Friday, October 10, 2008

Real costs of reduced pension wealth

Global stock markets are sliding, and pension funds – whose benefits are derived from the prices of financial assets such as corporate bonds and equities – are losing value....quickly. Peter Orszag, Director of the Congressional Budget Office, testified as to The Effects of Recent Turmoil in Financial Markets on Retirement Security. His testimony in short:

- The assets under a defined-benefit plans have declined about 15% over the last year. Under a defined-benefit plan, worker benefits are specified by a formula that is unrelated to the value of the fund itself. Since benefits do not change, the employers are forced to raise contribution rates. This has real economic impacts in terms of hiring, invesmtent, and reduced shareholder wealth.
- However, there has been a shift toward defined-contribution plans, where the benefits to retirees depend on the value of the fund, lika a 401k. As the Dow plummets over 5,500 points in one year, the defined-contribution benefits fall as well, and adverse wealth affects result. Households reduce consumption of goodes and services in order to compensate for their reduced wealth.
- Finally, potential retirees are working longer, affecting the labor supply. Studies provide mixed results on the correlation between stock market behavior and the behavior of older workers. However, there has been a recent shift toward higher labor participation rates – 58% in 1986 to 64% in 2007 – among those workers 55-64. The CBO implies that amid recent stock market losses, retirees will work longer going forward.

If this trend is exacerbated throughout the financial crisis, pressure will build in the labor market. With more workers coming out of, or not entering, retirement, the unemployment rate will rise with the supply of labor.

Can you identify with these individuals? From Bloomberg:
"Savers who have seen their retirement accounts slashed by a 19 percent drop in the Standard & Poor's 500 Index this year may be looking for higher yields to prepare for retirement. That is if they have any money left to invest.

Keren Olson, 34, an associate producer at American Forces Network in Riverside, California, said she and her husband stopped contributing to their Roth Individual Retirement Accounts on Sept. 22 because of escalating monthly bills.

``With the cost of fuel, groceries and electricity all rising, we just can't afford to contribute to another account right now,'' said Olson.

One-third of 1,000 employees aged 45 and over surveyed by the American Association of Retired Persons, a Washington, D.C.- based advocacy group, have stopped contributing to retirement accounts, as they cope with rising daily household expenses and decreased access to credit from the credit crisis.

Other workers are withholding contributions because they said they feel ``financially insecure,'' said David Certner, legislative policy director at the AARP, even if they don't need the extra cash immediately.

``Employees who contributed regularly to 401(k) plans are realizing that their savings aren't sufficient and 27 percent of workers 45 years old and over have delayed retirement plans,'' Certner said.”
It is easy to find negative news today, but we are talking about the welfare of individuals who have worked their entire life just to see their retirement portfolios crushed. The stock market panic is ongoing. Just today, the Nikkei tumbled 9.4% and the Hang Seng 7.9%, and U.S. markets are likely in for another downward sprial.

When will the panic end?

Rebecca Wilder

1 comment:

  1. Another angle is the pension system for already-retireds. One kind is based on annuities from insurance companies. What's to say those companies are not going to fail? Then what?