Americans who use defined contribution retirement savings plans (for example, 401(k) or 403(b) plans) or Individual Retirement Accounts will see their retirement security enhanced by two recently announced regulatory initiatives. The first is a series of Treasury Department/IRS proposed regulations that such individuals to use annuity-like guaranteed lifetime income products. The second is a final Department of Labor rule requiring complete fee disclosure to employers sponsoring retirement saving plans. Together, the two initiatives will give current retirement savers and future retirees more flexibility in structuring their retirement incomes, while making it possible to avoid excessive or hidden fees.

Four Treasury/IRS proposals, which were developed under the leadership of our former RSP colleague Mark Iwry, deal with several of the most pressing issues faced by employers and savers that currently reduce the use of annuities. The first proposal would reduce barriers to giving retiring savers the option of annuitizing part of their account balances. Currently, people need to annuitize either the entire balance or none at all. People are naturally wary of annuitizing the entire amount because it leaves them with little in the way of a cash cushion for emergencies. By choosing to annuitize part of the balance, people can retain a lump sum for emergency or other purposes.

A second proposal would remove a technical impediment to using longevity annuities, an annuity that is typically purchased close to retirement but does not begin to pay benefit until the retiree reaches age 85 or a similar age. Longevity annuities enable retirees to manage their money for a set period of time, secure in the knowledge that the longevity annuity will provide income after that, should they live longer than expected.

The third proposal would allow an individual to begin to partially annuitize their savings well before retirement. Starting to annuitize early by buying small pieces of an annuity over twenty or so years allows the saver to avoid having to make a “once and for all” decision and allows the savers to spread out the interest rate risk over time. This option had been subject to a requirement that the saver get a notarized statement from his or her spouse (if any) concerning whether the annuity covers just the saver or both the saver and his or her spouse. The proposal allows this to be handled by the issuing insurer when payments would begin rather than when purchases begin.

The fourth proposal would apply to relatively rare case where the employer has both a retirement savings plan and a traditional defined benefit pension, and would allow an employee to buy a low-cost annuity through the employer’s DB pension.

These four regulatory changes are positive developments. The changes announced today eliminate unintentional barriers to the use of lifetime income products without dictating how individuals should use them. Some may choose to partially annuitize at retirement, some to use longevity annuities to protect them in later years, and some to begin to buy annuities well before retirement. Whatever the choice, the proposals open up new options to future retirees, and should encourage even more market innovations.

At about the same time, the Department of Labor released final regulations requiring providers to disclose all direct and indirect fees to the employer sponsoring a 401(k) plan. The regulations will add needed transparency on fees that will enable increased competition to produce better results for employers and employees.

Despite removing a required template of charges, the new regulations nevertheless give employers a complete and accurate picture of all charges they have to pay, including indirect fees paid by the provider to others. Currently, many indirect fees are not disclosed even though they may reduce the earnings of participants. Endorsed by industry and consumer groups, the disclosures will enable employers who use this information properly to meet their fiduciary responsibility to choose a responsible fee level. What is even more important, the full disclosure will enable employers to structure their 401(k) plan so that individual savers can get the best returns possible, and not be subject to unreasonable fees.

While much more remains to be done to improve retirement savings plan, the steps taken by the proposed Treasury/IRS regulations and the Department of Labor’s final regulations will help savers to improve retirement security.

The new 2013 budget unveiled by President Obama on Monday again contains the Automatic IRA, which was developed by Brookings' Retirement Security Project in conjunction with The Heritage Foundation. This year's version again includes an important change that will also encourage more employers to offer a 401(k) account to their workers. However, important changes to the Saver's Credit, which had been in previous budgets failed to make it this year.

Nearly half of American workers - an estimated 78 million- currently have no employer-sponsored retirement savings plan. The Automatic IRA is a simple, easy to administer and understand system that is designed to meet the needs of small businesses and their employees. Employers facilitate employee savings without having to sponsor a 401(k)-type plan, make matching contributions or meet complex eligibility rules. Employees are enrolled automatically into an IRA with a simplified system of investment choices and a set automatic savings level. However, they retain complete control over all aspects of the account including how much to save, which investment choice to use, or even to opt out completely. Automatic IRAs also offer savings options for the self-employed, for independent contractors, as well as providing those who are changing jobs the ability to continue their retirement savings.

The new 2013 budget would also double the size of the tax credit that employers receive in return for starting a new 401(k) plan from $500 annually for three years to $1,000 annually for the same period. This increase will ensure that the credit covers more of an employer's costs, and should encourage more employers to offer such a plan. This is a very good move, but the credit could be still further expanded to $1,500 for three years as will be proposed by a new House bill coming from Rep. Richard Neal. As Congress examines the proposal, it will have the opportunity to also expand the smaller credit that would be offered to employers that start an Automatic IRA to ensure that they are fully reimbursed for all expenses connected with starting and operating such an account for their workers.

A disappointing development is the failure to again include proposals to expand and improve the Saver's Credit by making it fully refundable. The Saver's Credit is an incentive for middle-and lower-income taxpayers to save in 401(k)-type accounts or IRAs. Retirement Security Project research found that more than 69 million taxpayers had income that was low enough for them to be eligible for the Saver's Credit in 2007. However, nearly 45 million of these filers actually failed to qualify for the credit because they had no federal tax liability. If the Saver's Credit was made refundable as RSP has proposed and deposited directly into the account as a match for savings, those 45 million taxpayers could have taken advantage of the program and had significantly higher retirement savings.

Editor's Note: this article originally appeared in the 2012 Print Version of AARP: The Journal.

Using one platform to offer a variety of services

Known in the UK under the term “corporate platform” to indicate that it expands options available on the employer’s benefit platform, the development allows employees to use the employer’s retirement savings mechanism to save and invest for additional nonretirement purposes. When the corporate platform is fully implemented, employees will be able to man­age almost all of their investments and savings plans from one location, thus giving them a con­solidated view of their entire financial status. If carried to its full potential, the expanded saving platform will allow employees to shop for sav­ings products, among options that are available on the platform, instead of having to seek them out from individual suppliers—a search that often takes up work hours. Of even greater value, it gives employees one source to go to for indi­vidualized advice or financial literacy training.

The enhancement has special significance in the UK, where by fall 2012, the larger employers that don’t offer any other type of pension or retirement savings plan, must begin to automatically enroll their employees into basic retirement savings accounts. This requirement is causing a great deal of discussion about the future role of employer-provided benefits, as well as recon­sideration of the fees and services included in a traditional package. The platform enhancements allow an employer to differentiate its employee benefit package from the required basic account structure. It also gives younger employees a benefit of more immediate value, than they would have from a retirement savings account that they won’t access for a good 40 years.

Presentations from a variety of service providers at an October 2011 summit hosted by Pensions Insight, a UK trade journal, showed that the platform can be easily customized to meet the special needs of a specific workforce. Using a single computer interface, employees can select from a wide variety of savings and investment options that are appropriate for their income level and stage of life. Thus, an upper income manager who manages his or her own finances could see more sophisticated products, while an entry-level worker sees more basic sav­ings products. Live presentations by financial professionals who explain what is available on the computer platform add to the system’s value and increase its use.

A place to provide choice and to build financial literacy

The platform will have special value for moderate- and lower-income employees. While higher salaried employees may appreciate the opportunity to build their investments, the real value of the platform will be to enable moder­ate- and lower-income workers to find savings opportunities that they might otherwise miss because they don’t know where to go, are uncertain about what is a fair price, or for a variety of other reasons. Because employees tend to believe that services included on the corporate platform are implicitly endorsed by the employer, they usually have greater faith that the services are from legitimate providers at a fair price.

