• Some Highlights from this Interview
• Reasons to ring the "alarm bell"
• Putting too much expectation into the 401(k)
• The perils of individuals making their own financial plan
• Why some people will still be working at age 65

The baby boomer generation is headed for retirement in a couple of years. Are the baby boomers ready for retirement financially?

The early boomers, ... people who are going to retire in the next five years, they'll be OK. The problem is going to be with the young side of the boomers, people in their early 50s now. They're not going to be OK.

Why not?

People are just not going to have the type of money they think they are. Social Security under current law is going to provide less in the future than it does today relative to earnings, and our pension system has changed dramatically. People aren't going to have pensions like they used to, where you get a benefit for the rest of your life. People are going to retire basically with 401(k) plans, and that's all.

Are people saving enough?

Oh, people don't save. People save virtually nothing on their own. We have really good data [on] how much people have just as they're approaching retirement; we can look at their portfolios. People have their house, and people retiring today have some pension wealth, and they have Social Security wealth. The typical family has about $30,000 of income. That will give you about $300 a month.

So they're not saving enough. Are we saving as a country? You hear negative saving reports, that we're pulling money out of savings. ... Is that true? Is the savings rate in America today, for example, different from what it was 20, 25 years ago?

There's lots of ways to measure saving, and I think the number you're referring to comes out of our national income statistics. And you're right: That number is negative, but that number is very sensitive to how many old people there are compared to how many working-age people [there] are. I think the best way to look at saving enough is to look at what people have when they approach retirement, and the people who are approaching retirement today have pretty much OK-enough resources to support themselves.

These are the ones who have been depending on these lifetime pension plans.

These are the people with the lifetime pension plans and Social Security. They're retiring at age 65, and the Social Security retirement age is going to 66 and then 67, so that means that benefits for people who retire early are going to be cut more. The people retiring today haven't seen those cuts. They have the old-fashioned defined benefit plans. They've just benefited from a big housing boom, so they're really doing OK.

One of the problems here is that when people look out and see people retiring, they don't look in that bad a shape for the most part. There are some people who have really been hurt by these bankruptcies and discontinuation of plans, but generally people are OK, so it's very hard to ring the alarm bell and say down the road 10 years, 15 years, people are going to be in a lot of trouble.

But you sound as though you think the alarm bell should be rung.

For sure. I think this is a crisis in the making. I think 10 or 15 years from now, people who approach their early 60s are simply not going to have enough money to retire on.

And what does that mean?

They're going to have to do one of several things. One, they're going to have to just move from where they're living and go to a place where the living is a lot cheaper and really change their lifestyle. Or they can plan now and decide that they're not going to retire at age 62, but they're going to work until 63, 64, 65 or even 66, and that will help a lot. But this idea that people are going to continue to retire at 62, that we're going to have a smaller Social Security program, that people aren't going to have anything but these 40l(k) plans -- they don't save on their own, and we can't expect a housing boom every 10 years -- means that people are just not going to have enough money to stop working and try to support themselves at the level they've been living.

Are people not realistic? Are they not disciplined? Are they not informed? Life expectancy is getting longer; medical bills are getting higher. You're saying the effective changes in the Social Security system, even if subtle, means Social Security is going to do a fraction less. Are people unaware of that? What's the problem here?

A lot of change has happened in the last 20 years, so people started with one kind of pension system where all the decisions were made for them, and then they were guaranteed an income for as long as they were going to live. That's not the pension system that we have any longer, so people, when they grew up thinking that they were covered by one type of arrangement, are ending up finding they're being covered by a different type of arrangement.

Our new type of a pension arrangement is not anything we would ever have designed. These 401(k) plans were initially supplementary plans to these basic pensions, so it was fine if you left all the decisions up to the individual. If the individual wanted to join, fine. If not, fine, because they already had a base. They had Social Security, and they had these old-fashioned pensions, and then they had this third option.

What's happening is the old-fashioned pensions have disappeared, and so this plan that was sort of a supplementary plan is now everybody's basic plan, and it's so poorly designed, because it was never designed to be the mainstay of people's retirement.

... How did the 401(k) come about? ... It's wound up being different from what it was intended to be. What was it intended to be?

