The truth is our retirement system is in crisis. Read the headlines: "Bankruptcy booms among old Americans"; "Entering old age the least prepared in decades"; "42% of Americans at risk of entering retirement broke"; and "Social Security is running dry." It is fact, not future speculation. One in three Americans retiring in the next 10 years will be forced to live at or near the poverty level. Retirement security is the biggest financial worry for Americans across demographics. If we don't address this problem now, wrenching and painful changes will be required down the road.
Together, Professor Teresa Ghilarducci of The New School and I presented a comprehensive plan to address this problem in our recent book "Rescuing Retirement." Our plan does not require any new taxes, any increases in the deficit or any new government bureaucracy. But it does require serious, bipartisan legislation in Washington, and today's political climate doesn't seem ripe for this to happen.
Notwithstanding, there are five easy things our political leaders can do now to help mend our ailing defined contribution approach, which with Social Security, is the backbone of America's retirement system. Most of these things can be accomplished with modest regulatory rule changes or uncontroversial legislative adjustments. They are:
Multiemployer plans. Setting up 401(k)s is difficult and complex for small businesses. As a result, a whopping 40% of American workers today work for employers offering no retirement plan at all. To address this issue, businesses should be allowed to join open associations based on their state or industry so they can sign up easily for efficient, large-scale group 401(k) plans and avoid administrative burdens and fiduciary liability. Expanding workplace retirement plan coverage for working Americans has to be a top priority.
Employer incentives. States or the federal government should incentivize businesses to adopt at least the basic multiemployer plan described above. This could be done by offering a small, one-time tax credit for each new employee enrolled. The cost of these modest tax credits should be more than offset over time by a reduction in the government assistance needed to support struggling retirees.
Auto enrollment. Employees should be automatically enrolled in company-offered retirement plans, with contribution levels increasing at least 1 percentage point per year. Although employees could opt out at any time, auto enrollment has been shown to increase participation in 401(k)s by more than 35%. In addition, action should be taken to make these 401(k) balances easily and automatically portable from one employer to the next, reducing the erosion of savings from people cashing out when they change jobs.
Lifelong income. Upon retirement, employees' 401(k) account balances would automatically convert into an annual annuity for them and their spouse for the rest of their lives. The annuities would be paid by the federal government based on their 401(k) balances. There would be no risk or liability for taxpayers because each annuity is completely self-funded by the 401(k) balance. The annuity payments would be added to Social Security checks and disbursed efficiently through the existing Social Security payment system. For the retiree, there would be no expense, payor credit risk or complex paperwork. Retirees would still have the option of taking out their 401(k) balances as lump sums in cash at retirement if they choose. However, determining spending levels and investments when one gets a lump sum at retirement is highly complex and is well beyond the financial expertise of most people. Furthermore, studies show people with lifelong income are not only happier, but healthier. It is important we give people a simple, cost-effective path to lifelong income.
Better investments. Individuals should be given access to the same broad range of investments that pension funds have by providing safe-harbor rules for qualified managers to include alternative and illiquid assets in 401(k)s as part of diversified investment strategies. Such investments enhance returns and also reduce risk. 401(k)s, now limited only to liquid retail products, have historically returned only 3% to 4% per year. While pension funds, which can have longer term investment strategies including illiquid assets, have earned 7% to 8% per year. The difference between these compounding rates makes a massive difference to a person's retirement savings. The time has come to democratize access to the best investments for future retirees.
Taken together, these five steps would significantly enhance financial security for retirees. If we can't immediately do all five, each one can stand on its own, and each would help materially. That said, even if we implement all five, too many elderly will still be impoverished. To really solve the problem, we will someday need a more comprehensive plan.
At the state level, 23 states have passed or are working on legislation to enhance their residents' retirement security. There is also beginning to be some discussion of these issues in Washington with the House Retirement Enhancement and Savings Act. But these discussions come late, the proposed changes are insufficient and the chances of action are small. We need more.
It is indisputable that doing nothing is not the right answer, and the time to act is now.