The American retirement system is in urgent need of repair. Projections show that around half of all American households are not saving enough for retirement. Many Americans don’t have access to saving plans at work, and those who are saving need better options for turning their wealth into security.
Martin Neil Baily
Senior Fellow Emeritus - Economic Studies, Center on Regulation and Markets
Benjamin H. Harris
Former Brookings Expert
Executive Director of the Kellogg Public-Private Interface - Kellogg School of Management
Policymakers are taking action. The Senate recently introduced the Retirement Enhancement and Savings Act (RESA) and the House Ways and Means Committee passed the Setting Every Community up for Retirement Enhancement (SECURE) Act. These bills both work to improve the issues with today’s retirement policy.
An important first step in fixing the nation’s retirement system is expanding access to saving plans at work. As we recently outlined in a paper with Brookings scholar Mark Iwry, many of today’s workers, especially those at small companies, don’t have access to a 401(k)-like plan or company pension. For many employers, the administrative cost and burden of offering a plan often leads to them foregoing the benefit altogether.
An important provision of both the RESA and SECURE acts would make it easier to create multiple employer plans, or “MEPs,” which are retirement plans sponsored by a collection of small employers. MEPs spread the fixed costs of running a retirement plan over a larger number of employees, and thus keep costs down.
Currently, MEPs are allowed only for groups of companies that share a “common bond,” such as members of a local association of construction companies. The new legislation would allow pretty much any companies to band together in offering a plan. Financial institutions that administer retirement plans could also recruit unaffiliated companies to join a MEP and share the costs.
A second objective of the RESA and SECURE acts is to give Americans more retirement income security. For decades, traditional pension plans were very popular, allowing retirees to combine lifetime pension checks with Social Security benefits. But companies found these programs becoming increasingly expensive, especially as regulation forced them to keep the plans funded. Today, only about 4% of employees use a traditional pension plan as their sole retirement account, down from 60% in the 1980s, exposing retirees to the risk of running out of money and living on a small Social Security payment.
While it’s probably unrealistic to expect a return to widespread pension coverage, this new legislation fosters better retirement security by encouraging employers to include annuities as an option their employees can buy with their payroll retirement contributions. With annuities, retirees purchase their own pensions from an annuity provider, and receive that money back as regular payments for as long as they live — ensuring a steady stream of income throughout their retirement.
Currently, someone retiring could go out on their own and buy an annuity, but the fees in the individual marketplace are high and employees may feel they lack the knowledge to choose a good product. Employers could offer annuities as part of their 401(k) offerings and negotiate for a group rate that would lower fees, but in practice few employers do this — in part due to employers’ belief that offering annuities exposes them to considerable risk. In particular, employers are worried that they will be on the hook for annuity payments if the annuity provider they selected for their workers goes broke. The risks to employers are typically not very great if they choose an annuity provider sensibly, but many employers decide not to take the risk.
The RESA and SECURE acts try to get more annuities into workplace plans by making it easier for employers to protect themselves from future liability. They would not be responsible if the annuity provider goes broke, as long as they have followed a reasonable path when choosing the provider. Employers are still expected to undertake an objective, thorough and analytical search for annuity providers, but the new rules are intended to simplify and clarify this process.
While the RESA and SECURE acts won’t lead to a huge jump in savings, Congress’ incremental reforms should be a welcome step for workers looking forward to a more secure retirement. Truly fixing our nation’s retirement problems will require shoring up Social Security’s finances, making tax breaks for saving fairer and providing widespread access to saving plans at work.