By Sadaf Knight

Introduction

A generation ago, workers could count on being able to participate in a pension plan provided by their employer. In the mid-1970s, almost three-quarters of American workers had plans that guaranteed a certain percentage of their income, providing a secure savings plan to rely on for the future.¹ Upon retirement, workers could be sure that their hard work would pay off and that they would be able to pay for their needs and enjoy a decent quality of life. However, these types of retirement plans, known as “defined benefit” plans, have been on the decline in the decades since, making them increasingly scarce. In fact, by 2007, only about a third of employees had access to defined benefit plans.²

As defined benefit plans have declined, another type of retirement plan—“defined contribution” plans—has taken their place. The structure of defined contribution plans is significantly different from defined benefit plans; rather than guaranteeing a portion of the employee’s income, these plans require workers to make their own contributions that are then invested in the market. Employers can choose to make contributions toward their employees’ plans, but are not obligated to. As of 2003, only 45 percent of employees (at firms of more than 100 employees) participated in defined contribution plans with employer contributions.³ Consequently, the burden of saving and investing is shifted mostly onto the employee, whose investments in their retirement funds are subject to economic fluctuations.

Whether a defined benefit or defined contribution plan, overall 67 percent of workers still have access to some kind of retirement planning opportunity through their workplace.⁴ But this still leaves out a large segment of the workforce that has no access to employer-sponsored retirement plans at all. Many employers do not provide pension plans, leaving workers to plan and save for their retirement on their own. This not only jeopardizes the retirement security of individual workers, but also raises the question of how we, as a society, will care for the elderly who do not have enough resources to provide for their own needs. Currently, people aged 65 and older comprise about 14 percent of the Commonwealth’s population; by 2030, they will comprise 21 percent. As this population grows, the issue of retirement savings and the financial security of retirees will become essential to the health of our citizens and the state as a whole.

The key to solving this issue will be expanding retirement savings opportunities to those who have been excluded. Establishing a statewide Universal Voluntary Retirement Account (UVRA) program — a state-sponsored retirement system that businesses can easily participate in at low cost—can be a solution. In light of the current state of retirement savings among American workers, UVRA has the potential to expand access to many thousands of workers.

Why is Retirement Planning Important?

Retirement income is often described as a three-legged stool, each leg representing a different source of income to support workers when they reach retirement age: Social Security, personal savings, and retirement pensions. Each leg contributes to the overall financial security of individuals during retirement. As such, it is important that workers have the opportunity to save throughout their careers in order to pay for their basic needs and secure a decent quality of life upon retirement.

Personal savings are usually not sufficient to support even the basic needs of people as they age. A look at how much people save for retirement (Figure 1) shows that 40 percent of retirees have saved less than $10,000 for retirement, and over half of them have saved less than $25,000 (the first and second bars combined). This includes savings and investments (including defined contribution plans), but does not include the value of homes or defined benefit plans. Workers who do participate in an employer-sponsored defined contribution plan are three times as likely to report savings of at least $50,000, compared to workers who do not participate.⁵

One way to determine the value of retirement savings is to examine the cost of annuities, which are investments that individuals can purchase at retirement age that then provide regular payments for as long as the individual is alive. At $25,000, a person can purchase an annuity that will provide estimated monthly payments of $162 ($1,944 annually). At the highest end, however, an annuity purchased at $250,000 would provide monthly payment of approximately $1,617 ($19,404 annually).

What do these figures mean? The Elder Economic Security Standard estimates the cost of living for elderly residents in Massachusetts, taking into account housing, food, travel, and health care. Depending on where the person lives, their health care needs, and housing costs, the standard ranges between $14,700 and $28,100 annually in Massachusetts.⁶ When compared to the retirement savings described above, even the higher-cost annuity would barely be sufficient. Of course, most retirees do not rely on savings alone; however, even when combined with Social Security—two of the three legs supporting retirement income—many retirees would still struggle to make ends meet.

As a result of low savings, and because many workers are not offered the opportunity to participate in retirement plans offered through employers, more and more people are relying on Social Security as their primary retirement income source. Low-and moderate-income individuals, in particular, rely heavily on Social Security. For those in the lowest-income quintiles, Social Security comprises roughly 80 percent of retirement income (see Figure 2). Though Social Security is a stable source of income, it does not provide enough of an income to support a stable quality of life. For many individuals in the higher-income quintiles, pensions, earnings, and income from assets comprise a larger share of retirement income, providing a more diversified income source and greater financial stability. Some individuals in these quintiles are still working full- or part-time out of necessity and will move to lower quintiles when they stop working. As shown in the chart below, pensions comprise 24 percent of retirement income for individuals in the fourth quintile and 18 percent for individuals in the fifth quintile.⁷

As of December of 2008, the average annual Social Security benefits in the state was approximately $12,844—between 13 percent and 54 percent lower than the amount needed for elderly residents to cover their basic needs and expenses, as shown in Figure 3.⁸ Of course, this assumes that the retiree is relying solely on Social Security income. As Figure 2 illustrates, many of those in the lowest-income quintiles have some amount of savings (referred to as “asset income” in the chart). However, in addition to a more heavy reliance on Social Security, those with lower and moderate incomes do not have enough in personal savings to significantly increase their retirement income. On average, asset income is only 3.3 percent and 5 percent of the retirement income of the individuals in the first and second income quintiles, respectively, translating to an additional $346 to $931 annually—hardly enough to bolster retirement incomes and provide economic security.

It is clear that retirement planning plays an important role in the financial security and quality of life for retired workers, while personal savings and Social Security alone are not enough. Being able to participate in retirement plans is a key component of building up an adequate savings. However, if the plans are not offered through employers, then as the research shows, many workers are excluded from the opportunity to adequately plan for their future.

1. US Department of Labor. Employee Benefits Security Administration. "Private Pension Plan Bulletin Historical Tables and Graphs." January 2009. http://www.dol.gov/ebsa/pdf/1975-2007historicaltables.pdf

2. Ibid.

3. For employees in firms of more than 100 employees. Employee Benefit Research Institution. Databook on Employee Benefits. Chapter 4: Participation in Employee Benefit Programs. http://www.ebri.org/pdf/publications/books/databook/DB.Chapter%2004.pdf

4. US Department of Labor, Bureau of Labor Statistics. "Employee Benefits in the United States, March 2009." http://www.bls.gov/ncs/ebs/sp/ebnr0015.pdf

5. Employee Benefit Research Institution. 2010 Retirement Confidence Survey. March 2010. http://www.ebri.org/pdf/briefspdf/EBRI_IB_03-2010_No340_RCS.pdf

6. Elder Economic Security Initiative. “The Elder Economic Security Standard for Massachusetts.” December 2006. http://www.wowonline.org/ourprograms/eesi/state-resources/documents/MAEESI2006.pdf

7. US Social Security Administration, Office of Retirement and Disability Policy. “Income of the Population 55 or Older.” 2006. www.socialsecurity.gov/policy/docs/statcomps/incom_pop55/2006/

8. Social Security Administration. Boston Region. http://www.ssa.gov/boston/MA.htm