Americans need better access to retirement plans, help with drawdown phase.
For the 10-year anniversary of Morningstar magazine, I want to explore the key policy issues to watch over the next 10 years. Right now, most pundits (which I am not!) have a hard time making predictions about the next 10 minutes, much less the next 10 years, but I do think there are major issues that policymakers will need to address over the next decade that will shape individual investors’ experiences in the United States. In this article, I’ll explore the contours of these issues and how policymakers might address challenges investors face today.
Whenever we think about individual investors, it’s important to think about retirement savers. Seventy-five percent of investors invest exclusively in an individual retirement account or 401(k), according to our analysis of the Survey of Consumer Finances, and as the last generation of traditional pension participants moves to retirement, even more people will rely on defined-contribution plans. So, one key issue is access to retirement plans and whether U.S. policymakers can find a bipartisan way to expand access. Further, policymakers will need to explore how they can make defined-contribution plans work better for people, particularly during the drawdown phase. Addressing these challenges might mean reshaping the U.S. retirement system completely. Finally, will government unleash technological innovation for investors? Critically, how will regulators ultimately treat investors’ data in their investment accounts, savings accounts, and other accounts? Further, how will regulators answer the thorny questions of who owns this data, who can access it, and what third parties can do with it?
Will We Take Bold Steps to Expand Access to Retirement Plans?
The rate of participation in employer-sponsored retirement plans has remained stubbornly stuck at around 50% for years. (Closer to 60% have access to a plan, but some of those workers do not participate.) Part of this is due to small employers. They do not often offer a plan to their workers, who in turn rarely contribute to IRAs on their own. In fact, only about 14% of small employers sponsor some type of plan for their employees to save for retirement, according to the U.S. Government Accountability Office. Over the years, policymakers have tried to address this issue, but they haven’t been able to move the needle on coverage. This lack of savings is a big problem. Many workers will be forced to rely on Social Security for all of their retirement income.
Congress has tried to solve this problem before, without much success. In 1997, Congress introduced Simple IRAs to help small employers provide retirement plans to their workers without taking on the regulatory obligations of ERISA, as they would if they offered a 401(k). Simple IRAs provide a few key advantages to employers because they have no filing requirements, and they do not need to pass “nondiscrimination testing,” as would be required for a regular defined-contribution plan. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act, which tried to further incentivize business owners to set up retirement plans by increasing the amount that owners (along with everyone else) could contribute. These changes have not created a lot of new retirement plans. Although Simple IRAs are popular among small employers that offer plans—about 40% of them use Simples, according to the GAO—more than four in five workers at small companies still do not have a plan at work. And after the 2001 changes, the number of workers covered by small plans did not grow.
Policy experts on the politically left and right often agree that the only way to solve the problem is with some sort of mandate. Many countries, such as Australia and Chile, require workers to contribute to retirement plans. Americans, however, are likely to be less tolerant of such a blunt-force mandate. A more palatable solution might be automatic enrollment— leveraging inertia to automatically enroll workers in a retirement account (such as an IRA) but letting people opt out. Among employers that offer a plan, automatic enrollment has proved to be a boon, dramatically increasing participation. The next step is to explore automatic enrollment among people without workplace plans. The Obama administration proposed these automatic IRAs (without success), but some states are now working on them.
Such an approach would be an intermediary step to a longer-term solution: decoupling retirement plans from employers, at least for people who work for small employers. After all, IRAs have contribution limits that are too low to be a primary savings vehicle for most workers, and employers cannot contribute to regular IRAs. The United Kingdom provides an example with a program called the National Employment Savings Trust, which is available for small employers who don’t offer a plan, combined with a mandate to enroll workers in the plan. The program appears to be an early success and could be a model for the United States.
Will Policymakers Make Defined-Contribution Plans Look Like More Traditional Pensions?
In addition to workers lacking retirement plans during the accumulation phase, what about workers lucky enough to accumulate enough savings? What do they do when they get to the drawdown phase of retirement? Many retirement investors are confused, and their options of what to do are not great right now.
Broadly speaking, there are three options for investors at retirement: take their money as a lump sum; draw it down gradually with a structured withdrawal plan, or buy some sort of longevity insurance, such as an annuity.