Enhancing Future Retirement Income through 401(k)s
Kliesen, Kevin L., Regional Economist
With the retirement of the baby boom generation slated to get under say in about a decade, retirement issues are beginning to take center stage. Because Americans are living longer and retiring earlier, the number of years spent in retirement is also increasing. This means that the fUture strain on Social Security and Medicare-the two large public retirement programs that most elderly people rely upon a great deal-might be considerable. An additional uncertainty is the fact that the share of workers deriving their primary form of retirement income from traditional pension plans-also an important source of funds-continues to fall. Perhaps in response to these uncertainties, more and more people are beginning to supplement their retirement income through additional means, such as 401(k) savings plans.
Shades of Gray
Under current law, individuals can take early retirement at age 62. Thus, the first influx of baby boomers-those born between 1946 and 1964-beginning to draw Social Security and Medicare benefits will commence in 2008. When the last of the boomers reaches normal retirement age (67) in 2031, it is estimated that one-fifth of the U.S. population will be 65 or older (hereafter "the elderly"), compared with about 12 percent currently.l This graying of the population, which most other industrial countries also face, has spawned countless reports and studies that attempt to quantify its potential longterm economic effects. One such report is the Congressional Budget Office's annual Long-Term Budgetary Pressures and Policy Options. In the 1998 edition, the CBO estimates that, with no change in tax rates or benefits, the federal debt held by the public will reach an unprecedented 206 percent of GDP by 2050-nearly double the 122 percent at the end of World War II. Measured against this yardstick, the retirement of the baby boom generation has the potential to be a much greater financial commitment than World War II ever was.
Regardless of whether these forecasts are accurate, the dilemma facing the nation is stark: Americans are living longer, retiring earlier but saving less. A person born in 1997 can expect to live a little more than 76 yearsabout a dozen years more than someone born in 1940 and nearly 30 years more than someone born in 1900. In addition, an increasing proportion of the average American's life span is spent in retirement. In 1960, for example, only 10 percent of eligible workers took early retirement at age 62; by 1995, this percentage had jumped to just over 58 percent. As a result, the average retirement age dropped-from 70 in 1945 to about 64 in 1995 (see chart above).
This widening gap between retirement age and average life expectancy presents a host of problems for businesses, policymakers and retirees themselves. For businesses, the problem is potentially quite serious: how to pay for the health and pension benefits due to an increasing number of retirees without sacrificing equally important obligations, such as new product development, capital expenditures or workforce training. Policy-makers face a similar dilemma: how to fund a retirement system that was designed at a time when the average retirement age exceeded the average life expectancy at birth.
Compounding this problem, the number of workers drawing benefits will soon start increasing much faster than the number of workers paying into the system. In 1950, the ratio of the working age population (20 to 64) to retirees (65 and over) was a little more than seven; by 2030, it is expected to be about three. The economic consequences of this demographic shift are potentially enormous for both future workers and retirees.
Can Social Security Shoulder the Load?
According to the 1998 annual report of the Social Security Trustees, the cost of the program is projected to exceed revenues by $ 700 billion (best case scenario) to $19.9 trillion (worst case scenario) in 2075. A middle-of-the-road projectionwhat the trustees call an intermediate cost estimate-pegs this unfunded liability at about $ 7 trillion. …