Time for a National Conversation About Retirement Policy

For the next few weeks, Scott Cooley will be filling in for John Rekenthaler, who is on sabbatical.

On Monday, I reviewed a book, Falling Short: The Coming Retirement Crisis and What to Do About It, in which Alicia Munnell, Charles Ellis, and Andrew Eschtruth call for a series of changes to an arguably inadequate U.S. retirement system. In addition to prompting a national dialogue about retirement policy, Munnell, Ellis, and Eschtruth propose a series of mostly incremental but smart changes to the United States retirement system.

The authors' efforts to prompt a conversation about retirement policy are certainly welcome. As a number of scholars have noted, the structure of the U.S. retirement system arose because of a series of ad hoc decisions, including the outcome of decades-ago union negotiations; the proliferation of 401(k) plans that were originally intended to supplement defined-benefit programs; and companies' responses to the 2000-02 market downturn, which led many firms to close their defined-benefit program to new participants. Whatever the U.S. retirement system's positive features--and there are many of them--they arose mostly organically, rather than as comprehensive decisions about the best way to build a national retirement program.

So, what if, as part of this national conversation about retirement policy, we also considered more-sweeping, comprehensive policy changes? That is exactly what a number of other countries around the world have done. As part of the debate around U.S. retirement policy, it seems worthwhile to consider their experiences.

Compulsory Private Retirement Savings A number of countries around the world--including Australia, Chile, Singapore, and Malaysia--have simply mandated that workers must save for retirement. In the best-known example, that of Australia's superannuation system, the government requires employers to contribute 9.5% of workers' pay to 401(k)-style individual accounts, with a deferral rate that is scheduled to rise to 12% in the coming years. As a result, Australia now boasts the largest per capita fund ownership in the world. Moreover, despite a small population of just 23 million people, Australia now has the sixth-largest fund industry in the world.

Although superannuation is very popular in Australia, not everyone supports compulsory privatized savings. Given the U.S. political ructions associated with the Affordable Care Act's individual mandate, it may be unlikely that a requirement to save for retirement could be adopted here. Moreover, some argue the U.S. already has a compulsory system in Social Security, so there is no need to layer a mandatory privatized system on top of it.

Mandatory Autoenrollment If compulsion is not an option, then perhaps a strong nudge might be possible. In countries such as the United Kingdom and New Zealand, the government mandates that employers autoenroll workers in retirement accounts. Employees can still opt out of retirement savings, but they must take affirmative steps to do so. Research by scholars, such as Richard Thaler, and experience in the U.S., where many companies have voluntarily implemented autoenrollment, have shown that this approach significantly increases retirement plan participation rates.

Autoenrollment does have its limitations. First, some employees do opt out of retirement plans after being autoenrolled, so this approach does not cover all workers. Second, contribution levels are often too low. For example, in New Zealand's Kiwi Saver plan employees may contribute as little as 3% of their pay, though employers also contribute 3%. Most workers will need to contribute much more than that to maintain their preretirement standard of living. Moreover, a New Zealand-style autoenrollment scheme would likely face significant opposition from employers in the U.S., where half of private-sector workers between the ages of 25 and 64 lack access to any retirement plan.

Support for Defined-Benefit Pension Plans U.S. financial media coverage of pension plans often suggests that it is only a matter of time before private-sector pension plans are eliminated. Yet in many countries, including Germany and the Netherlands, defined-benefit programs are still quite common. In the Netherlands, the government actually requires that employers offer pensions in most industries, resulting in a defined-benefit coverage rate of more than 90% of the working population.

Defined-benefit programs have their own well-known drawbacks. Often, pension programs place enormous risk on employers, which can prove financially painful for the companies during times of sustained market downturns. This financial stress has been particularly acute for companies in declining industries, as experience in the U.S. steel, airline, and automaking industries has shown. Still, it is worth noting that other countries have made the policy choice to support defined-benefit plans--and a discussion of the pros and cons of traditional pension programs should be part of the U.S. retirement policy conversation.

Social Security Reform As is well known, the U.S. Social Security system faces significant funding issues. The trustees for the Social Security program currently estimate that the Disability Insurance program will run out of money in 2016 and the Old Age and Survivors Insurance trust fund faces depletion in 2033. For both programs, under current law recipients will face significant benefit cuts once the trust funds are depleted, with retiree Social Security checks projected to decline about 25% in 2033. Munnell, Ellis, and Eschtruth argue for adding additional government support to the Social Security trust fund--in effect, using income-tax revenue to bolster the program.

The U.S. is certainly not alone in facing demographic challenges, but some other nations have taken different approaches to delivering government pension benefits. For example, in Australia the government has long means-tested its pension benefit, which means that citizens with significant superannuation balances or other assets may receive no pension benefit at all. In the Netherlands, the government delivers a flat pension benefit regardless of a person's work history or amount of taxes paid.

Given that Social Security has long been considered an "earned benefit" in the U.S.--the more you have paid into the system, the larger your retirement check, in general--it is difficult to imagine the U.S. moving to a Dutch-style flat benefit, much less Australian means-testing. It is also unclear whether Americans would support bolstering Social Security with general tax revenue, as Munell, Ellis, and Eschtruth suggest. Former Iowa Senator Tom Harkin suggested a third approach with his proposal to lift the wage cap on Social Security contributions, which is currently $118,500, but also add a small incremental benefit for upper-income wage earners to partially compensate for their increased contributions.

A National Conversation Given the impending financial difficulties of Social Security and the complete lack of retirement coverage for many private-sector workers, it is imperative that Americans begin a national conversation about retirement policy. Although the U.S. private sector continues to be an innovator, offering a wide variety of solutions such as target-date funds to help investors reach their retirement goals, in public policy terms the U.S. has become a laggard. With retirement policy, other nations have engaged in what Franklin Delano Roosevelt called "bold, persistent experimentation." The U.S. has stumbled onto a path that has led to half of private-sector workers having no employer-provided retirement plan, while facing a future that could feature 25% cuts in their Social Security benefits. Clearly, a national conversation about retirement policy and perhaps some bold, persistent experimentation are in order.

A Reminder About the Tax Petition ... In last week's column, I wrote that it's high time for our political leaders to work together to provide tax fairness for mutual fund investors. If you agree with this position, please take a few moments to click here and sign a White House petition. Then forward the White House petition link to your friends, family, and colleagues. If we can obtain 100,000 signatures in 30 days, it will not only trigger an official White House response, but it will place investor interests front-and-center for our political leaders.