Testimony

The Importance of a Private Retirement System

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EPI Economist Monique Morrissey delivered the following testimony before the Philadelphia City Council’s Labor and Civil Service Committee on June 15, 2016.

Thank you for inviting me to testify today.

My name is Monique Morrissey. I am an economist at the Economic Policy Institute and author of The State of American Retirement: How 401(k)s Have Failed Most American Workers, an interactive chartbook accessible through EPI’s website, www.epi.org.

Before I move on to the topic of our private retirement system, I would like to say a word about Social Security. Social Security is the cornerstone of our retirement system, but it is not enough. Benefits replace slightly less than 40 percent of pre-retirement earnings for a middle-class worker, and this share is declining. Most experts think we need to replace 70–80 percent of our income in retirement.1 So Social Security benefits currently provide roughly half of what a middle-class worker needs.

In theory, therefore, most workers, with the help of their employers, should be accumulating retirement savings and pension benefits sufficient to replace 30–40 percent of their pre-retirement income—that is, enough to roughly double their Social Security benefits. For workers who do not have traditional pensions, this suggests they should be accumulating savings equal to roughly 10 times their pre-retirement income.2

If this seems like an unattainable goal to you, you are not alone.

The Boston College Center for Retirement Research estimates that fewer than half of working-age households are on track to accumulate sufficient savings and benefits to maintain their pre-retirement standard of living (Munnell, Hou and Webb 2014). The Center uses conservative assumptions, such as assuming every penny of savings, including home equity, is tapped in retirement.

Moreover, the share of households at risk of seeing a significant drop in living standards at retirement is growing as younger households fall further behind. This is a historic reversal. Until now, each generation had more retirement security than the last due to a gradual expansion of Social Security benefits and coverage.

Now, however, Social Security’s replacement rate is eroding due to benefit cuts enacted in 1983 that are gradually being implemented. This includes an increase in the normal retirement age that is equivalent to a 13 percent benefit cut, and an increase in the share of benefits subject to income tax as limits on untaxed benefits are not indexed to inflation.

These benefit cuts were implemented in 1983, right around the time 401(k) plans came on the scene. In hindsight, these cuts were a mistake.

Policymakers are beginning to realize this. Last year, almost every Democratic senator supported a budget amendment calling for Social Security expansion, and both Democratic presidential candidates support expansion. Republicans, meanwhile, appear to be retreating from previous calls to cut benefits. The Republican presidential candidate has said he will protect benefits, though he appears to be under pressure to reverse his position. (While Republican voters strongly support Social Security, their big-money donors do not.) This is a big shift from when I started working at EPI 10 years ago, when the question was not whether to expand Social Security or leave it alone, but rather how much to cut benefits.

What has changed? There is a growing recognition that the 401(k) revolution has failed. A quarter century after participation in 401(k)-style plans surpassed that in traditional pensions, most Americans have little or nothing saved in retirement accounts. Pension benefits remain six times as important to seniors as retirement account distributions.

It should be no surprise that 401(k)s were a bust. They were designed to supplement, not replace, pensions. They shift most of the cost and all of the risk of retirement on to workers. They are inefficient compared with pensions, which pool longevity and investment risk at no cost to workers or employers. 401(k) participants also face higher fees and earn lower net returns.

The problem is often defined as people not saving enough, but many people have rational reasons for avoiding a high-cost, high-risk system. Tax incentives for retirement saving are upside down—worth much more to taxpayers in higher tax brackets who can afford to take on more investment risk. Low-income workers often receive little or no help from their employers or the government, yet face penalties if they need to access savings before retirement.

401(k) plans magnify inequality. While 401(k)s have failed the overwhelming majority of Americans, some groups have fared worse than others: lower-income, black, Hispanic, less-educated, and unmarried Americans. For these groups, the typical working-age family or individual has no savings at all in a retirement account. And while women appear to be closing some gaps with men, their longer lifespans and lower lifetime earnings still put them at greater risk in old age. Only the financial services industry and the top 1 percent of Americans, for whom 401(k)s serve as a tax shelter more than a retirement vehicle, have an interest in maintaining the current system.

[Note: The following charts are from Morrissey (2016).]

Figure A

401(k)s magnify inequality: Share of total retirement account savings and total income for families age 32–61 by income quintile, 2013

Retirement account savings Income
1st (Bottom) 0% 2%
2nd (Lower-middle) 1% 5%
3rd (Middle) 5% 10%
4th (Upper-middle) 20% 19%
5th (Top) 74% 63%
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Note: Based on "normal income," which may differ from actual income if a family's income in the past year was unusually high or low. Retirement account savings include 401(k)s, IRAs, and Keogh plans.

Source: EPI analysis of  Survey of Consumer Finance data, 2013.

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Figure B

High-income families are 10 times as likely to have retirement accounts as low-income families: Share of families age 32–61 with retirement account savings by income quintile, 1995–2013

1st (Bottom) 2nd (Lower-middle) 3rd (Middle) 4th (Upper-middle) 5th (Top)
1995 10% 33% 50% 68% 79%
1998 15% 38% 57% 69% 83%
2001 17%   40%   56%   77%   89%  
2004 9% 37% 53% 74% 84%
2007 12%  34%  59%  76%  90% 
2010 12% 36% 53% 68% 86%
2013 8%  30%  52%  69%  88% 
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Note: Retirement account savings include 401(k)s, IRAs, and Keogh plans. Family-income quintiles are based on "normal income," a measure that ignores temporary fluctuations and is not available for years prior to 1995.

Source: EPI analysis of  Survey of Consumer Finance data, 2013.

