Is It Time for Mandatory Savings Accounts?Chris Farrell
The popular image of the good life in America and the prospect of a decent, financially secure retirement have become synonymous over the past half-century. Problem is, the evidence is overwhelming that America’s retirement savings system is broken.
Take the private economy. Retirement savings are scant in 401(k)s, the main pension plan for private-sector workers. The typical value of a 401(k) and IRA for workers nearing retirement is about $120,000, according to the Federal Reserve. (That sum would provide $575 in monthly income (PDF), assuming a couple bought a joint-and-survivor annuity, calculates Alicia Munnell, director of the Center for Retirement Research at Boston College.) A survey by the Employee Benefit Research Institute (PDF), a Washington think tank, reports that 57 percent of workers who hold a 401(k) say the total value of their household’s savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000.
The most disturbing data on the private pensions is this: Only 42 percent of private-sector workers aged 25 to 64 have any pension coverage in their current job, which translates into more than one-third of households with no pension coverage at all during their entire work lives, calculates scholars at BC’s Center for Retirement Research (PDF). Many of these workers are employed by small businesses that don’t offer a retirement benefit. The Government Accountability Office estimates (PDF) that in 2009 a mere 14 percent of small employers—businesses with fewer than 100 employees—sponsored some type of retirement plan.
State and local government pension plans are also feeling financial strains. The backbone of the public sector’s retirement system is the traditional defined benefit pension plan, the kind most private companies have abandoned. The economic turmoil of the past several years has exposed what pension fund experts have long warned: Too many of these plans are underfunded relative to their promised payout. Think Detroit, Chicago, and Stockton, Ill.; Louisiana and West Virginia. The long-term trend is for the public sector to embrace 401(k)-type plans.
The bright spot in the retirement landscape is Social Security, the unjustly maligned universal financial safety net against the financial risks of old age. Former Republican Senate Budget Committee Chairman Pete Domenici and Alice Rivlin, the White House budget director under President Clinton, described Social Security this way in their bipartisan plan (PDF) for bringing better discipline to the federal budget:
“Social Security is a defining piece of the social fabric and an incredibly successful program. It does not need to be fundamentally altered; rather, it needs only modest adjustments so that it can continue to serve as a financial foundation for millions of retirees, survivors and disabled workers across the country.”
That’s good news indeed considering 60 percent of those aged 65 and over receive at least 75 percent of their income from Social Security.
Still, Social Security isn’t enough. The retirement savings system isn’t working, especially when it comes to low-income and moderate-income workers. Workers have plenty of options for savings—too much, actually, with 401(k)s, 403(b)s, 457s, IRAs, Roth IRAs, Simple IRAs, SEP-IRAs, and more. The government has spent big bucks creating tax incentives to encourage retirement savings. Congress’s Joint Committee on Taxation estimates subsidies to encourage saving in 401(k)s and IRAs alone cost more than $100 billion a year. It’s time to go back to the drawing board and resurrect an idea that’s currently anathema in Washington: mandatory retirement savings.
There have been a number of proposals over the years, usually variations of a universal IRA account attached to Social Security accounts. Retirement experts in academia and finance, concerned about the aging of boomers and their lack of financial resources, are looking more closely at these mandatory savings proposals. For instance, Larry Fink, founder and chief executive officer of BlackRock, which manages more retirement money than any firm in the world, calls for a mandatory retirement savings plan. What’s more, Australia, Britain, and Israel are among the major industrial nations with mandatory retirement savings. Their experience is informing the current conversation.
Meir Statman, a finance professor at Santa Clara University, recently joined the mandatory savings club. He looked at mandatory plans in other countries, as well as plans at many American universities. Among the highlights of his mandatory retirement savings proposal, Statman advocates a combined contribution by employers and employees at a minimum of 12 percent of earnings (drawn from the Australian example), 15 percent of earnings (common at many American universities), or 18.33 percent (the minimum in Israel). Companies already offering their employees a 401(k) could administer the plan since they have the infrastructure in place. A central agency would implement it for other employers. Fees would be razor-thin, copying Britain, which charges no more than 30 basis points for handling an account. (A basis point is one one-hundredth of a percent.) “Mandatory defined-contribution would constitute a second layer in a retirement savings pyramid, above a first layer of Social Security and below a third layer of voluntary savings,” writes Statman.
Patience may be a virtue, but not with retirement savings. America is getting older, and eventually we all reach an age of retirement. There is much to be said for racing toward a system that’s simpler, fairer, more inclusive, and that ensures our elders live in dignity.