Employees at all levels can also use the site to receive guidance on individual products or basic financial literacy training. Individuals can choose from a range of options, from short videos on a specific topic by experts or fellow employees, to longer connected courses designed to meet the needs of specific age or income groups. Use is increased when employ­ees receive emails or text messages geared to birthdays or other life events, or generated after the employee visits a specific part of the website.

Understanding the value of peer evaluations to motivate others, some providers include a place where employees can post feedback about spe­cific products or savings choices. These postings help to guide other employees’ decisions and build the reputation of the platform as a source of unbiased information. The site can also include links to outside advisors who can answer specific questions, guide employees to another site for more information, or perform other services either online or over the telephone.

Differing age groups can be contacted and guided through different technologies. At the UK platform summit, David Harris, of Tor Financial Consulting, showed that younger employees preferred different communication methods than either older workers or the usual way employers provide information. However, the platform is able to use a wide variety of methods and is equally effective no matter which is used.

The platform’s value to international policy makers

Although the UK’s platform is intended as an enhancement to employer-provided benefits, it can also be used for a wide variety of policy goals, as the basic structure can be easily adapted to meet almost any nation’s specific tax and savings system. In the United States alone, policy experts have proposed dedicated savings accounts for nonretirement purposes ranging from unemployment benefits and retraining, home purchases, health care, and long-term health care coverage, to repaying student loans or building college balances for children or grandchildren. However, if all of these various accounts were established and funded, it is doubtful the employee would have any money left for food, clothing, and shelter.

Rather than having a host of specific savings programs, employees may be better served by more flexible accounts usable for a variety of purposes, as outside developments or chang­ing needs dictate. The platform concept would allow individuals to choose which purposes they need to save for and how much to save for each. Combined with targeted guidance or education, this structure could expose individuals to pos­sibilities they might not have considered before.

The structure is ideally suited to employment situations, but it could also be used by the self-employed or by consultants at sites aimed specifically at them and sponsored by trade associations, unions, or even government agen­cies. While their circumstances may preclude payroll deductions, the same products could be offered through direct debits to bank accounts.

The added value of nudge

The flexibility of the platform allows it to be used by employees with all levels of financial sophistication, but new participants would benefit from a variation on automatic enroll­ment that places certain amounts, in addition to the retirement savings amount, into a general savings account or similar vehicle. The automatic savings amounts deducted need not be large, and where the law allows, could vary according to employee age, with a larger proportion of the overall deduction going to nonretirement purpose for younger employees and to retirement for older ones.

As with automatic retirement enrollment, the employee would have the ability to vary amounts, divide the total among various accounts, and even stop all future contributions. However, automatic enrollment would offer workers direct experience with the nonretire­ment side of the platform. By varying enrollment in various accounts according to employees’ age, automatic enrollment could encourage them to consider saving for various purposes, such as a first home, college tuition for children, or additional health services.

Improving retirement security

Although the platform is applicable to a wide variety of other uses, its primary purpose is to build retirement security. Before retirement, the platform helps employees understand how to save, what they have, and how much more they need for a comfortable lifestyle. The other savings provide funds that can be used in the event of an emergency, thus helping to reduce leakage from retirement accounts in countries that allow early access to that money. At retire­ment, the platform helps individuals to see what other assets are available, and what loans or other liabilities must be factored in. In the UK, it is also being used to encourage individuals to use annuities and add them to their invest­ments. The UK experience can help to guide US policymakers in their efforts to increase the use of similar products.

The enhanced information and flexibility of the corporate platform should help individuals to better understand their finances and how to meet their goals. It moves retirement savings plans from a minor part of employees’ financial lives, to a central feature that has many more uses than just an event many years in the future. This promotes regular use of the platform, and a fuller understanding of what is necessary for a comfortable retirement.

Many American households do not save for retirement. Those that do save often contribute too little, invest poorly, or withdraw funds early. These patterns leave households, particularly low- and middle-income households, vulnerable to insufficient savings to finance adequate living standards during old age and retirement.

This research report proposes retirement saving reforms designed to help boost saving among low- and middle-income households. These 11 proposals are grouped under five themes: (1) making saving easier, (2) making saving more rewarding, (3) strengthening the market infrastructure for saving, (4) providing private information to savers, and (5) improving public education for saving.

Download the full report at aarp.org »

Event Information

Australia's mandatory Superannuation Guarantee requires its citizens to save at least 9 percent of their income towards retirement. In many Asian nations, economic growth has spurred reexamination of pension systems to meet the needs of rapidly evolving societies. Would a mandatory savings plan be more effective than the current U.S. voluntary system? How have Asian nations have restructured their pension systems to deal with legacy costs? And what can Americans learn from the way Australia uses both employer and employee representatives to shape investment choices?

On September 17, the Retirement Security Project at Brookings and the AARP Public Policy Institute hosted a discussion of what the United States might learn from retirement savings systems in Australia and Asia. Opening speakers included Nick Sherry, who helped shape the Australian system as a cabinet minister and ran a Superannuation fund in the private sector, and Josef Pilger, an advisor on pension reform to both the Malaysian and Hong Kong governments and many industry providers. Steve Utkus, David Harris and Benjamin Harris, retirement experts from both the United States and the United Kingdom, considered how reforms in Australia and Asia can shape the American debate and whether this country should adopt key features from those foreign systems.

Audio

• Retirement Savings in Australia, Asia and Beyond: What are the Lessons for the United States?

Transcript

• Uncorrected Transcript (.pdf)

Event Materials

• 20130917_retirement_savings_transcript

In this year’s State of the Union Address, President Obama announced a new retirement savings account for workers whose employers do not offer any form of pension or savings plan. He also promoted the Automatic IRA, a retirement savings plan that originated at the Retirement Security Project and has been in the Administration’s budget for several years.

Only about half of workers has access to a retirement savings plan at work. Millions of Americans lack the ability to save at work via payroll deductions. And while these individuals could in theory save on their own in an IRA, the best estimate is that only about one in twenty eligible to contribute to an IRA actually do so on a regular basis.

To help solve this problem, the President announced the creation of My Retirement Account, or “MyRA.” Similar to the R-Bond discussed in a recent AARP Public Policy Institute paper written by William Gale, David John and Spencer Smith, MyRA would allow individuals to save in a government bond account similar to the one offered as an option to federal employees through the Thrift Savings Plan. The details are unclear (there’s a WhiteHouse fact sheet here), but MyRA would allow new savers and those with small balances to accumulate retirement savings without either having to pay administrative charges or face market risk. Employers would not administer the plan or have any fiduciary responsibilities related to the accounts. Importantly, too, contributions come from employees, not employers. The plan is meant to build off of existing institutions—payroll deduction, Roth IRAs, the G-fund in federal employees’ thrift saving accounts. And it is meant to supplement, not substitute for, 401(k) and other company-based retirement plans. It accomplishes the latter by only allowing contributions up to the IRA limit, by limiting investment choice, and by having people with more than a set balance move into a regular account.

This approach is a boon to those who can only afford small contributions to retirement accounts. Private sector funds often require minimum contributions that are out of reach of low-income savers or assess high fees to offset their costs.

