Time to Bolster the U.S. Retirement System to Deliver its Full Potential
Remarks by Ronald P. O’Hanley
President, Asset Management and Corporate Services, Fidelity Investments
U.S. Chamber of Commerce Capital Markets Summit
April 10, 2013, Washington, DC
The focus of my remarks today is the need to act now to avert the looming catastrophe America
faces if we don’t get serious about addressing the inadequacy of our retirement savings system. This challenge poses a threat as serious as any to the security of America… a threat to the financial security of American retirees, as well as a threat to the nation’s economic strength, competitiveness, and future prosperity. The challenge is not new, but the potential consequences grow more ominous each day we put off addressing it...
For 10,000 people per day turn 65 in this country, and they are living longer than ever. We need to make significant reforms to the U.S. retirement savings system now in order to avoid the serious crisis that is bearing down on us… as ever-increasing numbers of Americans march toward retirement with little hope of maintaining their standard of living over the course of a retirement that could last 30 or more years.
Exacerbating this crisis is the fact that our retirement system has changed dramatically over the past
30 years. Many of the key retirement savings risks that used to be assumed by employers under the
old defined benefit system – such as savings adequacy, longevity, asset allocation and investment management – have now been shifted to the individual, who typically is not well-equipped to make investment decisions of such magnitude.
Consequently, the proverbial four-legged stool – consisting of Social Security, traditional pension plans, defined contribution plans and personal savings – is wobbly at best, and by and large does not exist for most Americans.
Most Americans are not saving enough for a secure retirement. And an alarming number of Americans do not participate in any retirement savings program! If tens of millions of Americans reach retirement with insufficient savings – the impact on our citizens, our economy and our national security could be catastrophic – and not something we could solve for most retirees after the fact.
I’m not sure what would be worse – millions of elderly unable to house and feed themselves… or the intergenerational strife that surely would erupt if young people are forced to lower their standard of living to pay for our failure to act in a timely manner to avert this crisis. But all is not lost – this crisis can still be averted if we act now to strengthen the existing retirement system and adopt new and innovative approaches to addressing the retirement challenge.
Today, I want to talk about what is working in the current system, the key challenges facing that system, and some simple, straightforward changes we can make to ensure the looming crisis never happens.
PRIVATE RETIREMENT SYSTEM HAS BEEN ENORMOUSLY EFFECTIVE
First, let’s start with the good news… More than $19 trillion is now invested in total U.S. retirement assets, representing 36% of all U.S. household assets1
. These assets are divided roughly 50/50 between IRAs and defined contribution plans on the one hand, and public and private defined benefit plans and annuity reserves on the other.2
This vast pool of capital not only represents future retirement income for American retirees, it has propelled capital formation for the private and public sectors in the U.S. and around the world on a
scale never before seen. Sustaining a robust retirement savings system is beneficial for all concerned – businesses big and small, federal, state and local governments, and most importantly, individuals saving for the future. But, as we know, the U.S. retirement system faces some serious challenges…
CURRENT RETIREMENT SYSTEM FACES KEY CHALLENGES
First of all, the stark reality is that most Americans simply are not saving anywhere near enough to support their current lifestyle in retirement. Scores of studies have demonstrated how serious the retirement savings gap is. Our own research at Fidelity shows that nearly 4-in-10 retiree households do not have sufficient income to cover their monthly expenses3
. Well over half of all Americans have less than $25,000 in total savings, not counting the value of their primary residence or pension plans. And 28% have put aside less than $1,0004
. Considering the general rule of thumb that a worker needs to save at least eight times his or her annual salary to support themselves in retirement, it’s clear that these current savings levels are drastically inadequate.
The second challenge to retirement security is the fact that 35% of all working Americans have no access to an employer-sponsored retirement plan5
. 35 percent! And, in many cases these Americans have no savings at all, and thus are reliant solely on Social Security for their retirement. Not being able to avail themselves of the many benefits of workplace savings programs, such as tax deferrals on contributions and investment returns as well as employer matches, virtually guarantees that these Americans will be unable to retire with dignity and security. The third challenge facing our retirement system is demographics and longevity.