... Before the 401(k) plan, there was a worse kind of arrangement. There was the supplementary defined contribution plan, these supplementary accounts, and there were nondiscrimination laws, so the idea was that higher-income people had to get lower-income people to participate. They allowed them to put in their $2,000 for one year and take it out in the beginning of the year and take it out the next year. They were sort of using low-income people to make it look like it was a nondiscriminatory plan, whereas in point of fact, these low-income people ended up with nothing.

The 401(k) plan was actually an attempt to make sure that at least the money stayed in until people were 59. So I actually think that it was a step in the right direction. It was making the supplementary plan better, but it was designed as a third tier, not for basic retirement [and] the only thing to supplement Social Security. ...

You sound concerned about the future for the second wave of baby boomers as they retire. Are you concerned, and if so, why?

I am extremely concerned about what's going to happen to people [who are] in their 40s and early 50s when they reach retirement, because I think they're going to have a surprise. They're going to be shocked when they look at what the balances in their 401(k) plan can buy for them. It's going to be much less than they think, and it's not going to be enough for them to support themselves, and so they're going to be scrambling.

As I get older, I am just increasingly sympathetic [with] how you don't want to be caught by surprise when you're in your late 50s and early 60s, because you don't have the kind of options then that you had when you're young. You don't want to have to be scrambling around for another job or trying to patch together different sources of income. You've worked hard your whole life. You'd like to have something secure that you can count on, and people are not going to have that.

What happened? Here we were, back in the 1980s and then particularly in the '90s, and 401(k) plans were the hottest thing around. ... You are not the only person among the experts and among the policy-makers who are saying, "Whoa, we're in for trouble." What went wrong? What happened with the 401(k)s?

There was an amazing coincidence when 401(k) plans came in 1981. In 1982, there was the longest stock market boom in history, except for 1987. People got the new plans to control their assets on their own and suddenly saw their piles just grow and grow and grow, so all Americans decided they were absolutely brilliant investors. Then we had 2000, and we saw these accumulations just being cut in half in some cases, and it was a rude shock to almost a generation that had grown up to think that markets only go up and don't go down. That's one thing. I think 2000 was a very important event, the fact that people lost a lot of money.

Where are we as a nation? ... Give us an overview of how 401(k)s are working, because I have a sense that part of the problem was the stock market crash, but part of the problem is human behavior.

Let me just back up. When you look at the labor market, or all workers at any moment in time, only half the people are covered by anything, so only half the workers have either a 401(k) plan or the old-fashioned pension. Now, if you look at households as they approach retirement, over that period of time and with two people in the household, you find out that two-thirds of households end up with some kind of pension, and ... one-third of the population that has nothing except Social Security will have nothing except Social Security, and maybe a house, going forward. Social Security benefits as a percent of earnings before retirement are going to go down. That group is definitely in trouble, and there's no possible way that they can do anything except perhaps save on their own. But savings is just too hard, and people do not do it.

Then you look back at the households that end up with pensions. Today, most of these people approaching retirement still have the old-fashioned plans, so they're going to be guaranteed an income for life. It's not perfect. No, that income is not adjusted for inflation, so it erodes [in] value over time, but they've got Social Security under that, ... and they've just had this big housing boom, so they'll be OK.

But if we look at the 401(k) world --

If you look at the 401(k) world, then you've got people -- these are the two-thirds with something -- they're going to have only 401(k) plans. And what is in those 401(k) plans? Well, we actually have very good data on how much are in those plans today for people approaching retirement: $40,000 to $50,000 ... for the typical household approaching retirement.

I'm being very generous when I say that. When we count 401(k) plans, we don't just say 401(k) plans. We also look at if they have an individual retirement account [IRA], and we add those two numbers together, because a lot of them -- all the money, virtually, in the individual retirement accounts are rollovers from 401(k)s. Putting those two together and looking at households approaching retirement today, they have about $50,000 in these accounts.

For a median American worker that's got an income of say, $45,000, $50,000, what is that 401(k)/IRA balance going to do for him? Is that going to be enough?

No, that's not going to be enough. That type of worker, the median worker with $50,000 or $60,000 needs a balance of about $250,000 to have enough money to supplement Social Security so that they can carry on their lifestyle. People are far, far from where they need to be.

You could say that well, it's not fair to look just at people approaching retirement today, because these plans only came in in 1981, and they really haven't had a full lifetime under them. But if you look at people in their 40s to 50s, or even 30s to 40s, they're not on track ... to have this kind of $250,000 when they retire.