The key questions are whether employers will participate and whether automatic enrollment (that is, a regular contribution on behalf of all employees who do not opt out) would be allowed for MyRA accounts. Research suggests that automatic enrollment would greatly boost the number of employees who participate.

President Obama also promoted the Automatic IRA, but that would require congressional action, something that has not happened so far. Because the Automatic IRA would require employers with more than 10 employees to offer retirement accounts, it would likely dramatically increase the number of workers who save for retirement. It would also give employees a greater choice of investment options and serve as a permanent retirement savings plan, rather than a starter account like MyRA.

With Tuesday night’s mention of both proposals, the president made retirement security a priority. Both proposals would allow workers to build economic security through their own efforts and promote the kind of values and self-reliance that both sides of the political spectrum find attractive.

Thank you for allowing me to testify before you today on the need to improve retirement savings opportunities for employees of private sector small businesses and ways to structure such an effort.

I am David John, a Senior Strategic Policy Advisor in AARP’s Public Policy Institute, AARP’s internal think tank. In addition, I am a Deputy Director of the Retirement Security Project at the Brookings Institution. Before I joined AARP last year, I was a Senior Research Fellow at the Heritage Foundation for almost 15 years.

My testimony this afternoon will focus on three areas: first, that there is a very real and growing retirement security problem in the United States; second, that the existing products and efforts are not resolving this problem; and third, that there are some approaches that Oregon could take that are compatible with existing law and would help future retirees to have a more comfortable retirement. These proposed actions would also help both your state and the country as a whole avoid the high costs of doing nothing. Let me be clear from the start that simply talking about increased education is not enough. This is a problem that will require action to improve.

The Problem Facing Us

Oregon and our nation face a serious problem if a large proportion of our workforce remains unable to save for retirement through an employer-related payroll deduction plan. This situation affects both those approaching retirement and those who are just starting their careers. However, older workers may have much higher access to defined benefit plans, and thus be much better off than younger employees who will have nothing to rely upon other than savings and Social Security.

Social Security is the foundation of retirement security both here and nationwide. In Oregon alone, its benefits keep hundreds of thousands out of poverty, but for most people, Social Security’s average benefit level of about $1,300 a month[1] does not provide enough for a comfortable retirement. That is about $15,600 a year. Economic security requires both Social Security benefits and sufficient additional savings to supplement them.

The lack of savings—and the opportunity to save at work through payroll deduction—is where the problem lies. Various industry groups and columnists have claimed that all is well, and that there really is not a problem. However, on close examination, there are holes in their figures, and they often focus on today’s retirees and those close to retirement, people who are much more likely to have a traditional defined benefit pension plan than younger workers who need to be saving now will have.

Even then, the numbers are not pretty. National data from the non-partisan Employee Benefit Research Institute (EBRI) show that in 2013, 51 percent of workers aged 45–54 had less than $25,000 in total savings and investments.[2] These are people between 10 and 20 years from retirement. Among workers aged 55 and above, those within 10 years of retirement, 43 percent had less than $25,000 in total savings and investments. These household savings numbers exclude home equity and defined benefit pensions (if any). Savings of that amount will not take an individual through one year of retirement, much less the 20 plus years that most healthy 65-year-olds are likely to experience.

Interestingly, the question in 2014 was revised to separate out those with access to an employer-sponsored retirement savings plan or pension and those without.[3] The answers showed once again the value of such a plan and the cost of not having one. About 62 percent of employees with access to a retirement saving plan through their employer had more than $25,000 saved, and 22 percent had $100,000 or more. However, 94 percent of those without access to such a plan had under $25,000 in total savings and investments, and only 3 percent had $100,000 or more.

Just to place these numbers in perspective, any amount of retirement savings is certainly better for a retiree than no retirement savings at all, but it takes a significant amount gradually built over a long period of time to build a significant level of financial security. Retirement savings of $100,000,[4] a sum that only 30 percent of the workers age 45–54 and only 42 percent of those age 55+ in the EBRI survey will equal or exceed, buys additional monthly income of $589 ($7,100 annually) for men at age 65 and $552 a month ($6,600 annually) for women at that age.[5] That would give men with $100,000 in retirement savings and average Social Security benefits a monthly retirement income of about $1,800 ($22,700 annually) and women with the same savings and Social Security benefits a monthly income of $1,750 ($22,200). Neither figure is likely to produce a comfortable retirement, and the EBRI data suggest that even that is out of reach for well over half of all Americans.

Admittedly, these are rough numbers, and many people will receive higher-than-average Social Security benefits. However, many other people will end up receiving much less than average. We know from other research that five groups are most likely to undersave: small business employees, lower-income individuals, women, younger workers, and members of minority groups. However, the problems are not limited to just these five groups. By the way, the recent column by Robert Samuelson[6] that repeats industry assurances that all is well cited the Investment Company Institute (ICI) as saying that the median value of IRA and 401(k) accounts held by people aged 55–64 is $100,000.[7] If that is true, then half of all those with such accounts would have annual retirement incomes equal to or less than the $22,000-plus level I just mentioned if they receive average Social Security benefits.

To make matters worse, when calculating the average amount in such accounts, researchers usually exclude those who have no account at all. In the case of the ICI data Samuelson cites, it appears that approximately 25 percent of households aged 55–64 did not have either a 401(k) or an IRA. They face an even worse future.

How can industry researchers present the existing retirement system as working very well? The answer is by using selective statistics. As an example, the EBRI study includes a question asking how many employees have saved for retirement.[8] The answer for 2013 is 66 percent of all workers and 74 percent of those aged 55 to 64. If one stopped there, the picture would look very good. It is only when one digs in deeper and asks how much they have saved that the true problem becomes evident. Similarly, other studies[9] that show no serious problem focus on today’s retirees, who had much more access to a traditional defined benefit pension than tomorrow’s retirees will. While many of today’s retirees are comfortable, their success does not imply that younger workers will automatically have the same future.

Access to Workplace Savings Is Essential

It is not that people do not want to save or cannot save. They do. The problem is often the lack of access to a convenient savings plan, and the inability to understand the many savings options that exist.

The existence of a workplace retirement savings plan is important. A recent Boston College Center for Retirement Research paper[10] found that access to a workplace retirement savings plan or pension is second only to having a job as the most important factor in assisting moderate- to low-income individuals to build retirement security. A wide variety of research shows that only about half of the U.S. workforce has the ability to save for retirement or has a pension at work. While there are a variety of data sources, each with its own strengths and weaknesses, another Boston College study[11] found that the coverage statistics are comparable between data sources when the same standards are applied. This included a study of IRS records[12] that appeared to show otherwise.

Regardless of the exact percentage point used to estimate coverage, the sad fact is that millions of Americans currently lack the ability to save for retirement at work through payroll deduction. This is especially true for small business employees. A recent U.S. Government Accountability Office (GAO) study[13] found that only about 14 percent (one in seven) of businesses with 100 or fewer employees offer their employees such a plan, and that between 51 percent and 71 percent of the roughly 42 million people who work for a small business lack the ability to save for retirement.

PPI research shows that about 642,000 Oregonians between the ages of 18 and 64—about 47.6 percent—are employed by a company that does not offer a pension or retirement savings plan.[14] The Oregon number is slightly better than the 51.1 percent national figure. That translates into 57 million Americans who are employed by the private sector and cannot save for retirement at work. These are not just younger employees who are new to the workforce. They include midcareer individuals who move from a large company that offered a retirement plan to a smaller company that does not. Often, these midcareer workers end up with a gap in their savings history that damages their ability to build economic security.

