The vast majority of Americans who expect to retire in the next decade can count on little income other than their Social Security. This is true not only for low-income workers, who have struggled most of their lives, but also for millions of middle-income workers. Although Social Security is a tremendously important program, and provides a solid base that retirees can depend upon, its $16,000 average annual benefit doesn’t go very far. Many if not most can expect to see sharp reductions in living standards.
The reason for such bleak retirement prospects is the disappearance of traditional defined benefit pensions and the failure of 401(k)-type plans to fill the gap. A recent analysis by the Employee Benefit Research Institute found that, in 2011, only 14 percent of private-sector employees participated in a defined benefit pension plan. The participation rate has been falling quite rapidly, so it was almost certainly lower in 2015.
Although many people were hopeful that 401(k)s would be sufficient to support a comfortable day-to-day retirement, this has proved not to be the case. In 2013, the middle fifth of households of people ages 45 to 54 had less than $60,000 in total financial assets. And most homeowners in this age group still had less than 40 percent equity in their homes, meaning they could look forward to paying off a mortgage well into their retirement.
In response to this situation, Illinois is developing a state-run retirement program that will make it easier and cheaper for workers to save. Many other states, including California, are studying this option.
Although there are differences in proposals, the common goal is to create a publicly managed system that will automatically include workers whose employers do not enroll them in a plan.
Workers would have a modest amount (around 2 percent to 3 percent) deducted from each paycheck, although they could opt out if they chose. The money would then accumulate like a 401(k) during a person’s working years, with the option to receive a lump sum or draw a monthly payment at retirement.
There are four main advantages to this idea.
Almost half the workforce does not have the option to enroll in a 401(k)-type plan at their workplace. By creating a state-run system, many would have access to such an account for the first time.
One problem with employer-managed retirement accounts is that when people change jobs, they often cash out their holdings, paying penalties and losing their savings. But a publicly run system would be portable, so that people could keep contributing to the same system from one job to the next.
Another benefit to the state system is that participation would be the default option. There is now a considerable body of research showing that workers will contribute to their retirement if they’re automatically enrolled, but won’t contribute otherwise. (The basic story is that inertia is powerful. Many people may want to take part in a retirement plan, but they have busy lives and never get around to doing the paperwork if it requires action.)
The last advantage is that a publicly run plan would have far lower costs than many privately run alternatives. The administrative fees for a plan in a large state such as California would almost certainly be under 0.5 percent of the annual holdings. By contrast, private plans can easily charge 1.5 percent or more. The difference for someone putting $2,000 a year into an account for 30 years would be more than $25,000.
It’s increasingly obvious that there’s a major hole in the retirement system, and that the government can help fill it. That’s why President Obama asked the Treasury Department to set up a new low-cost, low-maintenance savings plan for workers — called myRA for “my retirement account.” But the myRA limits are low and participants can only invest in low-yielding government bonds. What Illinois and, perhaps soon, other states, propose to try is more ambitious, and may ultimately be more effective.
This column originally ran in the Los Angeles Times.