Originally published at Project-Syndicate | Apr 26th, 2024
America’s 40-year experiment with a voluntary, individual-directed, commercial retirement system has failed, with the vast majority of US workers unable to accumulate enough savings over their working lives to enjoy basic economic security in old age. Bold reform is urgently needed – and surprisingly possible.
BERKELEY – America’s retirement system isn’t working. It is failing older workers, pensioners, and would-be retirees, and if we don’t fix it soon, it will also fail future generations, lowering living standards and increasing the risk of poverty. This is mostly a matter of poor design. But rather than improve that design, policymakers have consistently pushed what can be described only as fake fixes.
The pension crisis that the United States is facing is, however, all too real. As I show in my new book Work, Retire, Repeat: The Uncertainty of Retirement in the New Economy, tens of millions of older workers (aged 55 and up) – in fact, 80-90% of all working Americans – will have to keep working deep into old age if they want to maintain their pre-retirement standard of living.
The harsh truth is that if you are a middle-class worker in the US today, you are unlikely to become a middle-class retiree. Most people simply do not have enough savings to supplement Social Security, at least not to the extent that is needed to maintain their living standards. In fact, many retirees will end up living in poverty ($13,000-18,000 per year, depending on circumstances). In 2007-19, the share of near-retirees at risk of old-age poverty rose significantly.
Already, America’s elderly suffer a far higher rate of poverty – defined as half the median income or lower – than their peers in other high-income countries. As I explained in recent testimony before the US Senate Committee on Health, Education, Labor, and Pensions, the old-age poverty rate in the US is 23%, compared to about 15% in the United Kingdom, 12% in Canada, 4.4% in France, and just 3.1% in the Netherlands.
A FLAWED SYSTEM
It should not be surprising, then, that the Dutch pension system consistently ranks as one of the world’s best. The US, by contrast, is missing some of the basic components of an effective retirement system.
The US has a hybrid system, comprising government-funded Social Security, employer-sponsored personal pensions, known as a 401(k), and individual retirement accounts. But the advance-funded portions of that system are not accessible to all workers: just 54% of older white workers, half of older Black workers, and a mere 30% of older Hispanic workers currently enjoy such coverage.
In fact, the US pension system reflects and perpetuates economic inequities, including in education, wages, working conditions, and family assets. Student-loan debt is a case in point: you are more likely to become saddled with it – and be left making loan payments with money you could otherwise be saving for retirement – if your family cannot afford to pay for your higher education.
Moreover, the tax benefits designed to encourage retirement savings – retirement contributions and the investment gains aren’t taxed until withdrawal – accrue largely to higher-income workers, with fully 84% of the subsidies going to the top 40%. This is the Matthew effect: they who have more get more. So, one can say the system works for about 20% of the workforce with a 401(k), but even that would be an overstatement, as only the top 10% have enough money to maintain their living standard in retirement.
The reality is that even those with access to retirement-benefit plans struggle to save enough. This partly reflects flaws in the 401(k) system. For example, new hires could have to wait a year for their new 401(k) to kick in, resulting in a lot of lost savings.
Moreover, because it is both voluntary and individual-directed, portfolios are often badly managed, and savings can be lost or depleted. Indeed, over 40 percent of US workers with a 401(k) have had to cash out their retirement savings during job transitions. Other unexpected costs, from divorce to sickness, can also deplete retirement savings and increase the risk of old-age poverty. Americans who spend decades meticulously putting money aside for retirement can see their savings wiped out by unanticipated medical expenses.
A SKIPPED LUNCH IS NOT A FREE LUNCH
So, we know the problem: US workers cannot accumulate enough savings over their working lives; they cannot invest their savings well or efficiently; and they have access to few mechanisms to help them make their money last. Unfortunately, the “solutions” that US policymakers have promoted over the last 40 years have been utterly ineffective – and even counter-productive.
For example, some have advocated creating incentives for employers to put extra money into their employees’ retirement accounts. But employers are never going to pay more than they have to. Tweaks to the tax code have not expanded retirement coverage in the past, and they won’t now.
Policymakers’ favorite fake fix, however, is to have people retire later. This has been true since 1983, when US President Ronald Reagan’s administration cut Social Security and raised the age at which new retirees can claim full benefits to 67. As the Reagan administration weakened unions, the “gold standard” of defined-benefit pension plans all but disappeared.
Advocates billed “working longer” as a type of free-lunch policy that benefits everyone. They argued that workers would have more time to save before retirement – which would probably grow longer, owing to rising life expectancy – and enjoy higher Social Security benefits once they did retire. Employers would also benefit, the story went, thanks to older workers’ skills and experience.
But these were hopes, not a plan, and affording retirement by working longer is like affording lunch by skipping lunch. In reality, working longer benefited only a fortunate few – think senators, presidents, corporate executives, lawyers, and even professors – who were able to continue earning good money in comfortable jobs as they grew older. As Michael Papadopoulos, Anthony Webb, and I have shown, for a much larger share of people, working longer is a necessity, because they know they will not have sufficient retirement income otherwise.
AN ARMY OF UNWANTED LABOR
But staying in the labor force is easier said than done, not least because many jobs are not suitable for older bodies. As of 2022, 25% of older white workers and more than 40% of older Black and Hispanic workers toiled in the kinds of physically demanding jobs that take a heavy toll on health and longevity – and certainly cannot be maintained deep into old age.
Even for jobs that are not physically demanding, many employers have proved reluctant to hire – or even retain – older workers. This reflects not only age discrimination but also the fact that, in a constantly changing, tech-driven economy, skills become outdated or obsolete faster than ever.