The Need for Better Coverage Is Widely Acknowledged

AARP is certainly not the only organization to recognize the need to increase the number of people able to save for retirement through a payroll deduction plan or account. Here, in Oregon, the Retirement in Reach Coalition[15] is a broad-based collection of business, professional, labor, and civic groups that have come together to help more Oregonians to save.

Nationally, a number of organizations, including many prominent research institutions, have written about the number of people who lack the ability to save for retirement and the need to improve coverage. Please note that these organizations do not necessarily support any specific solution or, indeed, any solution at all. However, all have written about either the need to expand coverage or how retirement security would be improved through greater coverage. As an example, Putnam Investments CEO Robert L. Reynolds has written about the need to improve the ability to save in a short paper titled “Three Steps that Could Shore up Retirement.”[16] The paper noted that “today—two years since the first boomers turned 65—the Employee Benefit Research Institute estimates that 49% of American workers are still ‘not confident at all’ or ‘not too confident’ about having enough money in retirement, 57% of pre-retirees have less than $25,000 saved for the future, and 32% of all workers do not have access to a retirement saving plan at work.”

The paper’s Step Two was: “Access to workplace savings for all workers. Any worker paying FICA taxes should have access to a retirement savings plan at work.”

Other organizations that have either issued papers or made statements about the number of people who lack an employer-sponsored retirement savings or pension plan include the following: the Brookings Institution’s Retirement Security Project,[17] the New America Foundation,[18] the Aspen Institute,[19] the U.S. Chamber of Commerce,[20] the Heritage Foundation,[21] and the Urban Institute.[22]

Again, this is not to imply that any of these organizations endorse any approach that Oregon might decide to take on retirement savings or that they support any part of my testimony. I mention them solely to show that concern about limited opportunities to save for retirement is widespread.

Those without an Employer-based Plan

In theory, everyone without an employer-based plan could save in an IRA, but EBRI research estimates that only about 1 out of 20 actually does so regularly.[23] In addition, payroll deduction is viewed as very important for encouraging retirement savings by people at every income level[24]. Overall, 61.5 percent of those surveyed in the EBRI 2011 Retirement Confidence Survey said that payroll deduction was very important for encouraging them to save for retirement, and another 27.8 percent said that it was somewhat important. Together, 89.3 percent said that it was either very or somewhat important. Further, the survey also found that a significant number of those currently saving would either stop or reduce their saving if payroll deduction was not available. It is much easier for people to save regularly if their savings are deducted from their paycheck before they receive it. Otherwise, the press of immediate bills tends to crowd out savings for longer-term goals.

Another factor in the extremely low savings rate among those who can use only an IRA is availability and trust. Especially in low-income neighborhoods, there are often no financial institutions nearby other than check-cashing outlets. Low-income individuals are often reluctant to go to financial outlets in other areas as they may feel that they are not welcome or that they will be treated poorly. Another drawback that applies to individuals of all income levels is the fear that they will be taken advantage of. Because financial professionals will know much more about the subject than their potential customers and may use unfamiliar terms, people have a very real fear that they will be talked into something that benefits the financier rather than the saver.

In addition, behavioral research shows that when people are faced with an important decision where they are uncertain what to do, they do nothing. This inertia factor is especially present in financial decisions like retirement savings.

These are reasons why an approach that focuses solely on additional education is extremely unlikely to succeed. Such an approach does nothing to increase the number of local financial outlets or opportunities to save. In addition, such financial literacy training often uses the same complex terms that potential savers find confusing. There is a value to training, but only in addition to expanded access to retirement savings.

On the other hand, when employees are presented with a plan at work that is structured in a way that provides guidance, they take the opportunity to save. This is true at all income levels. The Boston College study on why lower-income people are less likely to save that I mentioned earlier[25] showed very similar take-up rates between income levels. Eighty-six percent of those with incomes under 300 percent of the poverty line participated in a retirement savings system or pension if they were offered one and were eligible, compared to 95 percent of those with higher incomes.

Existing Products Are Not the Solution

Opponents of a state-sponsored retirement savings effort often cite the number and kind of existing products that are currently available to small businesses. A joint IRS/U.S. Department of Labor publication[26] lists seven types of retirement savings plans that are currently available. Unfortunately, most of them are both expensive and complicated or require the employer to make a contribution. Only one that is not widely available really enables small businesses to offer their employees an opportunity to save without saddling them with high costs or requiring savings.

Both the traditional 401(k) and the automatic enrollment 401(k) are excellent solutions for employers who are willing to offer them. However, the GAO found[27] that smaller employers can pay much higher administrative costs than those paid by larger employers. In addition, they can be complicated and require employers to play a more active role than many are willing to do.

Three other plans, the SEP IRA, the SIMPLE IRA, and the safe harbor 401(k), are either totally financed by employer contributions or require employers to make contributions. In addition, another of the seven options—a profit-sharing plan—is both completely financed with employer contributions and doesn’t require regular funding. While this plan does allow for profit sharing in good years, it does not necessarily include regular contributions that an individual can use to finance a retirement income.

The seventh type of retirement savings account available to small businesses is the payroll deduction IRA. It does not require (or allow) any employer contribution, or saddle the employer with complex regulatory burdens or impose significant costs. All the employer has to do is make it available to employees, deduct the contributions from their paychecks, and then send it to the financial provider. Unfortunately, it is not widely available or sold, as it offers financial services companies only limited income potential. Oregon can help to change that situation.

Another type of retirement savings tool, MyRA, was announced in President Obama’s January State of the Union speech. MyRA has some very positive features,[28] but it is not a solution or a substitute for anything Oregon might decide to do to help more people to save for retirement. A key weakness is that an individual can only have a maximum of $30,000 in MyRA. That is not nearly enough for any appreciable improvement in financial security. Second, MyRA savings will be deposited only in government bonds. While that investment is completely safe, it does not allow any real investment growth. An individual with just a MyRA is likely to get little more than the inflation-adjusted amount they contributed.

Why Oregon Should Be Concerned about This Problem

This is a state problem because doing nothing will mean higher state and local taxes for your children and grandchildren. Low-income retirees will need state and local services financed by state and local taxes for health care, housing, senior centers, and a host of other services. As Oregon ages and the baby boomers retire, the demand from this population for additional state government services will only grow. However, there is a simple, low-cost alternative to taxpayer-funded government services.

What Oregon Can Do to Help

The statute that created the Oregon Retirement Savings Task Force includes the limitation that you cannot recommend anything that might be contrary to the federal Employee Retirement Income Security Act (ERISA). Some would have you believe that this limits you to proposing additional employee education. This is not the case.

While ERISA as it is currently written does limit Oregon’s options, there are still avenues open to the state that would help to directly increase the number of Oregonians who can save for retirement at work. Oregon could still sponsor a payroll deduction IRA[29] that could be available at low cost to every resident of the state who is not currently covered by another retirement savings or pension plan. Such an account could be available through either state-managed investments or one or more private sector providers chosen and monitored by a state agency.

The state, the employer, or any private sector provider would not be responsible for the performance of the savings, and there would be no promised retirement benefits. All of the savings would come from and be owned exclusively by the individual saver. It would be up to the saver to monitor his or her eligibility and compliance with contributions rules. The small costs of such a program could be paid out of fees assessed on the accounts, or the start-up costs could be subsidized by the state.