Two hundred fifty thousand dollars for an average worker sounds like an enormous amount of money. It sounds like, "Aw, I'm never going to need that." What's the reason? Is this life expectancy? Is this medical bills? It sounds like a lot, and I've heard even higher figures than that. ... Are you sure that's not an exaggeration?

If anything, I'm lowballing this number. The question is, is it possible, and why don't people have it? Is it possible? It's really possible. You can do little Excel spreadsheets that say if people put in 6 percent of their salary at age 30 and their employer matches, and it grows at some reasonable, not crazy, rate of return over everybody's working life, then our hypothetical worker will have about $300,000 at retirement. So the question is, why are people having $40,000, $50,000 in these accounts?

Yeah. What's gone wrong with that?

Everything. Everything has gone wrong. The individual has to make a choice every step along the way. [The] individual has to decide whether or not to join the plan, how much to contribute, how to allocate those contributions, how to change those allocations over time, decide what to do when they move from one job to another, think what to do about company stock. Then the hardest thing, which we haven't even gotten to, is what are they going to do when they get to retirement and somebody hands them a check? How do you figure out how to use that over your retirement span?

So what you're suggesting is all this individual control may not be such a good idea.

Well, the numbers aren't very encouraging. Between 25 and 30 percent of people who could join these plans don't join the plans. Of the possibility of contributing the maximum, less than 10 percent of people contribute the maximum. Half of the people don't diversify their portfolio, so [it's] either all in stock or all in fixed income. No one rebalances their portfolio as they age. Half the people cash out when they move from one job to another. Now, those are relative --

-- Wait a minute. "Cash out" -- that means they no longer have a savings account. They use the money for something they need right now.

Half the people, when they move from one job to another, take the money out of their 401(k). Now, they may even use it for something good. They may use it for further education, or they may use it [for a] down payment for a house, but it means it's not there when they come to retirement. So it's very discouraging. We can see this series of bad decisions that ends up, produces these small amounts [of savings] at retirement.

The question is, why do people end with such small amounts? Why do people make such bad decisions? Let me assure you it's not [just] them. ... I have made virtually every mistake that I look out there and see other people doing. We live busy, complicated lives. Saving for retirement is a really hard thing to do. You have to look way ahead. You have to put other demands aside. You have to resist temptation when you have the chance to get this nice pile of cash that would really solve all your problems. We're all just pressed, and so we don't make smart retirement decisions. ...

Jack Bogle says that the average investor cannot do as well as the market averages, because if you use a mutual fund or some other vehicle like that, they're going to take 2 percent in fees, so what should be an 8 percent gain is a 6 percent gain. It doesn't sound like much, but if you add it up over 20 or 30 years, you're going to wind up seeing a third, 40 percent, even 50 percent of your portfolio gone in these little-looking fees. The question is, number one, are fees a problem from your standpoint? But is it a system that's flawed even when the individual makes good decisions?

There are two things. I think that the fact that the individual keeps meddling with his or her account really reduces your returns. And then you're right: The fees are an issue. The fees aren't much of an issue when the stock market's going up 15 percent a year. The fees are a big issue when it's going up at 5 percent a year and you're losing 1 percent on your return year after year after year. A 1 percent fee over a 40-year lifetime reduces your final pile by 20 percent. That's a big chunk. ...

Was it a smart thing to move from defined benefit lifetime pensions to 401(k)s?

No one thought this out. The 401(k) plans were originally introduced as supplemental plans. No one ever said, "Oh, let's end these traditional pensions and replace them with 401(k) plans." What happened was these 401(k) plans came in at the same time the stock market took off. People liked them, because they liked having their own accounts that they could look at, and they liked being able to control their investments, particularly in an environment where stocks go up every year. And employers liked these plans because they didn't have to worry about the risk and what it might do to their earnings, and they didn't have to worry about whether interest rates were high or low when it came time to buy people annuities at retirement. So employees liked it; employers liked it.

At the same time, these defined benefit plans became less useful tools for managing people [in the labor force], because basically, this arrangement where people came young and stayed with one firm for a long time declined. You have a much more mobile workforce, and so with a more mobile workforce, young people looked at these defined benefit plans and said to themselves, "I'm probably not going to be here 20, 30 years down the road, so it really doesn't mean anything to me, and I really prefer these 401(k)s." [On] both the employee and employer side, you had this easing from one system to another without anybody ever thinking, is this a good way to arrange people's retirement income?

Had they been looking, would it have been a good idea?

