Idea in Brief
The Risk Problem
The move to saver-managed defined-contribution pension plans—most notably 401(k)s—has increased the likelihood of a pension crisis down the line as the baby boomers retire.
Why It’s Happening
Pension savings are invested so as to maximize capital value at the time of retirement, an objective imposed by regulation. But the goal of most savers is to achieve a reasonable level of retirement income. This mismatch almost guarantees that savings are badly managed, because an investment that is risk-free from an asset value standpoint may be very risky in income terms. At the same time, the defined-contribution process requires savers who often have little or no financial expertise to make complicated decisions about risk.
The Solution
Investment practice and regulation need to be changed to prioritize income security over capital gain, and communication needs to focus on variables the saver understands and give a clearer idea of the likelihood of reaching a given income target rather than emphasize investment returns.
Corporate America really started to take notice of pensions in the wake of the dot-com crash, in 2000. Interest rates and stock prices both plummeted, which meant that the value of pension liabilities rose while the value of the assets held to meet them fell. A number of major firms in weak industries, notably steel and airlines, went bankrupt in large measure because of their inability to meet their obligations under defined-benefit pension plans.