A key fact is that the only liability faced by the employer would be to collect and forward individual contributions to the provider or agency on a timely basis. In theory, such contributions could be forwarded using the same schedule as the state currently uses to collect its income tax revenues. Federal law limits the role of the employer to encourage its employees to save for retirement through providing general information about the payroll deduction IRA program. The employer is also allowed to answer any questions about the program or to refer them to the IRA provider and provide any informational materials written by the IRA provider, as long as no endorsement by the employer is provided. At all times, the employer must remain neutral about the provider.

This is not a perfect plan, and it does not include features that many who support increased access to retirement savings would like to see. However, we believe that such a plan would be legal and, if combined with an educational program, could increase retirement savings among Oregonians. As federal law either changes or is reinterpreted, additional features and services could be added. This would be a starting place, not a final destination.

Automatic Enrollment

At this point, any Oregon plan would probably not require the use of automatic enrollment. However, as both state and federal law evolve, it would be helpful to explore encouraging that feature in any retirement savings plan. Under automatic enrollment, an employee continues to have total control over his or her retirement savings decisions, but unless the employee decides otherwise, he or she is enrolled and saves a set percentage of income in a specific investment choice. Automatic enrollment uses behavioral economics to make inertia work for the employee. These features work. The five groups mentioned earlier that are most likely to undersave (women, younger employees, small business employees, lower-income employees, and minority groups) all see their participation rates climb from very low levels to close to 90 percent.

And employees like automatic enrollment. A 2007 survey[30] of automatically enrolled workers showed that 95 percent found that it made saving easy. Eighty-five percent started to save earlier than they would have without it. Almost all of the employees who were automatically enrolled and remained in the plan said that they were satisfied with the process (97 percent) and were glad their company offered automatic enrollment (98 percent). Even those who were automatically enrolled and decided not to save liked the feature, with 90 percent being satisfied with the process and 79 percent being glad their company offered automatic enrollment.

Conclusion

Again, thank you for allowing me to testify today. Improving the ability to save for retirement through the increased availability of payroll deduction savings would address a real need both here in Oregon and nationwide. From a policy standpoint, an active program that increases the access that small business employees have to payroll deduction retirement savings plans would help the nearly 650,000 Oregonians who don’t currently have such an opportunity. It would enable them to build economic security through their own efforts.

BEST PRACTICES:

• A universally available payroll deduction IRA that is available to any Oregonian who currently lacks an employer-provided retirement savings or pension plan.
• A very short list of available investments that includes both a stable value fund and a balanced or target date fund. New savers would go into a previously designated investment unless they chose otherwise. Savers wishing other investments would be able to find other IRA accounts.
• Regular statements that clearly indicate investments, earnings, fees, and account balance. A number indicating the monthly retirement income that such a plan could produce if the current amount is saved would be very helpful.
• A coordinated statewide education program that explains the accounts and how to use them as well as the value of saving for retirement.
• Financial literacy classes in every school.

In the 2015 State of the Union Address, President Obama made retirement security a priority for his Administration by promoting the Automatic IRA, a retirement savings plan that originated at the Retirement Security Project. The proposals would increase the ability of part-time workers to join their employer’s plan and improve tax incentives for businesses that either start an Automatic IRA or other type of retirement plan or add automatic enrollment to an existing plan.  

Only about half of all American workers have access to a payroll deduction retirement savings plan at work. For part-time workers, fewer than four in ten have the opportunity to save at work. And while these individuals could in theory save on their own in an IRA, the best estimate is that only about one in twenty eligible to contribute to an IRA actually do so on a regular basis.

Last year, the President announced the creation of My Retirement Account, or “MyRA.” Similar to the R-Bond discussed in a recent AARP Public Policy Institute paper written by William Gale, David John and Spencer Smith, MyRA would allow individuals to save up to $15,000 in a government bond account similar to the one offered as an option to federal employees through the Thrift Savings Plan.

Now, the White House proposes to build on the MyRA.  Because the Automatic IRA would require employers with more than 10 employees to offer retirement accounts, about 30 million more workers would have the opportunity to save for retirement via payroll deduction. Using automatic enrollment, a mechanism that both works and that employees strongly support, the Automatic IRA would serve as a permanent retirement savings plan, rather than a starter account like MyRA.

To further increase the number of retirement savers, the Obama Administration also proposes to allow part-time employees who have worked for the employer for at least 500 hours a year for the past three years to make voluntary contributions to the employer’s plan.  Currently, employers are allowed to exclude any employee who works less than 1,000 hours per year. 

And to encourage employers to offer retirement plans, the existing tax credits for small employers who start a new retirement plan or pension would be greatly expanded.  Small employers who create an Automatic IRA would be eligible for a $3,000 tax credit, while those who open another type of retirement plan would be eligible for a $4,500 tax credit.  And just adding automatic enrollment to an existing plan would earn a small employer a tax credit of $1,500.

While these proposals would all need the approval of congress, they may well be able to rise above the usual political maneuvering.  For instance, both left and right have made positive comments about the Automatic IRA, and businesses should support the call for expanded tax credits to cover their costs in implementing the plans.

Most important, the president continues to make retirement security a priority with practical solutions that would allow many more Americans to build retirement security through their own efforts.  His proposals promote the kind of values and self-reliance that both sides of the political spectrum find attractive.

Increasingly, many Marylanders are unprepared for retirement.

The US has the broadest range of retirement savings options in the world. There are thousands of retirement products offered. But most Marylanders don’t use them.

The need is growing. The Baby Boomers are the largest generation in history. They will live longer in retirement than any generation in history.

But – financially – many are not prepared. Many have virtually no retirement savings: more than a third those within ten years of retirement age have saved less than $10,000. $10,000 invested and spent over the average person’s retirement works out to about $1,000 of income per year. Even with Social Security, that’s not much to live on.

Fears about retirement are the #1 economic concern. Many Marylanders know they’re unprepared – and they’re worried about it. Concerns about retirement security are now more broadly based than the cost of health care, fear of job loss or other economic concerns – and have been for over a decade.3 Those concerns have grown since the financial crisis, even though the stock market has recovered. Many know they’ll have to defer retirement—and many fear they will never be able to afford to retire at all.

The key to retirement saving is having a retirement plan and contributing to it every paycheck. But many businesses, including most smaller businesses, don’t offer retirement plans. As a result 1,000,000 Marylanders working in private businesses across the State don’t have a retirement plan. There are, of course, individual retirement accounts (IRAs) -- but almost no one uses them who didn’t get access through an employer-based plan via payroll deduction.

Having a plan is essential, but not a panacea. Even when plans are available, many employees don’t join. Many who do contribute and save less than they need to meet their own goals. Even with plans, many will need to save more.

The challenge continues at retirement, because most of these plans are paid out in a single lump sum payment—few plans offer reliable retirement income for life that traditional pensions do. Since most retirees do not consult financial advisors and are not financial experts themselves, some who live longer than average or are unlucky in their investments will find that they haven’t saved enough and will exhaust their savings.

They will, of course, have Social Security. That’s why it’s so important that Social Security be both preserved and strengthened. But the average monthly benefit in Maryland is about $1,300 and for most people Social Security covers only a fraction of their basic needs in retirement. Most Marylanders will need additional income from retirement savings – and the State of Maryland can help them get it.

Other states and other governments are making it easier for people to save and for private employers to help them do it. Maryland should, too. Acting now will save Maryland taxpayers millions in the future.

