For Many, Running Out Of Money In Retirement Is A Risk — Fixing A Broken Retirement System
Many Americans are in danger of having to drastically change their lifestyle in retirement because they haven’t planned for enough income during these years. Improvements we can make to the American retirement system include changing the way we educate people on how to save for retirement by emphasizing retirement income planning and how the use of protected income can help pay for basic monthly expenses throughout retirement.
The average American is facing a retirement income crisis. Most of us don’t have enough saved, we’re struggling to increase our savings and we’re worried about running out of money in retirement.
Current concerns about Americans’ retirement savings go back more than 20 years. In a New York Times editorial in 1999, for example, Sens. Paul D. Coverdell and Robert J. Torricelli wrote: “The nation is experiencing a savings and retirement crisis that requires immediate, bipartisan attention. One-third of Americans have no savings at all, and the next third have less than $3,000 in savings.”
The numbers aren’t drastically better today:
- In a 2019 Northwestern Mutual study, 17% of baby boomers said they have less than $5,000 in retirement savings.
- Of the retirees in a Transamerica study released in September 2020, half have less than $45,000 in household savings.
- Vanguard says half the 401(k) accounts it administers for those 65 and above have less than $58,000.
Besides the potential savings shortfall, Americans have become increasingly concerned about their retirement security because of COVID-19. In the Alliance’s most recent Retirement Reset survey assessing Americans’ retirement attitudes during the pandemic, 7 in 10 have become more pessimistic about their retirement plans, and only a third are very confident they’ll have enough to cover all their retirement expenses. As a result, an estimated 3.2 million people might decide to retire later than planned.
How Did We Get Here?
No single event or decision has broken the retirement system, but the erosion of traditional company pensions — in favor of defined-contribution plans such as 401(k)s — was an important factor. Since plateauing in the mid-1980s, traditional company pensions, also known as defined-benefit plans, have steadily declined. In 2019, only 14% of Fortune 500 companies offered a defined-benefit plan to new hires, versus 59% among the same employers in 1998, according to consulting firm Willis Towers Watson.
The transition occurred for several reasons, including:
- Tax laws passed in the 1980s reduced incentives for employers to maintain traditional company pensions.
- The structure of defined-contribution plans gives employers more control over spending for wages and benefits, a feature that’s especially important during downturns. Meanwhile, traditional company pensions expose companies to more risk because the funding requirements are maintained through downturns.
- Estimating future liabilities of traditional company pensions is complex, and the accounting principles can complicate a company’s health in public financial documents.
- Investing assets in traditional company pensions requires significant expertise and draws management’s attention from core operations.
Amid the switch, employees haven’t participated in defined-contribution plans as much as they should. Some of the main reasons often cited include not having enough money after paying their bills. Employees’ health care costs, for example, have risen significantly over the years as their insurance premiums rise and deductibles increase.
A lack of financial literacy, including an understanding of how much is required to live a satisfying retirement, is also contributing to the underfunding. What might help with respect to underfunding is an IRS ruling from 2017 that a 401(k) plan may require mandatory contributions of 3% of compensation if the employer gives appropriate notice to employees and the employees have an opportunity to opt out of the mandatory contributions.
Another issue is that companies routinely provide retirement seminars for employees, but these sessions and discussions with financial professionals tend to focus only on accumulating funds. Financial education would provide better direction and be easier to digest if it emphasized:
- developing an estimate of monthly retirement expenses;
- developing an estimate of monthly income from both savings and protected lifetime income sources, such as Social Security and annuities; and
- working to balance monthly expenses and income.
For this approach to work, employees particularly need to understand how much monthly income their savings will generate. This process also would better prepare people for daily life in retirement. Even for those with well-funded retirement plans, there’s little guidance on the basics of the month-to-month expenses and income needed in retirement.
The retirement system is also feeling the strain of baby boomers drawing on Social Security, who began reaching age 62 in 2008. By 2031 there will be an estimated 75 million Americans over the age of 65 – a significant number of retirement-age people being supported by the U.S. workforce.
We’re also living longer, which not only further strains Social Security but also increases the risk we’ll run out of money in retirement.
How Retirement Systems Stack Up Elsewhere
Retirement system struggles aren’t unique to the United States:
- Germany has an aging population, creating problems with its statutory pension system. So the country now has company and private pension plans to supplement the government’s pension plan.
- Canada has a government-sponsored pension plan with an average monthly payout of only C$679 (about $515 in U.S. dollars) in 2019, according to government figures.
The Netherlands’ retirement income system was rated No. 1 globally by Australia’s Monash Centre for Financial Studies and consultancy Mercer in October 2019.
- The Netherlands’ system includes a flat-rate state pension fund related to minimum wages and funded by payroll taxes. Employer-sponsored pensions are an important component, too.
- “In per capita terms, the Netherlands has one on the largest pension reserves in the world,” says European Actuarial and Consulting Services.
In Fixing the U.S. System, Protected Lifetime Income Can Help
Policymakers, academics and financial services companies have been discussing solutions to the American retirement crisis for decades. Besides changing the emphasis in education and trying to increase participation in employer-sponsored plans, experts commonly discuss:
- Expanding the systems and funding for Social Security and Medicare.
- Increasing ages before retirement benefits can begin and providing more incentives to delay retirement.
- Increase employers’ share of the responsibility for retirement funding. A 2019 proposal from Sens. Amy Klobuchar and Chris Coons, for example, included mandating that employers pay at least 50 cents into an employee retirement plan for every hour worked.
- Giving more employees access to retirement plans — a 2019 Fast Company article reported that only about two-thirds of private-sector employees have access to a pension or retirement plan through their employer.
Including protected lifetime income from annuities in a country’s retirement system could help retirees meet basic expenses. Supplementing retirement savings and Social Security with a monthly payout that lasts throughout retirement could also help alleviate their increased longevity risks.
For policymakers, the structure of annuities provides an efficient way to provide protected income. Insurance companies use risk pooling to provide annuities, points out Wade Pfau, a Fellow of the Alliance’s Retirement Income Institute. The premiums from people who don’t live as long as expected fund payments to annuity owners who do live longer than expected. So for a pool of owners in an annuity, insurance companies can pay out more to them than they could get individually from a comparable holding. Or, looking at this another way, you would need to take less out of your individual holdings each year to preserve your assets as you try to provide income beyond your life expectancy.
The Stanford Center for Longevity paper “Funding Longevity,” published in May 2020, lends support to the structure of annuities. The authors propose, for example, creating guaranteed retirement accounts (GRAs) to supplement Social Security that would function like annuities. Workers would contribute at least 3% of their pay annually into GRAs.
The new SECURE Act also recognizes the benefits of protected lifetime income by making it easier for employers to add annuities to their retirement plans. It also mandates that account statements include estimates of the annuitized income the participant would receive based on their current account balance. This could be an important way to help Americans understand how retirement savings translates into meeting retirement expenses and how protected lifetime income can provide a measure of security during these years.
Solutions Are Years Away
Don’t look for immediate solutions to the retirement crisis. Any programs and legislation will take years to have a significant impact. In the meantime, work with a financial professional to secure your retirement.
As part of your planning, emphasize how you plan to live in retirement instead of focusing on how much you need to accumulate. This means matching your estimated basic monthly expenses with your sources of retirement income. Protected lifetime income from annuities can help meet your essential expenses by providing monthly income you can count on.