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March 30, 2005 at 07:00 PM
A good retirement plan should have three components
By Jack Bobo
The current debate on Social Security should have at least one beneficial effect. Hopefully those who are following the discussions, particularly lawmakers, will develop a better understanding of what the system is and how it works. In my years in Washington I was struck by how few people on Capitol Hill and elsewhere had a firm grasp of what was happening. The best remedies come when there is full knowledge and politics are set aside. That may be too much to hope for, however.
One important element to the discussions that should be of paramount interest to the public is not receiving the attention that is needed. I refer to the fact that Social Security is not now and never has been a retirement plan in and by itself. Alone it does not provide security but rather a base upon which true security may be built. In the past the program was intended to replace 32% of covered wages. The last number I have seen showed the replacement ratio currently at about 40%. Given todays longer life expectancy, that is not adequate for anyone and even mild inflation would soon make life even more difficult. Even pension supplements may be inadequate to maintain a healthy and interesting lifestyle.
More needs to be said about what we used to call the “three-legged stool” concept of providing for retirement. Simply stated, a good retirement plan should have three components: Social Security, employer plans and private savings. Any shortage of one leg of the stool must be compensated for by the other two. But for sure, its hard to sit on a one-legged stool.
The leg that I would like to address here is private savings. Despite the creation of IRAs of various types, as a country, we remain one of the lowest, if not the lowest, in savings rate among industrialized nations. Some studies have shown that IRAs did not create new net savings; rather they just shifted money from taxed accounts to tax-favored accounts. Moreover, tax incentives have more appeal to high-bracket taxpayers and that is not where the current problems lie. Median income for IRA holders is $62,500, whereas for non-IRA owners it is $35,000. IRA holders also have significantly greater additional assets. But even IRAs are losing popularity, with 25% less new money flowing into them compared to the mid-1980s. True, 401(k)s have taken up some of the slack, but again, primarily with high-wage earners. It will take more than tax savings to solve the problem.