California, Massachusetts, and Illinois have already enacted legislation. Illinois created a new program that requires employers who have no retirement plan to automatically enroll their employees in a state-created program. Massachusetts authorized a program for uncovered employees of non-profits. California created a board to plan and propose program similar to that in Illinois. Similar legislation is being or has been introduced in some fifteen other states – states all across the country with varying political orientations, populations, and economic bases.

Although there are many variations under consideration, these programs generally provide for an automatic payroll deduction of a set amount unless the employee opts out. Funds are to be invested professionally and may be pooled to achieve higher returns and lower costs. Those who cannot or do not want to make complex financial decisions are not required to do so – their contributions are placed automatically into a reliable fund or set of funds.

In order to ensure that employers – many of whom are small businesses – can participate in a program, it must be designed to help them avoid significant disruption, expense or administrative burden. This can be accomplished by enabling employers to use current payroll processes to help their employees to build retirement security, without requiring employers to make contributions themselves.

If Maryland doesn’t act now, Maryland taxpayers will face higher costs for decades to come.

These plans are designed to be self-sustaining: their operating costs are paid for by plan contributions and the State would not assume any obligations. In practice, however, these plans will end up saving taxpayer funds: If Maryland doesn’t act now, Maryland taxpayers will face higher costs for decades to come, as retirees are forced to turn to State assistance instead of living on their own savings.

There are many ways to improve retirement security. The key is for businesses to help their employees save, without becoming overburdened themselves.

Task Force is not recommending any one approach, but strongly recommends that Maryland join other states, by developing and implementing a plan that helps Marylanders have more secure retirements.We recommend development of a specific state-based program that meets Maryland’s needs from the options discussed in our report.

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Editor's Note: This blog originally appeared on AARP's Thinking Policy blog

Automatic enrollment for retirement saving is both effective and popular among all income, gender and ethnic groups. It has increased participation, helped people to both start saving earlier and to make appropriate investment choices.This mechanism would be even more useful, especially for younger workers and those with low-to-moderate incomes if retirement savings plans also allowed employees to save for unexpected expenses. Recent research by the US Financial Diaries Project, which looks at the actual income flows of low-to-moderate income consumers shows why this feature would be valuable.

Their studies found that low-to-moderate income households are saving for near-term small emergencies. However, those situations happen so often that they prevent households from building up higher savings for larger emergencies. A split auto enrollment plan would help them to have money for those bigger problems.

One way to structure such a plan would be to automatically enroll an employee into a saving program where part of the contributions would go to a regular 401k-style retirement saving account and the rest into a passbook savings account at a federally insured bank or credit union. The emergency savings could be a percentage of the total contribution or based on income levels, such as a percentage of contributions on the first $20,000 of annual income. Auto escalation would apply only to the retirement contributions.

Some will correctly argue that the split reduces potential retirement savings, but it also potentially reduces leakage from those accounts. When an unexpected expense arises, workers will have other savings that they can use instead of dipping into their retirement accounts.

As with all automatic enrollment plans, the saver would have complete control, and could choose to save more or less, change where the savings go, or even to not participate at all. If the employee already has a passbook account, he or she could either direct all contributions to the retirement account or send the passbook money to the existing account instead of a new one.

Savers would receive whatever tax benefit their plan type offers for retirement contributions, but they would not receive any additional tax advantages for the passbook balances. They could withdraw money from the passbook account at any time without any penalty. And those balances would earn whatever interest rate the bank or credit union is paying on passbook accounts.

Because the passbook account feature is under the legal framework of a retirement plan, it would be appropriate that no more than half of the total contribution would go into general savings. In addition, a plan should be required to set its base contribution rate at 6 percent of income before it could offer such a feature. The passbook savings are intended to supplement retirement contributions, and not to replace them. And if the employer matches savings, that amount would go into the retirement account.

This type of split is possibly legal already, but there are technical issues that need to be considered. The 2006 Pension Protection Act eliminated any state legal barriers for automatic enrollment into a retirement account. It may be that federal regulators could interpret that provision as applying also to passbook amounts as the split savings is a feature of the retirement plan. If not, then legislative action would be needed. Certain provisions of the PATRIOT Act may also need to be revised.

And to encourage employers to offer such an account, regulatory burdens should be kept to a minimum. An employer would be considered to have met its responsibilities for picking an appropriate product under the federal Employee Retirement Income Security Act if it chooses a simple passbook account at any federally insured bank or credit union. Adding an automatic enrollment passbook savings account could make 401k-type retirement accounts even more valuable to new and low-to-moderate income savers. Retirement would always remain the primary reason to save, but the split contribution would make a 401k more attractive and help to build a general savings habit.

Introduction

Many American workers do not have access to employer-sponsored payroll deduction plans for retirement saving. Groups with low rates of access include younger workers, members of minority groups, and those with low-to-moderate incomes. 1 Small business employees are especially at risk. Only about 14 percent of businesses with 100 or fewer employees offer their employees a retirement plan, leaving between 51 and 71 percent of the roughly 42 million people who work for a small business without access to an employer-administered plan (Government Accountability Office 2013).

Lack of access makes it difficult to build retirement wealth. A study by the Employee Benefit Research Institute (2014) shows that 62 percent of employees with access to an employer-sponsored plan held more than $25,000 in saving balances and 22 percent had $100,000 or more. In contrast, among those without access to a plan, 94 percent held less than $25,000 and only three percent hold $100,000 or more. Although workers without an employer-based plan can contribute to Individual Retirement Accounts (IRAs), very few do.2 But employees at all income levels tend to participate at high rates in plans that are structured to provide guidance about the decisions they should make (Wu and Rutledge 2014).

With these considerations in mind, many experts and policy makers have advocated for increased retirement plan coverage. While a national approach would be desirable, there has been little legislative progress to date. States, however, are acting. Three states have already created state-sponsored retirement saving plans for small business employees, and 25 are in some stage of considering such a move (Pension Rights Center 2015). John and Koenig (2014) estimate that 55 million U.S. wage and salary workers between the ages of 18 and 64 lack the ability to save for retirement through an employer-sponsored payroll deduction plan. Among such workers with wages between $30,000 and $50,000 only about one out of 20 contributes regularly to an IRA (Employee Benefit Research Institute 2006).

This paper highlights a variety of issues that policymakers will need to address in creating and implementing an effective state-sponsored retirement saving plan. Section II discusses policy design choices. Section III discusses management issues faced by states administering such a plan, employers and employees. Section IV is a short conclusion.

Note: this paper was presented at a October 7, 2015 Brookings Institution event focused on state retirement policies.

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In recent weeks, the Obama Administration has taken the two most important steps in nearly a decade to increase access to retirement savings for more than 55 million Americans who currently do not participate in a retirement saving plan.

The Treasury Department's myRA program, launched this month, will help new savers and the self-employed start accounts without risk or fees. And earlier this week, the Department of Labor clarified rules that will make it easier for states to create retirement savings plans for small business employees.

myRA

The new myRAs provide another way for new savers to build small nest eggs. They will also help consultants, contract employees, and part-time workers save for retirement or for emergencies. 

For employees, myRAs are payroll deduction savings accounts designed to meet the needs of new savers and lower income workers.  They have no fees, cost nothing to open, and allow savers to regularly contribute any amount.  Savings are invested in US Treasury bonds, so savers can’t lose principal, an important feature for low-income workers who might otherwise abandon plans if they face early losses.  Those who are not formal employees and thus lack access to an employer-sponsored plan can participate in myRA through direct withdrawals from a checking or other bank account. 

