Those testifying at this week’s finance committee hearing, titled “Retirement Savings 2.0: Updating Savings Policy for the Modern Economy,” defended many aspects of the current voluntary retirement system, acknowledged some improvements are needed, and cautioned lawmakers against heeding impassioned rhetoric aimed at tearing the DC system down.
“Americans do not face a retirement crisis,” stressed Andrew Biggs, resident scholar at American Enterprise Institute (AEI), during his testimony. “But that does not mean we have nothing to worry about.”
Biggs sought to refute recent research showing a dire outlook for workplace retirement savers, including a study from the New America Foundation that claims individual retirement accounts (IRAs) and 401(k) plans produce little in the way of sustainable retirement income. For this reason, the foundation advises policymakers to do away with tax preferences for private DC retirement savings and instead double Social Security benefits. Those claims “tend to underestimate the incomes that Americans will have in retirement while overestimating how much [they] will need to maintain their pre-retirement standards of living,” Biggs said.
He also pointed to research from the Social Security Administration (SSA) and the U.S. Census Bureau, which paints a more optimistic picture. In fact, Biggs said the Modeling Income in the Near Term (MINT) instrument, an advanced research tool used by the SSA to study income trends, recently projected that many Baby Boomer and Generation X retirees can expect income replacement ratios at or near 100% of average pre-retirement earnings, once all sources of income are factored in.
Others, too, presented more promising statistics to counter—or correct—negative information being widely reported. Brian Reid, chief economist for the Investment Company Institute (ICI), advised “looking below” the commonly cited number of 80.6 million workers who report their employer does not sponsor a retirement plan—a figure from the Current Population Survey (CPS)—and there is “a significantly different picture.” Chipping away the federal, state and local workers, the self-employed, part-time employees, and others such as those with a covered spouse, leaves only about 10.2 million private-sector wage and salary employees who would like to have access to a retirement plan but who are currently unable to save and invest at work, he said.
Such assessments distort the reality of DC retirement planning, as do criticisms that focus on one weak component of the system, or account balances only, to define the success of the whole, Reid said. Many of the harshest critics ignore the holistic manner in which most Americans save for retirement—as many participants do not depend on DC accounts alone for retirement income. He cited the importance of home ownership and pension plans, among other factors, in assessing the holistic retirement readiness picture of many Americans.
Reid praised the flexibility of the DC system, which “has led to tremendous innovation in retirement plan design over the past few decades and to continually lower costs for retirement products and services.” He also stressed that changes in policy “should build on the existing system—not put it at risk.”
According to one of the experts, though, the system is indeed already at risk. Vanguard Group founder John Bogle painted a grimmer picture of today’s retirement system, starting with the background. Boasting “many decades of writing extensively on the subject” of retirement plans, he described a layering/compounding of issues over the years, from too much speculation and too little investment to Americans’ rejection of frugality, the costs of mutual fund investing, and other key challenges.
Bogle pushed for a reorienting of the industry toward the shareholders—i.e., participants—rather than the fund managers. To help achieve this, he proposed giving institutional—including mutual—fund managers a mandatory fiduciary status. A federal standard would include, for one, the requirement that these fiduciaries act solely in the long-term interests of their beneficiaries.
Calling DC plans “the only realistic alternative for investors seeking to achieve a comfortable retirement,” Bogle said we must demand significant changes in their structure. The Thrift Savings Plan (TSP) makes a good model, he said.
“It is large, at $385 billion in assets, among the 25 largest pools in institutional money management. It is, well, cheap, with an annual expense ratio of less than 0.03%. It is largely indexed, with 100% of its long-term assets—some $212 billion—composed of four index funds,” Bogle said.
As it is, the defined contribution plan system is “structurally unsound,” he said. The money in accounts is too accessible, through loans and withdrawals, and participation too limited.
Unsound or not, the system works “well for millions of American workers,” said Scott Betts, senior vice president of National Benefits Services LLC, a fee-for-service third-party administrator (TPA) that supports 7,500 retirement and benefit plans in 46 states. Citing data from the Employee Benefit Research Institute (EBRI), he observed that middle-class workers are 15 times more apt to save for their families’ retirement at work than on their own in an IRA.
Still, he conceded, coverage could be enhanced and plan operations simplified. To that end, he said, the American Society of Pension Professionals & Actuaries (ASPPA) has developed a document containing more than 30 legislative proposals to improve the current system. These strategies, some already written into current legislation, would involve only “modest changes to the Internal Revenue Code [IRC] and ERISA,” he said. Eliminating unnecessary paperwork and widening the availability of savings options through simplified small business plans numbered among the ideas.
None of the experts, unsurprisingly, advised removing tax incentives for workplace retirement savings. Noting that tax deferrals should be left out of proposals to cap the value of exclusions and deductions, Reid said, “limiting [their] upfront benefit would impact workers arbitrarily, substantially reducing benefits for those closest to retirement.” In fact, the deferral limit, adjusted for inflation, has already eroded to less than half what it was when established under the Employee Retirement Income Security Act (ERISA) in 1974, he said.
Brigitte Madrian, a professor of public policy and corporate management at the Harvard University Kennedy School of Government, however, downplayed tax incentives’ importance. Armed with 15 years’ experience studying savings behavior, policy interventions and the plan design features that impact retirement plan participant outcomes, she said she has found financial incentives less important than just making things easy for participants. “From a behavioral economics standpoint, the tax code is particularly ill-suited to generating financial incentives to save,” she said.
Our tax system is too complicated for the average taxpayer, Madrian said, noting that even she gave up trying to understand the incentives of the Saver’s Credit for low- and middle-income taxpayers after about 10 minutes. People respond better to immediate, rather than delayed, financial incentives and often do not understand the tax implications of the different types of plans, she said.
The best way to get people to save, she said, agreed upon by essentially all of the experts, is automatic enrollment. It draws in groups known to be poor savers—younger and lower-income employees, she said, adding that “expanding [the DC system’s] reach is the most promising policy step we can take to increase the fraction of Americans who are saving for retirement.”
Biggs agreed, calling the strategy “the single most effective step we could take to increase retirement saving [and] far more effective than other policies, such as contribution matches.”
The crux is to simplify the saving process, Madrian said. Quick enrollment tools and policy initiatives such as auto-IRA proposals and the possibility of multiple employer plans with limited fiduciary liability would also help.
To summarize, she looks to the lessons of behavioral economics research: “If you want individuals to save, make it easy. If you want individuals to save more, make it easy. If you want employers to help their workers save, make it easy. And if you want individuals to spend less [of their retirement assets], make it harder to spend.”
-- Karen Wittwer