What If We Blew Up America's Retirement Savings System?

America's retirement savings system is a mess (that's a technical economic term). "System" is actually too grand a word for the ad hoc retirement savings plan edifice that has been built up over years.

Credit: getty

To be sure, the system works reasonably well for those on the payroll of an employer with a retirement benefit plan and a relatively stable job. Employees at larger companies typically have 401(k)s with automatic enrollment, automatic contribution increases and a target-date default option that provides a well-diversified portfolio for those unable or uninterested in managing their portfolio.

But for most people, the system is too opaque, too difficult to navigate and too often failing too many workers in providing economic security in their retirement years.

"I think the most important takeaway is that the American retirement system is too complex and confusing," David John, deputy director of the Retirement Security Project at the Brookings Institution think tank, told me in a recent interview. "It needs to be simpler for people to operate and to understand."

Amen to that.

John, who's also a senior strategic policy advisor at the AARP Public Policy Institute, is one of three editors of "Wealth After Work," an intriguing new Brookings book on improving the nation's retirement savings system. They're not quite ready to blow up the current retirement savings system, but have some smart ideas on what could make it much more equitable and helpful.

The other two editors are William G. Gale (a former senior staff economist under President George H.W. Bush) and J. Mark Iwry (a former deputy assistant secretary for retirement and health policy at the Treasury Department under President Barack Obama). It's hard to think of three smarter experts about retirement security policy.  

The policy-driven — okay wonky — book covers a wide range of challenges, such as:

• Worrisome retirement savings prospects for millennials
• How women are shortchanged with retirement savings and what to do about it (their suggestion: start with a robust paid family leave and medical program)
• Turning retirement plan account balances into a stream of dependable income in retirement (create a default “decumulation” strategy option, they say)
• Bringing the roughly half of the private-sector workforce without an employer-sponsored retirement savings plan into the retirement system (begin by expanding state-sponsored retirement savings plans, they advise; more on those shortly)

Despite the neutral tones of the veteran, bipartisan researchers, in the aggregate the essays are toss-the-book-across-the-room maddening: Why are the deep flaws in America's retirement savings system allowed to persist?

Every day that the current system continues is an intolerable injustice to working people who will eventually retire and should be able to anticipate a comfortable standard of living. Many can't, now.

The need for reform is pressing, at least partly driven by the interaction of four main factors, not counting the demographics of an aging population.

The first and best-known factor is corporate America's retreat since the 1980s from offering employees traditional "defined benefit" pension plans in favor of "defined contribution" plans like 401(k)s.

With a defined benefit pension plan, the employer bears all the investment risk and commits to a fixed payout of money for the remaining life of the retiree, typically based on a salary and years-of-service formula. In sharp contrast, with the 401(k), employees bear the risk of deciding how much to invest and where to invest (within regulatory and plan limits). And, of course, they need to find the money to do it.

Trouble is, living standards of near-retirees and the recently retired counting on their 401(k)s are extremely vulnerable to an unexpected market swoon. What's more, the 401(k) and other retirement plans like it offer little guidance on how to turn accumulated assets into a steady stream of reliable income in retirement.

The second drawback is that the U.S. relies on companies to choose to offer their workers a retirement benefit. Larger companies usually do, but many smaller and midsize businesses don't.

"If an individual doesn't have access to payroll-deduction, auto-enrollment and auto-escalation retirement plan, they are out of luck," says John.

Research from the nonprofit Employee Benefit Research Institute bears this out year after year, with huge disparities in retirement savings between people with 401(k)-type plans and those without them.

Third, the traditional employer-based retirement plan excludes contingent workers, such as independent contractors, gig economy workers, freelancers, security guards and maintenance professionals. Part-time workers are often left out, too.

Contingent workers and others with alternative work arrangements comprised almost 13% of the workforce or 20 million people in 2018. Those numbers have almost certainly increased since then.

"However well or poorly it serves the needs of traditional workers, the current retirement system does not meet the needs of contingent workers, who plausibly have less job stability than traditional workers," write Gale, John and Sarah Holmes Berk, research project director at the National Bureau for Economic Research in "Wealth After Work."

And, they add, "It is also inadequate for those who switch back and forth between contingent and traditional jobs."

Most importantly, the current system not only excludes or disadvantages contingent workers, but also minorities and women. The cumulative impact is to contribute to widening wealth inequalities between whites and minorities — particularly Blacks —in recent decades.