As the growing “gig economy” creates more independent workers, the myRA will be a valuable entry to the private retirement system.  These workers might otherwise retire on little more than Social Security. All workers can build myRA balances by redirecting income tax refunds into their accounts. Because a myRA is a Roth IRA (that is, contributions are made from after-tax income), savers can withdraw their own contributions at any time without penalties or tax liability.  

When a myRA reaches $15,000, it must be rolled into another account, and Treasury may make it possible for workers to transfer these savings into funds managed by one of several pre-approved private providers.  MyRAs won’t replace either state-sponsored plans or employer-related pension or retirement savings plans.  However, they will make it possible for new and lower-income savers as well as the self-employed to build financial security without risk or fees.  

State-Sponsored Retirement Savings Plans

The DOL announcement gave the green light to several state models, including Automatic IRAs, marketplace models, and Multiple Employer Plans.  About two dozen states are considering these plans and, so far, Illinois and Oregon have passed “Secure Choice” plans based on the Automatic IRA, while Washington State has passed a marketplace plan.

DOL’s proposed Automatic IRA rules (open for a 60 day comment period) would let states administer automatic enrollment payroll deduction IRAs provided that the plans meet certain conditions for selecting or managing the investments and consumer protections.  States would also have to require businesses to offer such a plan if they don’t already offer their employees a pension or other retirement savings plan. Companies that are not required to offer an Automatic IRA or other plan, but decide to join the state plan voluntarily could still be subject to ERISA. The Retirement Security Project at the Brookings Institution first designed the Automatic IRA, which was proposed by the Administration before being adopted by some states.

In a separate interpretation, DOL allowed states to offer marketplace plans without being subject to the Employee Retirement Income Security Act (ERISA).  These plans are essentially websites where small businesses may select pre-screened plans that meet certain fee or other criteria.  Under the DOL guidance, these marketplaces may include ERISA plans, but states cannot require employers to offer them.   However, if states sponsor a marketplace model, they could also require employers without other plans to offer Automatic IRAs.

Finally, DOL’s rules let states administer Multiple Employer Plans (MEPs), where individual employers all use the same ERISA-covered model plan.  MEPs are usually simplified 401(k)-type plans. Because the state would be acting on behalf of participating employers, it could assume some functions that would otherwise be the responsibility of the employer. These include handling ERISA compliance, selecting investments, and managing the plan.

The Retirement Security Project has issued a paper and held an event discussing ways states could create small business retirement savings plans. The paper is available here and the event is available here.

Together, the two initiatives—the new MyRA and the state-sponsored plans-- could greatly increase the number of American workers who’ll be able to supplement their Social Security benefits with personal savings.

Many American workers do not have access to employer-sponsored payroll deduction plans for retirement saving. Groups with low rates of access include younger workers, members of minority groups, and those with low-to-moderate incomes. Small business employees are especially at risk. Only about 14 percent of businesses with 100 or fewer employees offer their employees a retirement plan, leaving between 51 and 71 percent of the roughly 42 million people who work for a small business without access to an employer-administered plan (Government Accountability Office 2013).

Lack of access makes it difficult to build retirement wealth. A study by the Employee Benefit Research Institute (2014) shows that 62 percent of employees with access to an employer-sponsored plan held more than $25,000 in saving balances and 22 percent had $100,000 or more. In contrast, among those without access to a plan, 94 percent held less than $25,000 and only 3 percent hold $100,000 or more. Although workers without an employer-based plan can contribute to Individual Retirement Accounts (IRAs), very few do. But employees at all income levels tend to participate at high rates in plans that are structured to provide guidance about the decisions they should make (Wu and Rutledge 2014).

With these considerations in mind, many experts and policy makers have advocated for increased retirement plan coverage. While a national approach would be desirable, there has been little legislative progress to date. States, however, are acting. Three states have already created state-sponsored retirement saving plans for small business employees, and 25 are in some stage of considering such a move (Pension Rights Center 2015).

This policy brief, based on John and Gale (2015), highlights a variety of issues that policymakers will need to address in creating and implementing an effective state-sponsored retirement saving plan.

Download "Policy Design and Management Issues for State Retirement Saving Plans" »

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Critics of the nation's retirement system regularly complain that the system is in crisis. Too many private companies fail to offer their employees a retirement plan. Many employees who are covered by a plan fail to make contributions to it. Those who do make contributions may contribute too little or invest their savings unwisely. The end result: Many of us will reach retirement age with miniscule pensions or too little savings to enjoy a comfortable old age.

The argument that our retirement system has gaping holes is well founded. The notion that it faces an imminent "crisis" is nonsense. If the system currently faces a crisis, it has faced the same one for the past 40 years. While elderly Americans have seen their incomes and living standards improve in recent decades, the median working-age family has experienced little improvement in its real income. Nonelderly families that depend solely on the earnings of breadwinners who have below-average schooling saw a drop in their incomes.

In recent research with Brookings colleagues, I tracked the real incomes of families headed by aged and nonaged Americans. In the 34 years ending in 2012, the median real income of working-age families climbed a little more than 2 percent (in other words, by less than one-tenth of a percentage point per year). The median real income of families headed by someone past 62 increased a little more than 40 percent. The numbers suggest our retirement system is doing a decent job improving the living standards of the aged. Unfortunately, the labor market is doing a much worse job boosting the living standards of middle-class wage earners.

Critics of the retirement system might worry that it succeeds in protecting the incomes of the middle class elderly but fails to protect the incomes of the poor -- a concern not supported by the evidence. Income inequality has gone up among the elderly as it has among the nonelderly. But older low-income Americans have fared much better than low-income working-age adults. In the late 1950s, by far the highest poverty rate of any age group was that for people over 65. Even in the late 1980s, the elderly had a higher poverty rate than adults between 18-64. Since the middle of the last decade, however, the elderly have had the lowest poverty rate of any age group.

People who warn us of a retirement "crisis" are nonetheless correct in pointing to sizeable holes in the current system. Too few companies, especially small ones, offer their workers a retirement plan. According to recent government estimates, only about half of workers in companies with fewer than 100 employees are offered a retirement plan. Offer rates are higher in bigger companies and in government agencies, but about 30 percent of all employees are not offered any pension or retirement savings plan where they work. When retirement plans are offered, however, workers are very likely to participate in them -- even if they must make a voluntary contribution out of their pretax wages.

What is crucial for a retirement savings plan's success is automatic payroll withholding. Dollars that are withheld from workers' paychecks are harder for workers to spend on something other than retirement savings. A crucial improvement in our current system would be to require all employers to establish automatic payroll withholding for voluntary retirement savings in an IRA (individual retirement account). Companies that already offer a qualified pension or retirement savings plan should be exempt from any extra obligation.

The harshest critics of the current retirement system would go much further than this. Many want to bring back traditional retirement plans that guaranteed workers a specific monthly pension linked to their job tenure, final pay, and age at retirement. The advantages of such a plan for workers are that their employer is typically responsible for funding the plan and for ensuring that pensions are paid, regardless of the ups and downs of financial markets. A big disadvantage is that the promised benefits are not worth much if the worker's career with a company is cut short, either because of a layoff or quitting.

People who are nostalgic for old-fashioned pensions may be right that workers would prefer to be covered by such a plan, despite their disadvantages for short-tenure workers. I'm less persuaded that traditional pensions offer better protection to typical workers than modern 401(k)-type plans. Regardless of the pros and cons of the two kinds of plan, it is wildly unrealistic to think small employers or new employers will want to take on the risks and administrative burdens connected with an old-fashioned pension plan.

