BERKELEY – As the first wave of America’s baby boomers begins to retire, the retirement system is revealing its flaws. More than half of all workers (and more than 60% of low-income workers) are at risk of lacking sufficient savings to maintain their living standards after they stop working. In a recent international comparison, America’s retirement system received a passing grade of C; but, for a large and growing number of Americans, the system is failing.
The slow recovery from the Great Recession has exacerbated the challenge. Homes are most Americans’ major retirement asset, and, despite a recent pickup, housing prices are still 28% below their 2006 peak, while 28% of all homeowners owe more on their mortgages than their property is worth.
Discretionary employer retirement plans are a major pillar of America’s retirement system. But nearly 16 million Americans are either unemployed or have dropped out of the labor force, while more than half of the jobs created during the recovery are low-wage positions that usually do not offer such plans. By contrast, most of the 625,000 public-sector jobs lost during the recovery offered generous pensions.
Nearly 60% of all employed private-sector workers aged 25-64 are not covered by employer retirement plans, and coverage rates vary by income: 73% of all workers in the top earnings quartile are covered by such plans, compared to only 38% in the bottom quartile. Plan participation also varies by income, with low-income workers much less likely to participate than high-income workers. The lack of universal coverage also means that workers move in and out of plans as they change jobs; more than one-third of all households end up with no employer-based pension coverage. By contrast, in several other countries, mandatory employer and employee participation in national employer-based plans means nearly universal coverage.
Personal retirement savings, another pillar of the US retirement system, are woefully inadequate for most households, partly because the decades-long stagnation in median wages has made it difficult to save. According to a recent study, one-third of Americans aged 45-54 have nothing saved specifically for retirement. Meanwhile, three-quarters of near-retirees – those aged 50-64 – have annual incomes below $52,201 and average total retirement savings of less than $27,000.
The United States relies on generous tax incentives to encourage personal retirement savings, but these incentives are poorly targeted and yield limited returns. More than 80% of the value of these incentives goes to the top 20% of taxpayers, who earn more than $100,000 a year. Moreover, while the incentives cost the US Treasury nearly $100 billion annually, they induce little new saving; instead, they cause high-income taxpayers to shift their savings to tax-advantaged assets – a major reason why President Barack Obama proposes capping the tax deduction for retirement saving.
A more radical proposal would convert the tax deduction into a means-tested and refundable matching government contribution – deposited directly into a taxpayer’s individual retirement account (IRA). Taxpayers are more responsive to matching incentives than they are to tax incentives, because the former are easier to understand and more transparent.
Lack of coverage in employer-based plans and insufficient personal savings leave more than one-third of all households (and more than 75% of low-income households) entirely dependent on Social Security for their retirement income. And, because Social Security replaces only about 40% of pre-retirement income for low-wage workers and less than a third for median-wage workers, those who rely on it as their sole source of income live at or below the poverty line. (Replacement rates in other developed countries are in the 70% range, compared to a benchmark of 80% recommended by retirement experts.)
Addressing the looming retirement crisis in the US requires increasing worker coverage in employer-based plans. Here, automatic enrollment, unless workers opt out, has proved effective, boosting employee participation to more than 90%. Indeed, recent research indicates that automatic enrollment is much more effective than tax incentives for increasing retirement saving.
But many employers do not offer retirement plans, while almost all workers are eligible for tax-advantaged IRAs. As Obama has proposed, employers that do not offer retirement plans should be required to offer automatic contributions to their workers’ IRAs through regular payroll deductions. Matching government contributions should be used in lieu of, or in addition to, tax deductions to encourage low-income workers to participate.
California and several other US states are also evaluating new state-administered retirement-savings programs for private-sector workers without access to employer-based plans. The California plan, based on a proposal by Teresa Ghilarducci and her colleagues, would automatically enroll eligible employees, defined as private-sector workers at firms with five or more employees that do not offer retirement plans. Contributions would be made through automatic payroll deductions by employers at a default rate of 3% of gross pay, but employees could opt out or adjust their contribution rates.
Under this scheme, each worker would have an individual account balance (treated as an IRA from a tax perspective), but the assets that secure the plan’s benefits would be held in a pooled trust, with a real return guaranteed by private insurance and paid out as an annuity upon retirement. Accounts would be linked to workers, not to their employers, ensuring portability between jobs. (The lack of portability and the absence of annuity payouts are major shortcomings of most employer plans.) An independent board would oversee the state plan’s administration, relying on a competitive bidding process to select investment managers.
Senator Tom Harkin recently proposed a national plan with many similar features, open to all workers whose employer plans do not meet minimum requirements. The countries that outrank the US on the global retirement index in terms of coverage, adequacy of benefits, and long-term sustainability have national pension plans in addition to their basic social-security-type programs. Some are mandatory, some have automatic enrollment, and some rely on matching government contributions to encourage participation.
In the US, making saving easier and more financially rewarding through better-targeted tax incentives, matching government contributions, automatic IRAs, and state-wide retirement plans would help boost retirement savings, especially for low- and middle-income households. Improving financial literacy would also help. The current obsession with government deficits and budgetary constraints should not deflect attention from the need for reforms that address the looming retirement crisis confronting many Americans.