions — set the standard for the entire workforce.

The turning point was the 1970s.

To protect Social Security beneficiaries against rising prices, Congress passed a law making annual benefit adjustments for inflation. But wages also stagnated in the 1970s — and wages are the basis for Social Security contributions. That put Social Security in a financial crisis, and to solve the crisis, Congress adopted the recommendations of a 1983 commission led by Alan Greenspan: increasing Social Security taxes and decreasing benefits by taxing the Social Security checks of higher-income workers and gradually raising the retirement age.

From 1937 to 1983, Social Security benefits had only risen; the 1983 law, for the first time, set a long-term course for reining in that growth.

Meanwhile, a titanic shift was under way in employer-provided pensions.

Prompted by some cases of employers defaulting on their pension promises, unions had pushed for and won a law in 1974, the Employee Retirement Income Security Act (ERISA). The law required employers to adequately fund whatever pension promises they made. ERISA restricted the use of those funds. And it set up a government entity, the Pension Benefit Guarantee Corporation, to administer pensions to workers whose companies went out of business.

ERISA was based on the idea that the assets in pension funds were held in trust; the funds could only be used for the benefit of employees, and employers had an obligation to invest those funds prudently.

But what if employees were given a choice in how the funds were invested? Could employers then be relieved of the responsibility of guaranteeing a monthly check upon retirement? Could employers still get tax advantages with a pension plan that defined “contributions” but not benefits?

ERISA raised the question, but it took a 1978 tax law and a subsequent ruling by the IRS in 1981 to give the answer, making it clear to employers that such a “defined contribution” approach was legal.

Thus was the 401(k) born, named after the section of the tax law that made it possible: Title 26 of the U.S. Code, Subtitle A, Chapter 1, Subchapter D, Part I, Subpart A, Section 401, subsection K.

The legal language is not easy to understand, but the key thing about the 401(k) is that unlike traditional pensions, employees bear the consequences if the investments don’t do well. In effect, a 401(k) is a kind of tax-deferred savings account. Workers are given some limited choice as to how the money is invested.

Because it’s just a pile of assets with no promise of benefits attached, 401(k)s can follow workers from employer to employer, whereas the traditional pension was tied to a work history at an individual employer. And it doesn’t even have to be used for retirement; workers can borrow against their 401(k) account for certain purposes, and can even cash out the account when changing jobs, though they pay a tax penalty since the money in the account was never taxed.

At first, the 401(k) was seen as a kind of supplement to the traditional “defined benefit” plans sponsored by employers.

But increasingly, 401(k)s are replacing defined benefit pensions.

“We’ve seen a dramatic transition in the retirement system over the last 20 years,” says Edward Wolff, research associate with the National Bureau of Economic Research.

Among households nearing retirement (head of household aged 56 to 64), 70 percent were covered by an employer-sponsored defined benefit pension plan in 1983. By 2001, just 47 percent of households nearing retirement were covered by such a plan. In 1983, 9 percent of households nearing retirement had 401(k) style defined contribution plans; in 2001, 59 percent had such plans.

Overall, according to the most recent survey by the Federal Reserve, in 2001, 57.1 percent of families had rights to some type of retirement plan other than Social Security through current or past work. Of such families, 43.5 percent had only a 401(k)-type plan, 35.3 percent had only a defined-benefit plan, and 21.1 percent had both.

An estimated 42 million workers have 401(k) plans today, while the number of workers plus retirees in defined benefit plans is 44.4 million.

Frequently, employers provide both kinds of plans. But the trend is clearly in the direction of 401(k)s, and pension experts say that bodes poorly for workers’ retirement security.

“The 401(k)s were really never devised to be the sole retirement vehicle. Everybody in the business knows they’re not sufficient,” said Teresa Ghilarducci, a retirement policy expert at the University of Notre Dame.