No. It's not a good idea to make individuals so responsible for their own retirement planning and having each individual bear all the risk and having to make these choices about joining and investment and rolling over, rebalancing and all that type of thing. Individuals should not have to be financial planners.

I'm thinking also about certainty and security. ... Even if a defined benefit plan, a lifetime pension, was not indexed for inflation, at least it was a chunk of money that you knew was there to count on. I'm wondering now, as you look ahead for this generation, what this sense of insecurity and anxiety and uncertainty is now. Are there things that indicate how people are now towards retirement and how they feel about it?

There's a survey annually called the Retirement Confidence Survey, and each year people say, "I'm very confident about my retirement." Actually, given that these are people who are going to retire in the next few years, that's not too bad. But this also comes from people in their 40s and 50s, and they shouldn't be confident. They should be worried.

But is there evidence that, in fact, people's behavior is changing regardless of what they say, looking at the financials, and they're working longer?

Well, there are two problems. One, we've had for a long time a constant decline in the average retirement age. ... About the mid-80s, it started leveling out for a host of reasons. One, we got rid of mandatory retirement. There was a shift away from these defined benefit plans, which had a lot of incentives to retire early. Social Security incentives changed somewhat, too, in that the earnings test was not as strict, and they gave you more of a benefit for postponing retirement.

But still, the average today for men is 63, and it's not going to be possible for people to continue retiring at 63 and think that they can support themselves for the rest of their lives on a diminished Social Security benefit and whatever they have in their 401(k) plan.

If we could convince people in their 40s and 50s now that they should plan to work until at least 65, if not 67, that would be a wonderful thing, because then people would have a game plan. They wouldn't be scrambling at the last minute. But it's not clear how that's all going to work out, because I have great concern whether employers are going to want to keep people on through 65, 66, 67. It's very clear to me that people are going to have to work longer. I don't know how comfortable it's going to be, whether it's just scrambling around to find some kind of second job to provide some additional income or whether it's an orderly extension with your long-term employer.

... Do you see any mating up of employers that have needs for part-time workers and seniors who want to keep working maybe only part time?

There are some notable examples. When you walk into Wal-Mart, you see somebody in their 60s or 70s greeting you. In Home Depot, you see the same type of thing. But there are data on the percent[age] of people working part time, and that really hasn't gone up at all.

The desire of older people, in survey after survey, is to reduce their workload gently and move from full time to some kind of part-time arrangement. Certainly when you look at self-employed people, what you see is a gradual diminution in the number of hours worked. That's what older people want. They want to be able to have flexibility. They want to be able to work part time, but employers don't like part-time employees. They're expensive to hire. They get fringe benefits, so it makes them disproportionately expensive. You've got meetings on Thursday, and Frank's not there; it's just a nuisance. The question is, are employers going to be willing to adapt their work schedules and their fringe-benefit arrangements and all the things that they have to change as this group of older workers come on, who need to keep [being] employed?

Who are the winners and losers in the shift from the old lifetime pensions to the 401(k)-type plan?

The winners under the 401(k)-type arrangement are people who have mobile careers or intermittent careers. Women probably are doing better with 401(k) plans than they would have done under the old type of old-fashioned pensions, because they have an account; they can keep it with them. Whenever they go back into the labor force, they can add more to it. In the old days, if they left mid-career or got there late, they would not end up with a significant pension. It's really those type of mobile employees who have done better.

But the long-term worker who stays with his employer has really lost out. And the people who are really losing out are the people who are caught mid-career, late 40s, early 50s, when their employers freeze their pension.

... Can you just explain why is it that people in their mid-career are hit so hard?

People in their mid-career who suddenly face a freeze on their defined benefit plan, ... they were going to get a benefit based on their salary when they were 62 or 63, and they would be fine. Suddenly, they're going to get a benefit based on their salary when they're 50, which is much lower, and they're not going to build up any more credits in the old system. They're going to have a new 401(k) plan.

It is very hard to build a big pile in a 401(k) plan fast. That's why it's such a concern that people are cashing out at young ages, because the only way to get a big pile is to put the money in at 30, keep it in throughout this entire period, and then you're fine. But anything where you say, "Oh gosh, now I'm suddenly in a 401(k) plan, and I have to get a big pile of money because I want to retire in 10 years," you can't do it. People's incomes aren't big enough to let them put in the kind of contributions that they need to make. ...