For decades, the U.S. retirement system was described as a three-legged stool. One leg was the Social Security system, the second was the employer-sponsored retirement plan, and the third was personal savings.
Unfortunately, all three legs of this metaphorical stool have become fragile. The first to weaken was personal savings, as the individual- savings rate dropped from almost 9% per year in the 1970s to close to zero before the recession.
Fortunately, this is the one leg that individuals can do something about, and they are. Since the onset of the recession, the personal-savings rate has increased to more than 4% per year — not enough, but a start.
During the Reagan administration, the Social Security system was supposed to have been put on a stable long-term footing by a FICA tax increase and benefit cuts that Congress implemented following recommendations of the National Commission on Social Security Reform, headed by Alan Greenspan.
But Social Security now looks fragile too. The Social Security fund is expected to begin drawing down its reserves by 2016 and exhaust them by about 2037.
Further FICA tax increases or benefit cuts will be needed in the not-too-distant future to preserve the system. Unfortunately, Congress has been reluctant to tackle reform of Social Security, and President Obama has put it on the back burner.
The third retirement leg — the employer-sponsored plan — also is in poor shape. The portfolios of millions of individuals who are relying on their 401(k) or other defined contribution plans to finance their retirement have been hard-hit by the bear market.
Those near retirement may have suffered permanent damage.
Many of the remaining defined benefit plans also have been seriously hurt by the bear market, and more large companies may decide to terminate or freeze their plans, replacing them with 401(k)s. Even public employee plans may have to seek increased contributions from their state or local government sponsors at a time when tax revenue is declining and budget deficits are surging.
The market may recover and make many retirement plans and 401(k) participants whole, but weaknesses will remain, especially in 401(k) plans, and they must be corrected.
Robert Reynolds, president and chief executive of Boston-based Putnam Investments, is on the right track in proposing changes to 401(k) plans to reduce the risks for participants and in urging other financial industry leaders to join him in pushing Congress for action, as reported in InvestmentNews last week.
He has identified the two most critical changes that are needed. First, all employers should be required to enroll all employees in a 401(k) or similar plan, and all employees should be required to contribute a minimum percentage of their pay to the plan.
This would address the greatest weakness of the U.S. retirement system — the significant number of private-sector workers who aren't participating in any retirement plan.
Just 66% of full-time workers participate in such plans at large and midsize companies, and just 37% at small companies, ac-cording to the Employee Benefit Research Institute of Washington. Small companies, especially those with very slim profit margins, may need government assistance with the costs of starting and running such plans.
Second, employees must be given an opportunity and encouragement to annuitize a significant part of their retirement plan assets beginning at 50. Annuitization minimizes the damage to retirement in-come that can be caused by a major bear market as retirement approaches.
Although many other improvements to 401(k)s and similar plans are possible, these two would go a long way toward helping private-sector workers build a comfortable retirement.
The recession and bear market have revealed the weaknesses of the U.S. retirement system.
Perhaps the downturn also will spark the reforms needed to strengthen it.