Retirement, Financial Questions Answered by Brigitte Madrian

Many Americans are growing increasingly anxious about their retirement savings as they witness the declining value of their 401(k) accounts. For many who have lost large portions of their savings, retirement may have to be delayed or scaled back. Others may have an opportunity to recoup some of their losses through the courts.

Brigitte Madrian is the professor of public policy and corporate management in the Aetna Chair. Her current research focuses on household saving and investment behavior. Her work in this area has impacted the design of employer-sponsored savings plans in the U.S. and has influenced pension reform legislation both in the U.S. and abroad. We sought her perspective on how the current economic crisis is affecting retirement plans for American workers and their families.

Q: What is your financial advice for those nearing retirement in the next few years?

As we have seen over the past several weeks, financial markets can be quite volatile. Those nearing retirement need to first determine how much income they will need in retirement. Next, they need to determine how much they need to save in order successfully fund their retirement. If it is not possible to increase savings enough to fund their desired retirement, then individuals will need to revise expectations about when they can retire or their standard of living in retirement.

A few years before retirement, individuals should start planning how they will turn their accumulated wealth into retirement income. Social security and some employer pensions automatically provide a monthly stream of income. Individuals can turn other sources of saving, such as 401(k) or IRA assets, into a guaranteed monthly stream of income through a variety of annuity products that are available on the market today. This approach has the advantage of insulating retirement income from swings in the market.

Or, individuals can adopt various strategies to draw down their assets after retirement. This approach has more flexibility than purchasing an annuity, but leaves an individual exposed to two significant risks—the risk that a market downturn will severely erode the value of their assets, and the risk that individuals will outlive their assets. Of course, individuals can also adopt a combination of these two approaches.

Q: What advice do you have for employees in their 20s who are perhaps not feeling the significance of the economy in terms of retirement savings and pensions?

It is never too early to start saving for retirement. If your employer offers a match, you are leaving money on the table if you are not saving enough to at least take advantage of the employer match.

Q: For people who have lost their retirement funds, what financial help is available?

For individuals who have lost their retirement funds due to fraud or misrepresentation, there are several class action lawsuits that have been filed that may result in the recovery of some lost assets. But it will be years before we know how this litigation is resolved, and what recompense, if any, will be made.

Individuals who have yet to retire still have some flexibility in reassessing their retirement plans—they can save more today and retire later to partially compensate for their losses.

Individuals who are already retired likely have less flexibility. Some may choose to go back to work for a period of time. Others will cut back on consumption in retirement.

For those who have truly lost everything, the government does have programs to help the poor elderly, including help with health insurance through Medicare and Medicaid, and supplemental income through the SSI program.

Q: What will the long term effects of this economic situation be in the retirement markets?

The current economic crisis will likely lead to changes in the labor market for older workers. For much of the 1900s, the average age at retirement declined steadily. In the past two decades, however, the average age at retirement has flattened out and even started to increase slightly. Many older individuals will now find themselves forced, out of financial necessity, to work longer or to reenter the labor market after retirement. This will change the way in which older workers are viewed in the labor market, and may lead to changes in the way that companies structure jobs for older workers.

The current economic crises may also lead individuals and firms to rethink the way in which individuals save for and then fund their retirement. It is likely that we will see an increased interest in annuity-like products that provide individuals with a guaranteed stream of income, and along with that interest we will also see innovation in the types of financial products that are available. 401(k) and other similar savings plans will start to incorporate features that make it easy for workers to annuitize their retirement wealth.

Q: Is there a solution, either on a state or federal level, which is being overlooked?

There is definitely a need for more regulation of the financial sector, so that individuals and firms know the true risks that they face in making investment decisions. How is it that mortgages were being made to individuals who were likely to have a significant problem with repayment? How is it that bond rating agencies did not account for the possibility that house values could go down in their assessments of the risks of mortgage-backed securities?

But we don’t just need more regulation, we need better regulation. Some financial products are regulated by several agencies, both state and federal, which dramatically increase the cost of compliance and, consequently, the cost of products to consumers.

Q: Is there any good news coming out of this situation?

The idiom “once bitten, twice shy” might be appropriate here—a bit of skepticism when it comes to saving and investing is probably a good thing, but something in short supply over the past few years.