Testimony before the Oregon Retirement Savings Task Force

Thank you for allowing me to testify before you today on the need to improve retirement savings opportunities for employees of private sector small businesses and ways to structure such an effort.

I am David John, a Senior Strategic Policy Advisor in AARP’s Public Policy Institute, AARP’s internal think tank. In addition, I am a Deputy Director of the Retirement Security Project at the Brookings Institution. Before I joined AARP last year, I was a Senior Research Fellow at the Heritage Foundation for almost 15 years.

My testimony this afternoon will focus on three areas: first, that there is a very real and growing retirement security problem in the United States; second, that the existing products and efforts are not resolving this problem; and third, that there are some approaches that Oregon could take that are compatible with existing law and would help future retirees to have a more comfortable retirement. These proposed actions would also help both your state and the country as a whole avoid the high costs of doing nothing. Let me be clear from the start that simply talking about increased education is not enough. This is a problem that will require action to improve.

The Problem Facing Us

Oregon and our nation face a serious problem if a large proportion of our workforce remains unable to save for retirement through an employer-related payroll deduction plan. This situation affects both those approaching retirement and those who are just starting their careers. However, older workers may have much higher access to defined benefit plans, and thus be much better off than younger employees who will have nothing to rely upon other than savings and Social Security.

Social Security is the foundation of retirement security both here and nationwide. In Oregon alone, its benefits keep hundreds of thousands out of poverty, but for most people, Social Security’s average benefit level of about $1,300 a month[1] does not provide enough for a comfortable retirement. That is about $15,600 a year. Economic security requires both Social Security benefits and sufficient additional savings to supplement them.

The lack of savings—and the opportunity to save at work through payroll deduction—is where the problem lies. Various industry groups and columnists have claimed that all is well, and that there really is not a problem. However, on close examination, there are holes in their figures, and they often focus on today’s retirees and those close to retirement, people who are much more likely to have a traditional defined benefit pension plan than younger workers who need to be saving now will have.

Even then, the numbers are not pretty. National data from the non-partisan Employee Benefit Research Institute (EBRI) show that in 2013, 51 percent of workers aged 45–54 had less than $25,000 in total savings and investments.[2] These are people between 10 and 20 years from retirement. Among workers aged 55 and above, those within 10 years of retirement, 43 percent had less than $25,000 in total savings and investments. These household savings numbers exclude home equity and defined benefit pensions (if any). Savings of that amount will not take an individual through one year of retirement, much less the 20 plus years that most healthy 65-year-olds are likely to experience.

Interestingly, the question in 2014 was revised to separate out those with access to an employer-sponsored retirement savings plan or pension and those without.[3] The answers showed once again the value of such a plan and the cost of not having one. About 62 percent of employees with access to a retirement saving plan through their employer had more than $25,000 saved, and 22 percent had $100,000 or more. However, 94 percent of those without access to such a plan had under $25,000 in total savings and investments, and only 3 percent had $100,000 or more.

Just to place these numbers in perspective, any amount of retirement savings is certainly better for a retiree than no retirement savings at all, but it takes a significant amount gradually built over a long period of time to build a significant level of financial security. Retirement savings of $100,000,[4] a sum that only 30 percent of the workers age 45–54 and only 42 percent of those age 55+ in the EBRI survey will equal or exceed, buys additional monthly income of $589 ($7,100 annually) for men at age 65 and $552 a month ($6,600 annually) for women at that age.[5] That would give men with $100,000 in retirement savings and average Social Security benefits a monthly retirement income of about $1,800 ($22,700 annually) and women with the same savings and Social Security benefits a monthly income of $1,750 ($22,200). Neither figure is likely to produce a comfortable retirement, and the EBRI data suggest that even that is out of reach for well over half of all Americans.

Admittedly, these are rough numbers, and many people will receive higher-than-average Social Security benefits. However, many other people will end up receiving much less than average. We know from other research that five groups are most likely to undersave: small business employees, lower-income individuals, women, younger workers, and members of minority groups. However, the problems are not limited to just these five groups. By the way, the recent column by Robert Samuelson[6] that repeats industry assurances that all is well cited the Investment Company Institute (ICI) as saying that the median value of IRA and 401(k) accounts held by people aged 55–64 is $100,000.[7] If that is true, then half of all those with such accounts would have annual retirement incomes equal to or less than the $22,000-plus level I just mentioned if they receive average Social Security benefits.

To make matters worse, when calculating the average amount in such accounts, researchers usually exclude those who have no account at all. In the case of the ICI data Samuelson cites, it appears that approximately 25 percent of households aged 55–64 did not have either a 401(k) or an IRA. They face an even worse future.

How can industry researchers present the existing retirement system as working very well? The answer is by using selective statistics. As an example, the EBRI study includes a question asking how many employees have saved for retirement.[8] The answer for 2013 is 66 percent of all workers and 74 percent of those aged 55 to 64. If one stopped there, the picture would look very good. It is only when one digs in deeper and asks how much they have saved that the true problem becomes evident. Similarly, other studies[9] that show no serious problem focus on today’s retirees, who had much more access to a traditional defined benefit pension than tomorrow’s retirees will. While many of today’s retirees are comfortable, their success does not imply that younger workers will automatically have the same future.

Access to Workplace Savings Is Essential

It is not that people do not want to save or cannot save. They do. The problem is often the lack of access to a convenient savings plan, and the inability to understand the many savings options that exist.