"If this trend continues, wealth inequality will continue to increase, which will make it that much harder for minorities to save adequately for retirement," the book's editors write.

Taken altogether, the current situation is deeply wrong. Still, the "Wealth After Work" editors steer clear of calling for radical reform. Instead, they embrace evolutionary change by elucidating the best policy ideas they've seen to deal with particular retirement savings problems.

I think two proposals are especially worth highlighting, since both would broaden access to retirement savings plans.

One is to greatly expand the auto-IRA (Individual Retirement Account) state-sponsored retirement savings plan idea to more workers without employer-sponsored plans. Three states currently offer this type of plan — Oregon, California and Illinois. Many more are considering creating their own version.

"State-sponsored retirement savings plans offer the best chance in the near term to increase the number of Americans with access to payroll deduction retirement savings plans," write Gale and John in their chapter on the plans. "In the absence of a comprehensive federal program, they could provide the most significant improvement in coverage for many decades."

OregonSaves, which started in 2017, is a good example of this idea. It's an automatic-enrollment Roth IRA retirement savings program for private-sector workers in Oregon lacking access to workplace retirement plans.

Firms in the Beaver State lacking retirement plans are required to enroll their employees in OregonSaves. Every account is tied to the individual — not to their employer — ensuring easy portability when changing jobs. To keep costs down for employers, there is no company match. The default after-tax contribution rate for employees is 5% of gross pay. Workers can opt out if they don't want to participate (about one-third of eligible workers opt out).

A complementary approach is targeted at contingent workers. Here, the basic idea is to create "employer-facilitated" accounts where contingent workers would have a retirement savings account that travels with them from job to job. Employers would be required to provide contingent workers with the ability to make payroll-deduction contributions to their accounts (and withhold state and federal taxes).

The version the authors seem to favor would have such an account conform to the employer's plan (if offered). In other words, if a contingent worker gets a job at a company with a 401(k), the account would be subject to its 401(k) rules. If a firm doesn't have a retirement benefit, the contingent worker account would be treated as a payroll-deduction IRA.

Going through the various essays, I couldn't help but think, "Isn't it time to just blow up the nation's retirement savings system and start over?"

Certainly, that's what Martin Wolf, the estimable chief economics commentator at The Financial Times, believes. "The old is dying. But the new is miserable," he writes, adding that "policymakers must first dare to think more boldly." (His series of Financial Times essays is focused on the British pension system, but his analysis and suggestions apply to the U.S.)

Like so much in the American economy and society, retirement policies end up reinforcing inequities rather than combating them.

Frustrated, I called up Kurt Winkelmann, a senior fellow at the Heller-Hurwitz Institute at the University of Minnesota and co-founder of the investment research firm Navega Strategies. He noted that any broad-based solution has to take into account that we live in the U.S.

"We don't live in Canada or The Netherlands — countries with a more communitarian spirit," he told me. "Any pension change has to respect that."

I get it. History matters. So do institutions and political cultures. Still, the lure of sweeping, impatient reform is strong.

In another interview, with Zvi Bodie, a financial economist and professor emeritus at Boston University, he suggested a time-tested possible solution: Put everyone into something like the traditional TIAA variable annuity founded in 1918 by the Carnegie Foundation for teachers. (TIAA stands for Teachers Insurance and Annuity Association).

Participants in the fund are guaranteed at least 3% a year on their money;  they can earn more if the vast portfolio does better.

Another similar universal-retirement option favored by seemingly strange bedfellows — New School for Social Research liberal economics professor Theresa Ghilarducci (a Next Avenue Influencer in Aging) and Kevin Hassett, chairman of the Council of Economic Advisers under President Donald Trump — is to put everyone into the federal government's giant low-cost Thrift Savings Plan.

Put it this way: People with retirement savings have more choice in their elder years and less need for government services during them. Offering low-cost, broad-based, simple-to-understand retirement savings plans for all workers should be the kind of deal liberals, conservatives and independents alike would race to embrace.

When (if?) you finally retire, it isn't too much to expect that your standard of living won't drop sharply. If turning that insight into a retirement savings plan system is a radical goal, let the revolution begin.

Chris Farrell is senior economics contributor for American Public Media's Marketplace. An award-winning journalist, he is author of the books "Purpose and a Paycheck:  Finding Meaning, Money and Happiness in the Second Half of Life" and "Unretirement: How Baby Boomers Are Changing the Way We Think About Work, Community and the Good Life." Read More