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4 Ways to Fix the U.S. Retirement System

The 'Unretirement' author says they'd help you work longer if you want to

(This article is adapted from Unretirement: How Baby Boomers Are Changing The Way We Think About Work, Community, and the Good Life by Chris Farrell.)
Boomers have expressed a strong desire to remain engaged in the market economy. They still want to make a difference. They’re a creative force for change.

What could the government do to make it practical and desirable for more people to work longer? After spending two years researching my new book, Unretirement, I think the answer is: Fix four problems in America’s retirement system. In my opinion, these remedies would entice boomers to stay on the job, switch careers (possibly pursuing encore careers for the greater good) and launch businesses in midlife.

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Below are four initiatives I think might accelerate Unretirement; You may like all, a handful, or none of them. But hopefully, taken altogether, the ideas will spark a conversation about what’s possible and desirable for encouraging Unretirement and encore careers.

1. Make America’s retirement savings system universal and with lower costs. It’s high time to acknowledge that our retirement savings system is not only broken, but unsuited for the new world of Unretirement.

Only 42 percent of private sector workers ages 25 to 64 have any pension coverage in their current job. The result, according to the Center for Retirement Research at Boston College, is that more than one third of households end up with no coverage during their working years while others moving in and out of coverage accumulate small 401(k) balances. In short, the current system doesn’t even come close to universal coverage for the private economy.

The typical value of 401(k)s and IRAs for workers nearing retirement who do have them was about $120,000 in 2010, according to the Federal Reserve. That sum would provide a mere $575 in monthly income, assuming a couple bought a joint-and-survivor annuity, calculates Alicia Munnell, director of the Center for Retirement Research at Boston College.

Defined-contribution savings plans, like 401(k)s, can be improved. They’ve asked too much of people. You’ve usually had to voluntarily join (a difficult decision for lower-income workers living off tight budgets); many employees have been overwhelmed by their plans' enormous mutual fund options and high fees have eroded their returns.

In addition, most 401(k) participants don’t have the option of receiving payments from their plans as a stream of annuitized income that they can’t outlive in retirement. It’s widely recognized that plans need to offer their near-retirees this choice.

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Lawmakers should require 401(k) plans have: automatic enrollment (where you can opt out if you wish); automatic annual escalation of the percentage of pay employees contribute (again, you could opt out of this feature); limited investment choice (say, no more than five or six); low fees and an annuity option for retirees.

The government could open up to companies that don’t offer a retirement plan to their workers — usually smaller firms — the federal government’s Thrift Savings Plan (TSP), one of the world’s best designed plans. Contributions could be made through payroll deduction, so the cost to firms would be minimal.

The TSP offers five broad-based investment funds along with the option of a lifecycle fund. Its annual expense ratio was an extremely low 0.027 percent in 2012, meaning for each fund, the cost was about 27 cents per $1,000 of investment.

“What’s the downside?” asks Dean Baker, co-director at the Center for Economic and Policy Research, during an interview at his office. “It’s common sense.”

Better yet, lawmakers could create a universal retirement plan attached to the individual. There have been a number of proposals over the years along these lines. For instance, the government could enroll every worker in an IRA through automatic payroll deduction.

(MORE: Sorry State of Small Business Retirement Plans)

2. Allow Americans who delay claiming Social Security to take their benefits in a lump sum. That’s a proposal being floated by Jingjing Chai, Raimond Maurer, and Ralph Rogalla of Goethe University and Olivia Mitchell of the Wharton School at the University of Pennsylvania.

The scholars give this example: Older workers who decide to stay on the job until age 66, rather than retire at 65, would get a lump sum worth 1.2 times the age 65 benefit and would also receive the age 65 annuity stream of income for life when filing for benefits at 66. Those who wait until 70 would get a lump sum worth some six times their starting-age annual benefit payment, plus the age 65 benefit stream for life.

Among the attractions of a lump sum are financial flexibility, the option of leaving money to heirs, and — for “financially sophisticated individuals” — the opportunity to invest the money. The lure of the lump sum would encourage workers to voluntarily stay on the job, on average by about one and a half to two years longer, the researchers calculate. Nevertheless, the workers’ Social Security benefits wouldn’t be cut, they would still have a lifetime annuity to live on and Social Security’s finances would remain essentially the same.

3. Offer Social Security payroll tax relief. A leading proponent of this idea is John Shoven, an economist at Stanford University. The current Social Security benefit formula is based on a calculation that takes into account a worker’s highest 35 years of earnings. Once 35 years have been put in, the incentive to stay on the job weakens, especially since older workers usually take home less pay than they did in middle age, their peak earning years.

Why not declare that older workers are “paid up” for Social Security after 40 years, asks Shoven. Why not indeed? There are a number of proposed variations on the idea, but they all converge on the notion that eliminating the employee share of the payroll tax around that point would be an immediate boost to an aging worker’s take-home pay and getting rid of the employer’s contribution then would lower the cost of employing older workers.

The change seems like a win-win situation from the Unretirement perspective. “It’s an incentive for people to work longer,” says Richard Burkhauser, professor of policy analysis at Cornell University.

4. Change the rules for required minimum distributions (RMDs) beginning at age 70 ½ from 401(k)s, IRAs and the like. The requirements are Byzantine. For instance, with a traditional IRA, the RMD is April 1 following the year you reach 70 and six months, even if you are still working. The withdrawal requirement includes IRAs offered through an employer, such as the SIMPLE IRA and a SEP IRA. The same withdrawal date applies with a 401(k), unless you continue working for the same employer. But there is no RMD with a Roth IRA.

Got all this?

A pet peeve of mine is how unnecessarily complicated the rules are for retirement savings plans. Washington could raise the required minimum distribution rules on all plans to, say, age 80 or 85. Then again, Washington could simply eliminate the RMD altogether.

Like the other proposals mentioned earlier, I think it’s worth a try.

Copyright 2014 by Chris Farrell. Reprinted by permission of Bloomsbury.

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