The good news is: We are living longer – which means more time to enjoy the things we love to do…
and to spend time with the ones we love. The bad news is: We are living longer… and may need to
fund a retirement that lasts 30 years or more – potentially including extra years of expensive health care.
Consider this: When the U.S. Social Security system was established in 1935, the average life
expectancy was 63, and the retirement age was 65. Since then, as standards of living and quality of
health care have advanced, so has life expectancy. Today, many Americans are living well into their 90s… and beyond. And, the challenge only increases. Most demographers believe that the first person to live to 150 is alive today! Think about funding that retirement. This increasing longevity is a major factor driving up liabilities – for individuals funding their own retirement, as well as for Social Security and public and private pension plans.
As a result of rising pension liabilities, plan sponsors are closing their defined benefit pension plans
or limiting coverage. Many are shifting retirement benefits from a defined benefit plan to a defined contribution plan – essentially transferring responsibility and risk – savings risk, performance risk
and longevity risk – to employees and retirees to manage.
So, ready or not, Americans are taking on more responsibility for their retirement savings. Which leads to the fourth challenge facing the American retirement system – low levels of financial literacy. Many simply do not have a good grasp of basic financial concepts – such as living within a budget, saving, and investing for the future.
In our schools, we teach children about sex and drugs but not about money. And, in the workplace, some employers are reluctant to provide financial and retirement education and guidance out of fear of lawsuits, and recent signals from the Department of Labor suggest this fear is well founded. So, at a time when Americans are required to be responsible for their retirement security, we are erecting obstacles to the very education, tools, and providers that Americans need.
As if these challenges aren’t serious enough, the final challenge is a new threat on the horizon – from our own Government. Retirement savings vehicles such as defined contribution and traditional IRAs provide incentive to save in the form of tax deferral on contributions and accumulated returns. Participants pay no tax today, but pay tax on everything – contributions and earnings – at the ordinary income rate in the future as they draw from the plan. Makes sense.
Numerous studies have demonstrated that this tax deferral provision operates as a powerful incentive for retirement savings. And all segments – rich and poor – point to tax deferral as a major reason for participation. Despite the demonstrated effectiveness of this tax deferral on retirement savings levels, various proposals, including Simpson Bowles, have lumped the “tax deferral” element of retirement savings in the same bucket as “tax breaks” like the home mortgage deduction and employer-sponsored health insurance, and propose to cap or even eliminate them. All in the name of deficit reduction.
Not only will such a proposal further challenge retirement savings, it will not generate additional revenue.
Remember, this is not a tax break; it’s a tax deferral – indeed, a tax deferral on an amount that grows over time. Eliminating the tax deferral provisions of retirement savings is nothing more than a different form of borrowing. In this case we are moving forward tax revenues from the future – and most likely lowering those revenues.
Do we really need our own Government putting another obstacle in front of Americans
trying to save for retirement? Do we really need more borrowing?
REALIZE THE PROMISE OF PPA
The coming retirement crisis is real, and the potential challenges and ramifications are quite serious.
So, what can we do about it? First, we can build on what is working well.
Congress gets a lot of criticism these days… but we really should laud them for one of their greatest achievements of the past decade – the Pension Protection Act. Congress showed great bipartisan leadership in 2006 when it passed the PPA, which was truly a watershed moment for the private retirement savings system. Yes, you heard right. I used “bipartisan” and “Congress” in the same sentence.
The Pension Protection Act was a major stride toward improving individual retirement savings outcomes by expanding fiduciary safe harbors and enabling employers to more proactively drive workers to take advantage of and realize more benefits from their workplace plans. The highlights of PPA included enabling automatic enrollment, automatic savings increase programs, and auto default to lifecycle investment strategies. These features have had a major impact on getting more participants to enroll in plans and have been a key driver of improved outcomes for workers. Auto enrollment has played a big role in getting more participants to enroll in their plans, particularly younger and lower-income workers.
