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Defined Contribution Plans Are Not Enough to Fund Retirement in the U.S.

Poor design and insufficient assets are the top reasons U.S. pension and retirement plans are behind those in other countries say two new studies.

Everyone knows that the U.S. retirement system is in trouble. But it turns out that the factors that are usually blamed – underfunded corporate pension plans, even weaker public plans, a rickety Social Security system, paltry individual savings– are not the biggest problems.

The true culprit? Lousy benefits and defined contribution plans.

At least those are the findings of new reports comparing the U.S. to the rest of the world, coincidentally published one day apart by two different benefits consulting firms.

The two reports actually cover different issues and emerge with starkly different conclusions about the status of the U.S., but jointly they demolish the usual blame game.

Aon Hewitt’s version is more optimistic but also more limited in its scope. When the Illinois-based firm looked at the funded status of the largest corporate plans in the U.S., the United Kingdom, Canada, and continental Europe in the third quarter, it found that the first three were in similar and fairly good shape, 82 to 88 percent funded, on average. While the U.S. was at the bottom of that triad, it was far better off than continental Europe, which was only 66 percent funded.

Europe lags because most countries there don’t have stringent funding requirements, Joe McDonald, Aon Hewitt’s global risk services leader in the U.S., explained in an interview.

Meanwhile, when the New York-based consulting firm Mercer and the Australian Centre for Financial Studies considered a much broader picture in 14 developed or close-to-developed countries, the U.S. came in just tenth – below (in descending order) the Netherlands Switzerland, Sweden, Australia, Canada, the United Kingdom, Chile, Brazil, and Singapore. Only China, Japan, Germany and France did worse.

That study used 40 factors - financial, plan-design, demographic and others - to analyze each country’s entire retirement savings picture including corporate defined benefit and defined contribution plans, public plans (including Social Security and state and local plans in the U.S.), and individual retirement and nonretirement savings.

Presumably, judging by Aon Hewitt’s data, the U.S. did okay on the corporate funding side. So was it the notoriously weak public plans that hurt its standing?

No, says David Knox, a senior partner in Mercer’s Melbourne, Australia office, who oversaw the study. “Many other countries are underfunded in their public plans as well,” he said in an interview.

Individual savings, then? Again, “the U.S. level of household savings is slightly below average but is not something that necessarily pulled the U.S. down.”

The key factor is that American pensions are too meager and poorly designed, the report concludes. In his interview, Knox gave some examples. Among all OECD countries – which the report generally uses as a baseline -- the minimum pension covers 27 percent of the average wage. In the U.S., it’s 18 percent. And the U.S. allows 401(k) accumulations to be paid out in a lump sum, rather than converting it to an annuity-style income stream after retirement. That’s a serious problem because, as traditional, reliable, monthly pensions have been replaced by do-it-yourself 401(k)s – and with threats to do the same to Social Security.

“There’s a huge risk that people will outlive their savings. “As we’re living longer, it’s very hard for people to continue to manage their money on an individual basis,” Knox said.

Mercer calculates that converting 60 to 70 percent of a 401(k) portfolio to an income stream “would be ideal,” according to Knox.

“Pension provision is a multi-faceted issue,” he added. “It’s about funded pensions, it’s about the role of government, it’s about the impact of demography, and it’s about good governance.”

In other words, it’s not enough to put money aside. What counts even more is to make sure people have that money to last their lives.

Fran Hawthorne is the author of the award-winning “Pension Dumping: The Reasons, the Wreckage, the Stakes for Wall Street” (Bloomberg Press) and “Inside the FDA: The Business and Politics behind the Drugs We Take and the Food We Eat” (John Wiley & Sons). She writes regularly about finance, health care, and business ethics.

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