All U.S. workers are covered by a traditional, defined-benefit pension: it's called Social Security. It has worked well over the past four decades in protecting and even lifting the incomes of the retired elderly. It may not work as well in the future if benefits are cut substantially to keep the program solvent. Boosting workplace retirement savings is a sensible way to insure future retirees will have adequate incomes, even if Social Security benefits have to be trimmed. An essential first step to boosting savings is to require companies to put a retirement savings plan in every workplace.

Editor's note: This piece originally appeared in Real Clear Markets.

No. We should exempt workers earning the lowest wages.

Social Security faces a serious funding problem. The program takes in too little money to pay all that has been promised to future beneficiaries. Government forecasters predict Social Security’s reserve fund will be depleted between 2030 and 2034. There are two basic ways we can eliminate the funding gap: cut benefits or increase contributions. A common proposal is to increase the age at which workers can claim full retirement benefits. For people nearing retirement today, the full retirement age is 66. As a result of a 1983 law, that age will rise to 67 for workers born after 1959.

When policymakers urge us to raise the retirement age, they are proposing to increase the full retirement age beyond 67, possibly to 70, for workers now in their 30s or 40s. This saves money, but it also cuts monthly retirement benefits by the same percentage for every worker, unless workers delay claiming benefits. The policy might seem fair if workers in future generations could all expect to share in gains in life expectancy. However, new research shows that gains in life expectancy have been very unequal, with the biggest improvements among workers who earn top incomes. Life expectancy gains for workers with the lowest incomes have been small or negligible.

If the full retirement age were raised, future retirees with high lifetime earnings can expect to receive some compensation when their monthly benefits are cut. Because they can expect to live longer than today’s retirees, they will receive benefits for a longer span of years after 65. For low-wage workers, there is no compensation. Since they are not living longer, their lifetime benefits will fall by the same proportion as their monthly benefits. Thus, “raising the retirement age” is a policy that cuts the lifetime benefits of future low-wage workers by a bigger percentage than it does of future high-wage workers.

The fact that low-wage workers have seen small or negligible gains in life expectancy signals that their health when they are past 60 is no better than that of low-wage workers born 20 or 30 years ago. This suggests their capacity to work past 60 is no better than it was for past generations. A sensible policy for cutting future benefits should therefore preserve current benefit levels for workers who have contributed to Social Security for many years but have earned low wages.

Editor's note: This piece originally appeared in CQ Researcher.

Financial advisors offer their clients many advantages, such as setting reasonable savings goals, avoiding fraudulent investments and mistakes like buying high and selling low, and determining the right level of risk for a particular household. However, these same advisors are often incentivized to choose funds that increase their own financial rewards, and the nature and amount of the fees received by advisors may not be transparent to their clients, and small-scale savers may not be able to access affordable advice at all.  What is in the best interest of an individual may not be in the best interest of his or her financial advisor.

To combat this problem, the Department of Labor (DoL) recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code.  The proposed conflict of interest rule is an important step in the right direction to increasing consumer protections.  It addresses evidence from a February 2015 report by the Council of Economic Advisers suggesting that consumers often receive poor recommendations from their financial advisors and that as a result their investment returns on IRAs are about 1 percentage point lower each year.   Naturally, the proposal is not without its controversies and it has already attracted at least 775 public comments, including one from us .

For us, the DoL’s proposed rule is a significant step in the right direction towards increased consumer protection and retirement security.  It is important to make sure that retirement advisors face the right incentives and place customer interests first.  It is also important make sure savers can access good advice so they can make sound decisions and avoid costly mistakes.  However, some thoughtful revisions are needed to ensure the rule offers a net benefit. 

If the rule causes advisors’ compliance costs to rise, they may abandon clients with small-scale savings, since these clients will no longer be profitable for them.  If these small-scale savers are crowded out of the financial advice market, we might see the retirement savings gap widen.  Therefore we encourage the DoL to consider ways to minimize or manage these costs, perhaps by incentivizing advisors to continue guiding these types of clients.  We also worry that the proposed rule does not adequately clarify the difference between education and advice, and encourage the DoL to close any potential loopholes by standardizing the general educational information that advisors can share without triggering fiduciary responsibility (which DoL is trying to do).  Finally, the proposed rule could encourage some advisors to become excessively risk averse in an overzealous attempt to avoid litigation or other negative consequences.  Extreme risk aversion could decrease market returns for investors and the ‘value-add’ of professional advisors, so we suggest the DoL think carefully about discouraging conflicted advice without also discouraging healthy risk.

The proposed rule addresses an important problem, but in its current form it may open the door to some undesirable or problematic outcomes.  We explore these issues in further detail in our recent paper.

Americans are enjoying longer lifespans than ever before. Living longer affords individuals the opportunity to make more contributions to the world, to spend more time with their loved ones, and to devote more years to their favorite activities – but a longer life, and particularly a longer retirement, is also expensive. The retirement security landscape is evolving as workers, employers, retirees, and financial services companies find their needs shifting. Once, many workers planned to stay with a single employer for most or all of their careers, building up a sizeable pension and looking forward to a comfortable retirement. Today, workers more and more workers will be employed by many different employers.  Additionally, generous defined benefit (DB) retirement plans are less popular than they once were – though they were never truly commonplace – and defined contribution (DC) plans are becoming ever more prevalent.  

Figure 1, below, shows the change from DB to DC that has occurred over the past three decades.

In the past many retirees struggled financially towards the end of their lives, just as they do now, but even so, the changes to the retirement security landscape have been real and marked, and have had a serious impact on workers and retirees alike. DB plans are dwindling, DC plans are on the rise, and as a result individuals must now take a more active role in managing their retirement savings. DC plans incorporate contributions from employees and employers alike, and workers much choose how to invest their nest egg.  When a worker leaves a job for retirement or for a different job he or she will often roll over the money from a 401(k) plan into an Individual Retirement Account (IRA). While having more control over one’s retirement funds might seem on its face to be a net improvement, the reality is that the average American lacks the financial literacy to make sound decisions (SEC 2012).

The Council of Economic Advisers (CEA) expressed concern earlier this year that savers with IRA accounts may receive poor investment advice, particularly in cases where their financial advisors are compensated through fees and commissions. “[The] best recommendation for the saver may not be the best recommendation for the adviser’s bottom line” (CEA 2015). President Obama echoed these concerns in a speech at AARP in February, asking the Department of Labor (DoL) to update its rules for financial advisors to follow when handling IRA accounts (White House 2015). The DoL receives its authority to craft such rules and requirements from the 1974 Employee Retirement Income Security Act (ERISA) (DoL 2015a).

The DoL recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code (DoL 2015b). The proposed rule has generated heated debate, and some financial advisors have responded with great concern, arguing that it will be difficult or impossible to comply with the rule without raising costs to consumers and/or abandoning smaller accounts that generate little or no profit. Advisors who have traditionally offered only the proprietary products of a single company worry that the business model they have used for many years will no longer be considered to be serving the best interests of clients.

Rather than offering detailed comments on the DoL proposals, this paper will look more broadly at the problem of saving for retirement and the role for professional advice. This is, of course, a well-travelled road with a large literature by academics, institutions and policy-makers, however, it is worthwhile to think about market failures, lack of information and individual incentives and what they imply for the investment advice market.

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