Ten thousand people a day turn 65 in this country, and they are living longer than ever. I believe 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 managed 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.
The four-legged stool: wobbly at best
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.
Key challenges facing America's retirement system
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 assets.1 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 also has propelled capital formation for the private and public sectors in the United States 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.
- Inadequate savings. 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 four in ten retiree households do not have sufficient income to cover their monthly expenses.3 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 $1,000.4 Considering the general rule of thumb that workers need to save at least eight times their annual salary to support themselves in retirement, it’s clear that these current savings levels are drastically inadequate.
- Limited access to workplace savings plans. Thirty-five percent of all working Americans have no access to an employer-sponsored retirement plan.5 And in many cases, these Americans have no savings at all, and thus are reliant solely on Social Security for their retirement income. 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.
- Demographics and longevity. The good news is that 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 that 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.
- Poor financial literacy. Ready or not, Americans are taking on more responsibility for their retirement savings. This leads to the fourth challenge facing the American retirement system—low levels of financial literacy. Many people 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 health 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. 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.
- Policy uncertainty. 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 incentives 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. I believe that 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.
Build on what’s working
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 (PPA). Congress showed great bipartisan leadership in 2006 when it passed the PPA, which was truly a watershed moment for the private retirement savings system.
The PPA 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 the 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 encouraging more participants, particularly younger and lower-income workers, to enroll in their plan.
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 2008 crash and recovered more quickly because of the asset allocation feature of these funds.
I believe the brilliance of the PPA lay in its grounding in and harnessing of the realities of human behavior. The 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 I believe that 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 is a crucial step 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 the PPA’s potential. I believe three straightforward extensions of the PPA are required:
- 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. I believe policymakers should take steps now to increase the default savings rate to at least 6%. Our research here is clear: Plans whose employees who are auto-enrolled in their workplace plan, regardless of contribution level and income level, have nearly identical acceptance rates. So, whether an employer sets an initial default contribution of 1%, 6%, or anything in between, roughly 88% of employees accept the default rate.6
While some employees 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 will be 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.
- 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 one-third of all contribution increases last year and nearly two-thirds of increases by workers in their early 20s.7 Unfortunately, far too few employers are taking advantage of these programs to nudge up savings rates for their employees over time. Policymakers should further encourage employers to adopt auto-increase programs by easing fiduciary and testing burdens and essentially expanding the PPA safe harbors.
- Mandate these auto features—along with a participant opt-out—in all new plans. Few people like 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.
- Simplify and streamline 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 today—401(k)s, SEP IRAs, SIMPLE IRAs, Roth IRAs, nonqualified 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 two employees or 20,000.
- 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 be 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 them save—throughout their entire life.
An inherent limitation to all aspects of retirement savings—DB, DC, Social Security, and IRAs—is that one can’t start participating until one starts to work. Why? Adequate retirement savings are 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 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 these are 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 businesses.
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. Because 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 must 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 significantly expand 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 repropose its rule later this year—and I believe we need Congress and others to reject any proposal that would limit the availability of education and guidance to American workers.
Take steps to meet the challenge
These simple steps—extending the PPA, broadening coverage, and increasing 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 discussion for another day. For now, let me simply say that 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.