A Q & A with MFS's Robert Pozen on reforming the retirement landscape.

American retirees could have a brighter future than the one that is usually painted for them, despite dismal Social Security projections and our own stingy savings rates. But it will take some determination and finesse, both politically and personally, Robert C. Pozen, chairman of the $137 billion Boston-based MFS Investment Management, told us recently in a frank session on what the future holds for America's retirees. Pozen is a man who has been thinking out loud about retirement a lot in the past few years.

Before joining MFS, Pozen spent two years on President Bush's blue-ribbon commission to strengthen Social Security. The model he developed for closing the long-term funding deficit, Arm Yourself For the Coming Battle over Social Security, was published by the Harvard Business Review in November 2002. He spent 2003 in an equally high-profile job, as Massachusetts Secretary of Economic Affairs under Governor Mitt Romney. In addition to supervising banking, insurance and utilities, Pozen helped Romney close the state's sizeable budget deficit and is still active in helping craft retirement and health care policy.

Pozen's career was no less storied before that. After spending almost a decade as general counsel of Fidelity Investments Pozen, a graduate of Harvard and Yale Law School, was tapped to be the company's president and vice chairman in 1997. He took the job, despite being the Clinton Administration's number one choice for U.S. trade representative to Asia. That would-be assignment, and the chance to lead trade talks with China, was a reward for Pozen's successful four-year battle to open up the Japanese market to U.S. mutual funds. But the challenges at Fidelity were equally daunting: He stanched a fund manager exodus, and managed explosive growth that nearly doubled the fund company's assets to $900 billion.

As chairman of MFS, a post he accepted in February, one week after the company paid $350 million to settle improper trading charges, the former Securities and Exchange Commission attorney still takes the stage regularly both nationally and in Massachusetts to help steer policy in the financial services and the retirement arena. Several years after he advanced his ideas for Social Security reform at the White House and in Congress, we wanted to know what he thinks has to be done to cure the impending shortfall in Americans' retirement plans. Here's what he had to say.

Financial Advisor: It's hard to talk about the future of this country and not talk about the coming retirement shortfall. We will see the first generation in recent history retire without the safety net of pensions. And we're grappling with estimates that tell us that one-third of Americans will retiree to a life below their standard of living and one-third probably won't get to retire at all, due to lack of planning. Where do we go from here as a nation?

Pozen: First, the largest question we have is what will happen with Social Security. We know it will reach a tipping point around 2019, where it will start to go negative on a year-to-year cash flow basis. If you account for it like a pension, it already has a big deficit. There could be some efforts to address the situation. The second thing is, there has been a lot of focus on the accumulation phase of retirement and people have not given as much thought to the distribution phase. Given the particular experience of people in the last few years, where they saw both the downside and upside of the market, there will be an increasing demand for partially protected products. These are basically annuities where the worst you can do is get your money back and you are willing to trade a smaller upside for that. The third question is how long are people going to live and what is the longevity risk.

FA: Census Bureau statistics recently showed that the number of people living to be 100 or older swelled from one in 100,000 in 1990 to one in 10,000 today. Those ranks are expected to increase tenfold in the next 40 years, and that's just a small part of the longevity story in this country. What is the longevity risk?

Pozen: All of the studies we see are based on averages, but if you look at all of the assumptions, longevity predictions are probably the ones most vulnerable to change. We really don't know what will happen. There are 300 biotech companies in Massachusetts alone. One is trying to evaluate more comfortable alternatives for genetic research that shows if you starve yourself, you live longer. If someone comes up with a cure for cancer or heart failure, longevity numbers will change dramatically.

[Recently], there was approval of a heart implant device that offsets heart failure in certain types of heart attack patients. The good news is that instead of longevity going up two to three years, it could go up ten to 20 years. That's the good news. The bad news is that you'll have to financially support yourself. But what is neat is the big unknown. By its very nature, it's very susceptible to big movements. We could have folks living to be 100, and we're really not geared for that yet.

FA: How will that change the notion of retirement in this country? I've seen numbers that show that while the average American believes he'll work until mid- or late-60s, most people are forced to retire at age 62 because of health problems or because they're forced out by their company.

Pozen: The notion of work, particularly part-time work, will change dramatically. The average age of retirement might be 62 now, but in the future you won't have another generation of workers pushing from behind for people to retire. People will also be healthier. And the nature of work will continue to be less physical. Already we've moved the age when folks qualify for full Social Security benefits up to age 65 and age 67, depending on when they were born. You'll have more folks continue working, but not full time.

FA: As you've pointed out, living longer means we need bigger nest eggs. How do we get there as a nation? How does your suggested funding change to Social Security work?

Pozen: Most people think Social Security benefits are adjusted annually based on price changes, but they're adjusted up based on wage increases. During the last 50 years, wages have gone up 1% faster than prices. That's a big increase. If from now on we said all initial benefits will be adjusted based on price increases, it would cure 100% of the problems in funding Social Security. It would also decrease the wage replacement ratio from about 46% today to about 30%. How can you justify that? You can do it for two reasons. Those people earning $100,000 or above are already participating in every IRA and retirement plan available, but under $50,000 participation is much lower. My answer is, for those folks under $25,000 a year I'd stay with wage indexing.

FA: When it comes to incentivising the private sector, you've suggested tax incentives for certain workers and an opt-out type plan at the employer level. How would those work, and can the Bush-proposed Retirement Savings Accounts and Lifetime Savings Accounts speed the way?

Pozen: To create these accounts without also reforming Social Security would be a mistake, for the reasons I've cited. The people who would use them already take advantage of all their retirement savings options. We need both sets of reforms. I've suggested, along with others, that one way to help all households save for retirement is to change the current 401(k) opt-in requirement (which requires workers to sign up to save), to an opt-out requirement so that 1% of all workers' income would automatically be contributed to an IRA at a qualified financial institution. I also think some type of refundable tax credit for contributing would help those earning $25,000 or less annually. Many don't currently pay federal income tax, so the incentive can't be a credit. It has to be a refund.

FA: Studies from the Employee Benefits Research Institute and the American Association of Retired Persons already show that retirees feel ill-prepared financially to meet their health care needs. Can public policy really change this?
Pozen: The number of employers that offer post-retirement health care is rapidly declining. Employers find it too expensive to be on the line. There will be a huge drain on Medicare and the new drug benefit. I don't think anyone knows what it will cost. But we have to try to keep the costs within reason. I've done a lot of work for public officials in Massachusetts, and I've come to believe that we need higher co-pays and deductibles to keep costs down, combined with education about relative costs and choices.

Has anyone not gone to see a doctor as a result of a $10 co-pay? That's why I'm interested in the new HRSAs (Healthcare Retirement Savings Accounts). They give people more skin in the game and provide a tax deduction coming in, tax-deferral on the funds that accumulate and you can use it in retirement for Medicare and to fund the donut hole in drug coverage. It's also critical that people are educated about their choices and costs and are charged accordingly. They should be able to choose between a $100 x-ray and $200 x-ray, but today you can't find out how much you're being charged, so you can't make an informed decision. People need a financial stake.

FA: Thanks, Bob.