The Older Workers and Retirement Chartbook, produced by the Schwartz Center for Economic Policy Analysis and the Economic Policy Institute, suggests that more than half of retirees (52%) were pushed out of their jobs before they were ready to retire. And as Lisa Berkman and Beth Truesdale have shown, only half of people aged 50-62 are steadily employed. If even these younger seniors can’t get steady work, how can we expect people to find stable jobs that enable them to save for retirement when they are 66?
As policymakers pretend they are solving the problem by forcing people to work longer, older workers, lacking sufficient retirement savings or good job prospects, become increasingly desperate. With few options, they often end up enduring low wages and dangerous conditions to keep a roof over their head, drawing down assets and claiming Social Security early – taking the financial hit for doing so – to supplement their low wages.
To add insult to injury, the argument that higher retirement ages are warranted by increased longevity is based on an aggregate picture that bears little resemblance to reality. Though life expectancy has increased for those with more education and higher incomes over the last 40 years, it has stagnated for people in the bottom half of the income distribution.
WHY OTHER CAPITALIST DEMOCRACIES DO BETTER
If working longer isn’t working, and defined-benefit pensions have all but disappeared, how can economic and retirement security for older Americans be guaranteed? In answering this question, it is worth looking at countries that do better.
Australia, Denmark, Finland, and the Netherlands all get high marks for their pension-system design. While each country’s framework is different, they have some things in common: they are hybrid systems that offer universal coverage, professional and pooled investments, and mechanisms for making savings last.
In all four countries, the state-funded plan – financed primarily through current tax revenue, and analogous to the US Social Security system – forms the system’s base and ensures a minimum level of retirement income. This plan is supplemented, for all workers, by an effective occupational retirement system for private contributions. The occupational plans, often advance-funded, are tailored to the specific industry requirements and employee demographics.
Because the highly-rated pension systems are relatively simple and comprehensible, while accounting for individuals’ unique circumstances, they support a smoother transition into retirement for workers than the US system. Moreover, since plans often apply to entire groups of workers, administrative overhead costs are reduced for both employers and pension providers.
All of this contributes to broad popular support. In Denmark, for example, few complain about the high payroll taxes associated with the pay-as-you-go system, and satisfaction with that system’s performance probably has much to do with it.
THE GREY NEW DEAL
For the US, building a better retirement system requires increasing Social Security, universal pension coverage, and better mechanisms for keeping health-care costs low (such as lowering the eligibility age for Medicare to 60). There should also be more employment protection for elder workers, who should be able to remain in the workforce if they so choose. I call this bundle of policies the Grey New Deal.
The US seems to be making progress on one element of this scheme. In 2021, I worked with Kevin Hassett to devise a plan to expand pensions, so that low- and moderate-income workers across the country could build wealth for retirement. Hassett and I might seem an odd match: he chaired the White House Council of Economic Advisers during Donald Trump’s administration. But, as economists, we readily agree that bold and expansive action is needed to boost economic security for all Americans in their older years.
Our white paper formed the basis of the Retirement Savings for Americans Act (RSAA), which will get an additional 69 million American workers – 55% of the workforce – onto a retirement plan. This includes contingent, self-employed, or temporary workers, as well as people who work for small employers that don’t offer pensions. Lower-income, less-educated, and nonwhite workers will benefit most from the RSAA.
Workers who lack access to an employer-sponsored retirement plan would be automatically enrolled in a retirement plan, to which they would contribute a small portion – up to 5% – of their income. The federal government would match contributions for low- and moderate-income workers – at a level of 1% automatically, and up to 4% via a refundable federal tax credit – with matching contributions being phased out starting at median income. For someone earning $50,000 per year and having 5% withheld, this would translate into a $2,500 (5% of $50,000) annual contribution, with the government matching up to $2,000 (4% of $50,000). That is $4,500 per year going into retirement savings.
Somewhat miraculously, the RSAA has bipartisan support in both the Senate and the House of Representatives. Republicans want to get more people in the stock market, and Democrats want to boost workers’ economic security. But the legislation also has its detractors, not least the National Association of Plan Advisors, a lobby group that has accused me of opposing the 401(k) system in which its members work.
Yes, lobby groups like to pick an enemy, so they can raise more money. But it is worth highlighting that the RSAA complements the current employer-based system; it doesn’t supplant it. Far from opposing 401(k)s, I have one, and for decades I have worked steadily for two employers who provide 10% matches. As a finance expert with a PhD in economics, I can manage my investments pretty well. But you shouldn’t need a PhD and decades of finance expertise to have a sustainable and manageable retirement plan. That is where the RSAA comes in.
A MORE EQUITABLE FUTURE
The RSAA would be more effective than home ownership or baby bonds to equalize retirement security. Home equity, long thought of as the holy grail of long-term economic security, no longer builds wealth. Large loans and shrinking down-payments mean that the real value of home equity has not improved for the bottom 90% of the population. Since 1992, the only growth in wealth for workers in the bottom 90% has come from Social Security, which still ranks as America’s most effective anti-poverty program.
Well-designed retirement accounts preserve and build wealth and prevent leakage during periods of unemployment. That is why the universal pension coverage offered by the RSAA is a critical component of the Grey New Deal.
The story of America’s 40-year experiment with a voluntary, individual-directed, commercial system is for another day. What is important is that the very features that make it voluntary allow half the workforce to be left out. For participants, the “do-it-yourself” approach leads to badly managed portfolios and benefits that run out. And the commercialization of pensions leads to high fees and little incentive to cover low- and moderate-income workers.
The results are highly inequitable. Differences in financial readiness for retirement and in morbidity and longevity mean that the wealthy enjoy more healthy retirement years than their lower-income counterparts. The RSAA offers a critical opportunity to reduce these inequities by closing gaps in the retirement system. For Americans, well-being in old age depends on Social Security and universal pension coverage.
Teresa Ghilarducci: Is Professor of Economics at The New School for Social Research.