Fully one-third of workers who are eligible to participate in a 401(k) fail to enroll at all. Of those who do participate, less than 10 percent contribute the maximum. And about half the people who have a 401(k) withdraw funds from it when they lose their jobs, or cash out the accounts when they change jobs.

As a result, the typical household approaching retirement has only $55,000 in its 401(k) account — not much to support two decades in retirement.

“I don’t think people understand the magnitude of the amount of money they need when they retire to maintain their standard of living,” Ghilarducci said. “It’s nothing near $50,000. It’s more like a half a million.”

“If you’re a young worker today and the only pension you have besides Social Security is a 401(k), then you’d better work every single year for 40 years and contribute 15 to 20 percent of your salary every single paycheck, in order to replace what you need to maintain your standard of living.”

In addition, because contributions are voluntary in most 401(k) plans, 401(k)s are exacerbating income inequality among retired workers. Lower paid workers are less likely to participate at all, and if they do participate, they usually contribute a smaller percentage of their salaries.

In the modern era, it’s often said that a secure retirement is a three-legged stool consisting of individual savings, employer pensions, and Social Security. All three of those legs are in danger.

• Individual savings have declined substantially over the last 30 years, and savings has come to be cancelled out by debt for most Americans. At the same time, home values are up, but inflation and an increase in home equity loans and other mortgage debt have negated the impact on wealth.

• Defined benefit pensions are less common and less secure, as growing numbers of traditional employers default on pension obligations or go out of business. And defined contribution (401(k)-style) pensions are under-funded and more vulnerable to stock market risk.

• Social Security is projected to suffer a 25 percent shortfall four decades from now, but rather than contemplate increasing contributions, President George W. Bush is proposing to cut benefits via “progressive indexing” and to divert needed revenues into individual private investment accounts.

Critics argue that private accounts are unacceptable because they introduce risk into the one remaining guarantee.

“The relative importance of Social Security has increased,” said Christian Weller, economist with the Economic Policy Institute. “We need to pay more attention to maintaining Social Security rather than cutting benefits.”

For most workers, retirement security is not a stool, but a pyramid, Ghilarducci argues — with the largest portion, the base, coming from Social Security.

The rule of thumb is that retired workers need 75 percent of pre-retirement income to maintain their standard of living. Under current law, Social Security promises a replacement rate of about 42 percent for workers who earn the economy-wide average wage, and about 56 percent for low-wage workers, who earn 45 percent of the economy-wide average wage.

Social Security is the only source of income for one-third of Americans 65 and older, and it’s the biggest source of income for two-thirds of those 65 and older.

The average monthly Social Security benefit is $955 for a single retired worker and $1,574 for a couple where both are beneficiaries. Today the poverty rate for those age 65 and older is 10.2 percent – a historic low. Without Social Security that rate would rise to almost 50 percent.

A study released by Weller and Wolff in May offers detailed evidence that Social Security is now at the heart of any improvement in retirement security. Wolff told the Labor Press that if current trends continue, 2001 may prove to be the high-water mark of retirement security.

Americans are already reacting to a decline in retirement security by postponing retirement.

Workforce participation rates have been on the rise for Americans over 55 since the 1980s, even as they declined for the population as a whole. And the official retirement age is going up under the Greenspan plan. For more than six decades, the official retirement age — the age at which Americans could collect full Social Security old age benefits — was 65. That age began going up by two-month increments in 2003; now it’s 65 and a half. For those born between 1943 and 1954 it will be 66; for those born 1960 or later it will be 67. Workers can still start getting Social Security benefits as early as age 62, but permanently lose about half a percent of their benefit for every month early they retire. That works out to just under 25 percent for workers who retire today at age 62.

If President Bush succeeds in enacting his proposed privatization of Social Security, the well-being of future retirees may depend almost entirely on how well the stock market is doing when they retire. If their investments do exceptionally well, they may be able to retire comfortably. But if the market crashes before they retire …

© Oregon Labor Press Publishing Co. Inc.