Annual increase programs are a major driver of increased savings levels by workers. The increased use of target date funds has had a positive impact on the overall asset allocation of plan participants. Indeed, most target date fund participants lost less during the 2009 crash and recovered more quickly because of the asset allocation feature of these funds.
The brilliance of PPA lay in its grounding in and harnessing of the realities of human behavior. PPA enabled employers to use the power of inertia to put their employees on a better path to retirement security. We know that once people make an initial decision about investing in their workplace plans,
most take no further action. So guiding employees to automatically enroll in their plans, automatically increase their contribution level over time, and invest in a fund that automatically adjusts for their life stage are critical steps to putting them on a better path to success.
By enacting this landmark legislation in 2006, Congress showed it can make important policy changes that serve to strengthen the retirement system and give Americans a better shot at achieving retirement security. But Congress needs to do more to fully realize PPA’s potential. Three straightforward extensions of PPA are required.
First, we need to increase the default savings rate. While auto enrollment has had a major impact on plan participation, the 3% default savings level set by the PPA is too low. Policymakers should take steps now to increase the default savings rate to at least 6%.Our research here is clear – employees who are auto-enrolled in their workplace plans, regardless at what level and regardless of income level – have nearly identical opt-out rates. So, whether an employer sets an initial default contribution of 1%, 6% or anything in between, roughly 88% of employees accept the default rate6
. While some may object to a contribution rate of 6%, the reality is that 6% is still too low. Australia, home of the world’s most successful private retirement system, has a combined employer/employee contribution of 18%, and moving soon to 20%. Setting a floor of 6% should be the very minimum of what we can do to get employees to save more – with the ultimate goal of having participants save 10-15% of their salary annually, including employer matching contributions.
Second, policymakers should require auto-increase programs as part of plan design, unless employees choose to opt out of participating. Automatic annual increase programs are the single most effective driver of employee contribution increases, accounting for close to a third of all contribution increases last year and nearly two-thirds of increases by workers in their early 20s7
. Unfortunately, far too few employers are taking advantage of these programs to nudge up savings rates for their employees over time. Policymakers should further incent employers to adopt auto increase programs by easing fiduciary and testing burdens and essentially expanding the PPA safe harbors.
Thirdly, Congress should mandate these auto features – along with a participant opt-out – in all new plans. We all hate mandates. But, these simple features cost the employer nothing incrementally and are proven drivers of retirement savings. In summary, the full promise of the Pension Protection Act can be realized if Congress completes its work
FILL THE “COVERAGE” GAP
I’ve talked about improving savings levels for those participating in a retirement plan. But what about the 35% of private sector workers who either don’t have access to a workplace plan or are not enrolled in one? This so-call “coverage gap” is a serious issue that must be addressed if we are to take steps to avoid the crisis to come.
Two main areas need attention. The first is simplifying and streamlining the savings vehicles that exist today to make them easier to use and more cost-effective for employers to offer. There is no shortage of retirement savings options that exist today – 401(k)s, SEP IRAs, SIMPLE IRAs, Roth IRAs, non-qualified plans, etc. While these vehicles all have different benefits and features, they have one thing in common – they can often be administratively complex and costly, particularly for small businesses. Many of these costs are regulatory driven. With the vast majority of jobs and job growth in the country coming from small businesses, it is imperative that we create simple, streamlined savings plans that make it as easy for an employer to offer a retirement plan to its employees as it is to offer them a paycheck. Regulators need to take a fresh look at the rules that govern these plans and make changes with an eye toward making plans simple and easy to set up and administer. Our goal should be to create a system where it is easy to offer a retirement savings plan… whether you have 2 employees or 20,000.
The second coverage issue we need to address is to provide new incentives and expanded choice of savings vehicles for people who do not have access to an employer-sponsored retirement plan. There
are many reasons Americans don’t have access to traditional workplace retirement plans. They may
be working part-time or self-employed or seasonal – or perhaps they haven’t started working yet.
For these individuals, we need to consider the power of Individual Retirement Accounts to help people save – throughout their entire lives.
