Why are so many Americans struggling to save for retirement?
This week marked the beginning of the presidential primary season, and economic fears such as jobs and wages have taken center stage on the campaign trail.
Yet one of voters’ biggest economic problems has thus far received short shrift from the candidates: Americans’ growing inability to save for retirement.
A handful of Republican and Democratic candidates have laid out proposals for Social Security reform, but none have adequately addressed the substantial and growing deficit in total retirement savings.
The retirement crisis is real, as I’ve also been documenting for the past 15 years and most recently in my new book, Retirement on the Rocks. More than half of us won’t have enough savings when we retire to maintain our current standard of living and will have to make substantial spending cuts once we stop working.
How did we get here, what are the consequences and how can we fix the problem?
An inability to save
The share of households with working-age adults that could expect to have to make substantial and potentially harmful cuts to their spending in retirement has spiked in recent decades, rising from 31 percent in 1983 to 52 percent in 2013, according to the National Retirement Risk Index at the Center for Retirement Research.
Some groups are particularly likely to have insufficient retirement savings. Communities of color, single women and those with less education, for example, tend to be less prepared for retirement than white households, single men and those with more education.
For example, 60 percent of African Americans and Latinos near retirement in 2010 were deemed likely to struggle economically when they stopped working, compared with only 45 percent of whites.
Why aren’t we saving enough?
This crisis is a result of the extended period of economic uncertainty we’ve lived through for the past 30 years.
Wages have become more volatile, while the duration of unemployment and underemployment has also gone up. As a result, people have less discretionary cash, requiring them to set aside more for emergencies – and less for retirement.
But that’s only part of the economic uncertainty story.
Even when people do manage to sock away money for their later years, these savings have become less stable. The stock and housing markets have been going through cycles of boom and bust with increasing frequency in recent decades, destroying wealth and adding a layer of confusion and uncertainty to people’s decisions about their futures.
Record-low interest rates since the financial crisis are making matters worse.
Five policy shortcomings
At a time of such growing volatility in the labor, financial and housing markets, logic suggests that people should reduce their exposure to risky assets.
Yet when it comes to retirement savings, exactly the opposite has happened. This is due to five clearly identifiable policy shortcomings, which have led to greater economic risk exposure at a time of ever-rising risks.
- Social Security benefits have decreased in value as the age at which people can receive full benefits has increased. At the same time, the decline of defined benefit (DB) pension plans has further eroded people’s retirement security. In their stead, people have saved more and more with retirement savings accounts, such as 401(k) plans and Individual Retirement Accounts (IRAs). These individualized accounts offer fewer protections against labor and financial market swings than is the case for Social Security and DB pensions.
- Congress has increasingly made private employers the primary gatekeepers controlling access to good retirement plans, giving them additional tax benefits for doing so. However, since the 1980s, companies have reduced contributions to their employees’ retirement savings accounts and increasingly ended such benefits entirely. In 2012, the last year for which data are available, employers contributed an average of US$1,765 (in 2013 dollars) to workers’ 401(k) plans, down from $1,947 in 1988.
- Existing savings incentives such as tax breaks are fairly inefficient. The largest incentives are offered to high-income employees working for an employer that offers retirement benefits – the people who arguably least need the help in saving more. At the same time, the smallest incentives go to lower-income employees, especially those who work for an employer that doesn’t offer retirement benefits. A high-income earner who expects to pay lower taxes in retirement than during working years will reap about twice as much as a low-income earner for the same contribution to an IRA or 401(k) plan.
- Savings incentives in the U.S. tax code are unnecessarily complex. A dozen savings incentives exist, in addition to specific incentives for housing, health care and education. This complexity often confuses people and keeps them from saving enough or from saving at all. The share of households without any tax-advantaged savings increased from 18.9 percent in 2001 to 23.5 percent in 2013, despite the more widespread efforts to get people to save more.
- And finally, while policymakers focused their efforts largely – and ineffectively – on getting people to save more, efforts to actually protect those savings from increasingly volatile market swings fell on the back burner. As a result, people invested ever larger shares of their savings in stocks and houses, just as the odds those assets would lose value went up. As people borrowed record amounts, they exacerbated the risk associated with a market downturn even further.
Exact data on how people handle insufficient retirement savings are hard to come by. It seems clear, though, that there are a number of strategies people use to “muddle through retirement.”
Some people will live with economic hardships, from not being able to pay for their utilities to simply living in poverty. Others will rely on help from local governments, charities and family members, and some will even move in with their adult children. Others will simply delay retirement and keep working, even as physical and mental difficulties develop.
As a result, many people will struggle economically and possibly suffer from worse health than otherwise would be the case, government budgets and charities will be strained and economic growth could slow.
The bottom line is that the retirement crisis is large, becoming more severe and potentially harming the economy.
Addressing the shortcomings
The good news, though, is that policy can tackle the retirement crisis in doable steps by addressing the five identifiable shortcomings described above. After all, the retirement crisis is in large part a result of inattentive and wrongheaded policies.
- Congress could update Social Security, especially for vulnerable populations, which would increase households’ protections from labor and financial market risks. For instance, policymakers could create a meaningful minimum benefit that would ensure nobody who paid into Social Security for 30 years would receive a benefit less than 125 percent of the federal poverty line – currently $11,354 per year for an adult 65 or older. Other updates could include improvements to the survivorship benefit and a new benefit for beneficiaries who reach age 85.
- Congress and state legislatures could create low-cost retirement savings options that are not dependent on employers choosing to offer a retirement benefit. The exact details of such an alternative to employer-provided retirement benefits could vary from state to state, especially since the federal government is currently in the process of developing guidelines for states to establish retirement savings for private sector workers.
- Congress and state legislatures could redesign savings incentives that would offer more help to lower-income savers than is currently the case. This could include a refundable tax credit, rather than a deduction from taxable income that disproportionately benefits higher-income earners.
- Simplification of savings incentives should be part of a policy effort to make tax incentives for savings more effective. This would mean streamlining existing incentives and making them easier to use.
- Finally, Congress and state legislatures should make protections against market swings an integral part of savings policies. This could include automatic risk management of retirement savings accounts and incentives to diversify savings – not putting all eggs in one basket.
- Finally, Congress and state legislatures should make risk protections an integral part of savings policies. This would include comprehensive, concise and comparable risk disclosure in retirement savings accounts, and new incentives to balance risks between savings in financial assets, such as stocks and bonds, and savings in nonfinancial assets, such as housing.
Restoring a dignified retirement
The retirement crisis in the United States is real and getting worse. It will have severe effects on Americans, the government and the economy unless policymakers respond to this challenge.
The bad news is that past policy decisions have substantially contributed to this crisis. The good news is that policies can change, if the political will exists.