Bob Pozen’s keynote address in Boston closing the Monday session of the Retirement Income Symposium was billed as “The Fund Industry: How Your Money Is Managed,” the title of his newly published book. But by the time the chairman emeritus of MFS Investment Management wrapped up, he had galloped through the federal budget deficit, underfunded state pension plans, target-date funds as default 401(k) plan investments, challenges of income distribution in retirement, and the future of retirement itself. Some highlights of his speech, which raised the consciousness, and sometimes ire, of the 200 RIS attendees:
The Budget Deficit
Pozen, now a senior lecturer at Harvard Business School, senior research fellow at the Brookings Institute and former economic advisor to President George W. Bush and then-Governor of Massachusetts Mitt Romney, considers it vital to shrink a federal debt-to-GDP ratio that now exceeds 60%. However, he warned, big spending cuts should be phased in over time in order not to damage the frail economy.
That may not be a problem. We should aim for $5 trillion in reduced spending, he said, but “it’s pathetic how little we’ve agreed to cut”—just $0.9 trillion so far. The deficit supercommittee is supposed to carve out another $1.2 trillion by Nov. 23, but with every special-interest group hollering, “Not me,” Pozen said he doubts whether enough cuts will be found to meet that target.
Underfunded Pension Plans
The distorted accounting used to determine pension plan funded rates is coming to light as states grapple with budget shortfalls, Pozen said. Plans can assume future rates of return without regard to realistic benchmarks. The higher the assumed rate, the less funding is needed. When Pozen reported that the average annual rate of return assumed by state pension plans is 8.5%, an incredulous laugh went up from the audience of financial advisors.
A potential rule requiring pension administrators to use a more realistic rate would, of course, put even more pressure on state budgets. “I’m not asking for full funding right away,” he insisted, “just honesty at the state level.” He suggested that putting new workers into a defined contribution plan would find favor with taxpayers who realize their state’s defined benefit plan is unaffordable.
Asked if states should be required to balance their budget every year, Pozen said there may be times when a state would need to overspend. When he mentioned that nearly every state requires a balanced budget except Vermont, one attendee shouted out “What do you expect from a socialist state!” Pozen recommended a less rigid requirement, such as no more than a 2% to 3% loss over 10 to 20 years.
Target-Date Funds as Default Investment Options
Pozen is agin ’em. He said, “Target-date funds purport to say, ‘Okay, you were born in 1950’” and group you with other investors of the same age in a one-size-fits-all asset allocation. However, it’s highly unlikely, he argued, that everyone of the same age would retire at 65 or have the same plans for what to do with their money once they are retired.
Another concern with target-date funds is that plan participants don’t know what they’re getting, he said. In 2008, 50% to 60% of funds maturing in 2010 were at least 35% invested in equities, exposing investors on the brink of retirement to the market downfall of 2008-2009.=
The larger issue, as Pozen sees it, is that target-date funds encourage plan participants to put retirement investing on autopilot. “You have to think about retirement at least once in your life,” he argued. “When will you retire? What’s the time horizon for your investments? What will you have for assets?” He would prefer to see a balanced fund with 50/50 stocks and bonds as the default DC plan investment. Expenses would be lower, transparency would be improved and investors would be kept alert by the need to adjust portfolio allocations as they approach retirement.
The Distribution Phase of Retirement Investing
Life expectancy has been rising about 2½ years every 10 years since 1900, Pozen said. Why don’t important actuarial projections assume that this trend will continue? He suggested that Social Security’s estimated life expectancies of 79 years for men and 83 years for women may be too low in both cases by six or seven years.
He went on to note four ways that retirees can convert savings into an income stream: systematic withdrawals, a managed distribution fund, partial annuitization at age 65 or annuitization at age 80. With longevity risk on the rise, why do fewer than 10% of pension recipients choose lifetime annuity income? He speculated that people want more flexibility to leave their money to their kids or keep it for a healthcare emergency.
Solutions for the Future of Retirement
Traditionally, retirement meant withdrawing from work. Cushioned by a pension and Social Security, previous generations had more flexibility to retire when they wished. Now people expect to live longer, most DB plans have gone away and DC balances have deflated. The upshot, he said, is that 49% of baby boomers expect to work past age 65 and 72% anticipate continuing to work after they reach retirement age.
Given this situation, Pozen advised companies and lawmakers to make some changes:
- Create more flextime and part-time jobs
- Allow partial retirement plan withdrawals for participants working part-time
- Provide health care benefits to age 65
- Move the normal retirement age back
- Offer financial incentives for Social Security recipients to work longer
- Address disability issues for those performing physical labor