An inherent limitation of all aspects of retirement savings – DB, DC, Social Security and IRAs – is that
one can’t start participating until starting to work. Why? Adequate retirement savings is far more likely if savers start early. Indeed, saving early is how we can turn increased longevity from a financial liability
into the blessing it should be. Here we should enable IRAs to be opened as early as birth…and without the requirement of earned income. Allowing parents, grandparents, godparents or anyone else to contribute early on to a young person’s account, coupled with added years of potential compounded returns, would be an enormously powerful tool for generating retirement savings.
In addition, we need to find better solutions to enable workers to easily access and enroll in retirement vehicles without imposing burdensome obligations on small businesses. Whether so-called auto-IRAs
or some other retirement vehicle, the key to success is devising administratively simple approaches
that open retirement savings choices to individuals not covered by traditional DC plans, while not
imposing burdensome mandates on small business.
REMOVE OBSTACLES TO FINANCIAL EDUCATION AND GUIDANCE
As I mentioned earlier, lack of financial literacy is a major challenge for our retirement system. We simply must get serious about the importance of financial education in this country. Since we have required individuals to take on more responsibility for managing key risks related to their retirement security, people need access to a wide variety of advice and guidance. We need to help people not just become more financially literate but turn that knowledge into positive financial behaviors. We need to provide them with the knowledge and tools they need to make informed decisions about saving and investing for success.We should all be doing everything we can to expand, promote and perhaps require financial education in the workplace.
Investors certainly need proper protections in place. But their best interests can only be served if the regulatory framework allows for a wide range of tools to serve the needs of investors and provide the
low-cost guidance, education and advice they want and need. The Labor Department’s original ERISA Fiduciary investment advice proposal would have significantly expanded the definition of fiduciary investment advice. The effect of such a rule would shift the legal line between investment advice and education, and thus dramatically curtail the valuable education and guidance investors receive today.
The real outcome of this misguided proposal would be no education and no guidance for average and low-income Americans. We know Labor will re-propose its rule later this year – and we need Congress and others to keep the pressure on Labor and reject any proposal that would limit the availability of education and guidance to American workers.
These simple steps – extend PPA, broaden coverage, and increase financial education – are enormous strides toward averting the retirement security crisis. Do they fully solve the problem? No.
Social Security, the growing need for retirement income solutions in a low rate environment, and the challenges facing younger workers as they enter the workforce with significant debt also need to be addressed. But that’s another speech…for another day.
Let me close by saying the U.S. retirement system is at a crossroads, and the path we choose will have wide-ranging implications for generations to come.
With so much riding on the success of the defined contribution system, and Americans taking on more responsibility for their retirement security, we need to stack the odds in favor of the individual saving for his or her retirement. We can’t afford to wait any longer. We must act now to improve those aspects of the system that we know work, and find innovative solutions to fix what’s not working.
Solving the retirement challenge requires our collective efforts:
• Government certainly has a major role to play, but it can’t solve the problem by itself.
• Corporations and small businesses can help drive better outcomes for their employees, but they can’t exclusively shoulder the burden.
• Financial services firms can help – by providing the tools, education and guidance that people need to make better decisions… and by developing innovative solutions to help people achieve better outcomes.
• Individuals – indeed, each and every American – must be part of the solution.
The retirement challenge is a vital national security issue. Let’s all work together with a sense of urgency to solve this challenge while we still can. Thank you for your time today.
1 Investment Company Institute, “America’s Commitment to Retirement Security,” Feb 2013
2 ICI, “America’s Commitment to Retirement Security,” Feb 2013
3 Fidelity Retirement Savings Assessment press release, April 18, 2012
4 EBRI, “2013 Retirement Confidence Survey,” March 2013
5 Cerulli Quantitative Update, U.S. Retirement Markets 2012
6 Based on Fidelity recordkept data of 20,000 defined contribution plans and 11.9 million participants as of Dec. 31, 2012,
7 Based on Fidelity recordkept data of 20,000 defined contribution plans and 11.9 million participants as of Dec. 31, 2012.
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