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Figure C

The gap between the retirement ‘haves’ and ‘have-nots’ has grown since the recession: Retirement account savings of families age 32–61 by savings percentile, 1989–2013 (2013 dollars)

50th (median) 60th 70th 80th 90th
1989 $0 $5,423 $14,461 $32,536 $90,379
1992 $0 $4,874 $16,248 $39,384 $90,987
1995 $2,277 $9,866 $24,286 $47,054 $113,841
1998 $6,004 $17,440 $38,597 $73,763 $160,106
2001 $7,879 $23,638 $48,326 $92,818 $223,247
2004 $6,166 $19,730 $49,326 $102,351 $246,628
2007 $11,228 $30,315 $61,754 $123,508 $258,243
2010 $5,358 $19,291 $42,868 $96,453 $246,490
2013 $5,000 $20,100  $50,000  $116,000  $274,000 
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Note: Retirement account savings include 401(k)s, IRAs, and Keogh plans. Scale changed to accommodate larger values.

Source: EPI analysis of  Survey of Consumer Finance data, 2013.

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Figure D

College-educated families are much more likely to have retirement savings: Share of families age 32–61 with retirement account savings by education, 1989–2013

No high school diploma/GED High school diploma/GED Some college College degree or more
1989 22% 43% 49% 69%
1992 18% 42% 50% 67%
1995 23% 49% 57% 71%
1998 30% 52% 62% 74%
2001 24%  54%  57%  82% 
2004 19% 51% 57% 75%
2007 27%  52%  61%  79% 
2010 18% 46% 57% 75%
2013 18%  43%  53%  76% 
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Note: Retirement account savings include 401(k)s, IRAs, and Keogh plans. "College degree" includes associate degrees.

Source: EPI analysis of  Survey of Consumer Finance data, 2013.

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Figure E

Most black and Hispanic families have no retirement account savings: Share of families age 32–61 with retirement account savings by race, 1989–2013

White non-Hispanic Black Hispanic
1989 57% 26% 22%
1992 57% 31% 26%
1995 60% 37% 40%
1998 65% 44% 29%
2001 67%  47%  39% 
2004 66% 39% 33%
2007 67%  47%  38% 
2010 65% 39% 31%
2013 65%  41%  26% 
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Note: Retirement account savings include 401(k)s, IRAs, and Keogh plans.

Source: EPI analysis of  Survey of Consumer Finance data, 2013.

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Figure F

Single people are less likely to have retirement savings: Share of families age 32–61 with retirement account savings by gender and marital status, 1989–2013

Married or living with partner Single men Single women 
1989 56% 40% 33%
1992 57% 36% 36%
1995 64% 37% 41%
1998 66% 49% 46%
2001 69%  55%  44% 
2004 67% 51% 39%
2007 69%  50%  47% 
2010 65% 41% 45%
2013 65%  43%  42% 
ChartData Download data

The data below can be saved or copied directly into Excel.

Note: Retirement account savings include 401(k)s, IRAs, and Keogh plans.

Source: EPI analysis of  Survey of Consumer Finance data, 2013.

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Inequality is not news—we have learned to expect it. The surprising thing is that we used to have a fairly egalitarian retirement system and no longer do. Social Security is and has always been a great equalizer, and traditional pensions at least do not exacerbate inequality. Before the 401(k) revolution, black workers were almost as likely to participate in pensions as white workers, and high school–educated workers were almost as likely to participate as college-educated workers. This remains true for workers lucky enough to participate in these pensions. But there are now more than twice as many workers in 401(k)-style plans as traditional pensions, and as we have seen, participation in 401(k) plans is very unequal.

What needs to be done? First and foremost, we need to reverse Social Security cuts and expand benefits across the board. To do this, we need to raise revenues, starting by lifting the cap on taxable earnings. As Warren Buffet has pointed out, he faces a lower tax rate than his secretary because earnings above $118,500 are not subject to Social Security tax. I am also in favor of very slowly increasing Social Security contributions for all participants, split equally between employers and employees, to offset increases in life expectancy.

Second, we need to defend pensions for those who still have them. This includes most public-sector workers, since government employers are in a better position than many of their private-sector counterparts to provide pension benefits decades into the future—at least if elected officials keep up with required contributions. (Pension underfunding, incidentally, has little to do with pensions–it is simply a way to get around balanced budget requirements.)

Third, we need new solutions for workers whose employers are not in a position to provide traditional pensions. States are experimenting with hybrid plans that provide workers with some of the advantages of pensions without requiring employers to take on long-term liabilities. The California Secure Choice Plan, for example, is a good model, especially if California adopts a reserve fund to provide intergenerational risk smoothing.

In short, we face a looming retirement income crisis brought on by ill-timed Social Security cuts and a shift from secure pensions to risky, high-cost, and highly unequal 401(k) plans. However, this crisis can be averted if policymakers rise to the challenge of fixing our do-it-yourself retirement system. I thank the Philadelphia City Council for addressing this issue.

Endnotes

1. Social Security’s replacement rate is somewhat higher for lower-income workers and somewhat lower for higher-income workers due to a progressive benefit structure. However, lower-income workers need a higher replacement rate to maintain their standard of living in retirement because they will see less of a decline in expenses after retirement.

2. This rule of thumb is sensitive to interest rate and other assumptions.

References

Morrissey, Monique. 2016. The State of American Retirement: How 401(k)s Have Failed Most American Workers. Economic Policy Institute.

Munnell, Alicia H., Wenliang Hou, and Anthony Webb. 2014. NRRI Update Shows Half Still Falling Short. Boston College Center for Retirement Research, Issue Brief #14-20.

See more work by Monique Morrissey