Über die Autorinnen und Autoren

<div><p><b>Alicia H. Munnell </b>is the Peter F. Drucker Professor of Management Sciences, Carroll School of Management, and director of the Center for Retirement Research at Boston College. She has served as assistant secretary of the Treasury for economic policy (1993&#150;1995) and as a member of the President's Council of Economic Advisers (1995&#150;97). She was also cofounder and first president of the National Academy of Social Insurance. Munnell has written or edited numerous books, including <i>Coming up Short: The Challenge of 401(k) Plans</i>, with Annika Sund&#233;n (Brookings, 2004).</p><p><b>Steven A. Sass </b>is associate director of the Center for Retirement Research at Boston College. He was previously an economist at the Federal Reserve Bank of Boston and taught at Rutgers and Brandeis. His books include <i>The Promise of Private Pensions: The First Hundred Years </i>(Harvard, 1997), <i>Social Security and the Stock Market: How the Pursuit of Market Magic Shapes the System</i>, with Alicia H. Munnell (Upjohn Institute, 2006), and <i>The Social Security Fix-It Book</i>, with Alicia H. Munnell and Andrew Eschtruth (Center for Retirement Research, 2007).</p></div>

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Working Longer

Brookings Institution Press

Chapter One

Every morning more than 100 million Americans wake up and head out to work. They grab a bite, get the news, then turn their attention to the issues they'll face that day. At times, however, it becomes necessary to look beyond this workaday routine and deal with issues that could disrupt one's life if not addressed. This is one of those times, and the issue is retirement.

A wake-up call regarding one's retirement should come as no surprise. The press is filled with calls to fix Social Security, shore up employer pensions, and make 401(k) plans work better. Indeed, Social Security benefits-relative to earnings-are declining. Employer pensions have become increasingly scarce. And 401(k) balances are generally inadequate. At the same time, longevity is steadily rising. The retirement challenge is typically framed as a financial problem, requiring more saving and better asset management or cuts in promised benefits. The challenge, however, is in many ways better framed as an employment problem.

According to the standard life-cycle model, rational actors respond to a rise in longevity and decline in Social Security and employer pensions in three ways. They spread the burden across the life cycle by consuming less and setting aside more of their income while working; they remain in the labor force longer; and they live on less in retirement. But the baby boom generation has not set aside more of its income while working. Nor do subsequent cohorts seem to be saving much more. This lack of saving puts more weight on the other two responses: working longer and consuming less in retirement. A failure to work longer shifts the entire burden to lower retirement consumption, implying a steep reduction in living standards upon exiting the labor force. Alternatively, the most effective lever for securing a comfortable retirement, especially for the baby boom generation now at the cusp with little opportunity to save, is to remain in the work force longer.

At first blush, it may seem strange to say: "You need to reduce your retirement to ensure your retirement." But it's not nearly as bad as it sounds. Because life expectancy has increased dramatically over the past several decades while the average age of retirement has fallen, working longer does not mean having fewer years in retirement than workers earlier in the postwar era. The working-longer prescription is not about no retirement at all; it's about beginning your retirement somewhat later.

Spending a few additional years in the labor force can make a big difference. It directly increases current income; it avoids the actuarial reduction in Social Security benefits; it allows people to contribute more to their 401(k) plans; it allows those plans to accumulate more investment income; and it shortens the period of retirement. By and large, those who continue to work until their mid-60s or beyond should have a reasonably comfortable retirement.

Working longer, however, will not be simple. It requires thought and planning on the part of individuals. It also requires employers to retain, train, and even hire older workers. Government also has a role to play. And the sooner everybody realizes that staying in the labor force is the best way to ensure a secure retirement, the better.

The Retirement Income Challenge

The major reason that people have to work longer is that the retirement income system is contracting. This system-Social Security and publicly subsidized and regulated employer-sponsored plans-is the major source of support for people as they withdraw from the labor force and as earnings decline. But Social Security and employer-sponsored retirement income plans will provide relatively less in the future than they do today. Employers have also backed away from offering retiree health insurance, leaving households exposed to rapidly rising health care costs. In addition, life expectancy is rising: for men, life expectancy at age 65 was less than fifteen years in 1980 but in 2020 is projected to be nearly eighteen years. Workers in the future will thus need more resources, not fewer, if they continue to retire at the same ages as they do today.

The Outlook for Social Security

At any given retirement age, Social Security benefits will replace a smaller fraction of preretirement earnings than in the past. Today, the hypothetical average earner retiring at age 65 receives benefits equal to about 41 percent of previous earnings. After payment of the Medicare part B premium, which is automatically deducted from Social Security benefits, the replacement rate is 39 percent. But under current law Social Security replacement rates are scheduled to decline for three reasons. First, the full retirement age is currently in the process of moving from 65 to 67, which is equivalent to an across-the-board cut. Second, Medicare part B premiums are slated to increase sharply due to rising health care costs. Finally, Social Security benefits will be taxed more under the personal income tax, as the exemption amounts are not indexed to inflation. These three factors alone will reduce the net replacement rate for the average worker who claims at age 65 from 39 percent in 2002 to 30 percent in 2030 (figure 1-1). This percentage does not include premiums for the part D drug benefit, which will also claim an increasing share of the Social Security check. Nor does it include any additional benefit cuts enacted to shore up the solvency of the Social Security program.

The Outlook for Private Sector, Employer-Sponsored Pensions

With a diminished role for Social Security, retirees will be increasingly dependent on employer-sponsored pensions. At any moment in time, however, less than half of the private sector workforce ages 25-64 participates in an employer-sponsored plan of any type. This fraction has remained virtually unchanged since the late 1970s and is unlikely to improve. Since pension participation tends to increase with earnings, only middle- and upper-income individuals can count on receiving meaningful benefits from employer-sponsored pension plans.

While the level of pension coverage has remained flat, the nature of coverage has changed dramatically. Twenty-five years ago, most people with pension coverage had a traditional defined benefit plan that pays a lifetime annuity at retirement. Today the world looks very different (figure 1-2). Most people with a pension have a defined contribution plan, typically a 401(k) plan, which is like a savings account. In theory workers could accumulate substantial wealth in a 401(k) and offset the decline in both Social Security and employer-provided pensions. Simulations suggest that the worker in the middle of the earnings distribution, who contributes regularly throughout his work life, should end up at retirement with about $300,000 in his 401(k) or individual retirement account (IRA). (Most IRA assets are rolled-over balances from 401(k) plans.) This amount, when combined with Social Security, could easily provide an adequate retirement income. But reality looks quite different. The Federal Reserve's 2004 Survey of Consumer Finances reports that the typical household head approaching retirement (ages 55-64) had combined 401(k) and IRA balances of only $60,000. Nor do younger cohorts seem to be on track to accumulate sufficient wealth...