The existence of a workplace retirement savings plan is important. A recent Boston College Center for Retirement Research paper[10] found that access to a workplace retirement savings plan or pension is second only to having a job as the most important factor in assisting moderate- to low-income individuals to build retirement security. A wide variety of research shows that only about half of the U.S. workforce has the ability to save for retirement or has a pension at work. While there are a variety of data sources, each with its own strengths and weaknesses, another Boston College study[11] found that the coverage statistics are comparable between data sources when the same standards are applied. This included a study of IRS records[12] that appeared to show otherwise.

Regardless of the exact percentage point used to estimate coverage, the sad fact is that millions of Americans currently lack the ability to save for retirement at work through payroll deduction. This is especially true for small business employees. A recent U.S. Government Accountability Office (GAO) study[13] found that only about 14 percent (one in seven) of businesses with 100 or fewer employees offer their employees such a plan, and that between 51 percent and 71 percent of the roughly 42 million people who work for a small business lack the ability to save for retirement.

PPI research shows that about 642,000 Oregonians between the ages of 18 and 64—about 47.6 percent—are employed by a company that does not offer a pension or retirement savings plan.[14] The Oregon number is slightly better than the 51.1 percent national figure. That translates into 57 million Americans who are employed by the private sector and cannot save for retirement at work. These are not just younger employees who are new to the workforce. They include midcareer individuals who move from a large company that offered a retirement plan to a smaller company that does not. Often, these midcareer workers end up with a gap in their savings history that damages their ability to build economic security.

The Need for Better Coverage Is Widely Acknowledged

AARP is certainly not the only organization to recognize the need to increase the number of people able to save for retirement through a payroll deduction plan or account. Here, in Oregon, the Retirement in Reach Coalition[15] is a broad-based collection of business, professional, labor, and civic groups that have come together to help more Oregonians to save.

Nationally, a number of organizations, including many prominent research institutions, have written about the number of people who lack the ability to save for retirement and the need to improve coverage. Please note that these organizations do not necessarily support any specific solution or, indeed, any solution at all. However, all have written about either the need to expand coverage or how retirement security would be improved through greater coverage. As an example, Putnam Investments CEO Robert L. Reynolds has written about the need to improve the ability to save in a short paper titled “Three Steps that Could Shore up Retirement.”[16] The paper noted that “today—two years since the first boomers turned 65—the Employee Benefit Research Institute estimates that 49% of American workers are still ‘not confident at all’ or ‘not too confident’ about having enough money in retirement, 57% of pre-retirees have less than $25,000 saved for the future, and 32% of all workers do not have access to a retirement saving plan at work.”

The paper’s Step Two was: “Access to workplace savings for all workers. Any worker paying FICA taxes should have access to a retirement savings plan at work.”

Other organizations that have either issued papers or made statements about the number of people who lack an employer-sponsored retirement savings or pension plan include the following: the Brookings Institution’s Retirement Security Project,[17] the New America Foundation,[18] the Aspen Institute,[19] the U.S. Chamber of Commerce,[20] the Heritage Foundation,[21] and the Urban Institute.[22]

Again, this is not to imply that any of these organizations endorse any approach that Oregon might decide to take on retirement savings or that they support any part of my testimony. I mention them solely to show that concern about limited opportunities to save for retirement is widespread.

Those without an Employer-based Plan

In theory, everyone without an employer-based plan could save in an IRA, but EBRI research estimates that only about 1 out of 20 actually does so regularly.[23] In addition, payroll deduction is viewed as very important for encouraging retirement savings by people at every income level[24]. Overall, 61.5 percent of those surveyed in the EBRI 2011 Retirement Confidence Survey said that payroll deduction was very important for encouraging them to save for retirement, and another 27.8 percent said that it was somewhat important. Together, 89.3 percent said that it was either very or somewhat important. Further, the survey also found that a significant number of those currently saving would either stop or reduce their saving if payroll deduction was not available. It is much easier for people to save regularly if their savings are deducted from their paycheck before they receive it. Otherwise, the press of immediate bills tends to crowd out savings for longer-term goals.

Another factor in the extremely low savings rate among those who can use only an IRA is availability and trust. Especially in low-income neighborhoods, there are often no financial institutions nearby other than check-cashing outlets. Low-income individuals are often reluctant to go to financial outlets in other areas as they may feel that they are not welcome or that they will be treated poorly. Another drawback that applies to individuals of all income levels is the fear that they will be taken advantage of. Because financial professionals will know much more about the subject than their potential customers and may use unfamiliar terms, people have a very real fear that they will be talked into something that benefits the financier rather than the saver.

In addition, behavioral research shows that when people are faced with an important decision where they are uncertain what to do, they do nothing. This inertia factor is especially present in financial decisions like retirement savings.

These are reasons why an approach that focuses solely on additional education is extremely unlikely to succeed. Such an approach does nothing to increase the number of local financial outlets or opportunities to save. In addition, such financial literacy training often uses the same complex terms that potential savers find confusing. There is a value to training, but only in addition to expanded access to retirement savings.

On the other hand, when employees are presented with a plan at work that is structured in a way that provides guidance, they take the opportunity to save. This is true at all income levels. The Boston College study on why lower-income people are less likely to save that I mentioned earlier[25] showed very similar take-up rates between income levels. Eighty-six percent of those with incomes under 300 percent of the poverty line participated in a retirement savings system or pension if they were offered one and were eligible, compared to 95 percent of those with higher incomes.

Existing Products Are Not the Solution

Opponents of a state-sponsored retirement savings effort often cite the number and kind of existing products that are currently available to small businesses. A joint IRS/U.S. Department of Labor publication[26] lists seven types of retirement savings plans that are currently available. Unfortunately, most of them are both expensive and complicated or require the employer to make a contribution. Only one that is not widely available really enables small businesses to offer their employees an opportunity to save without saddling them with high costs or requiring savings.

Both the traditional 401(k) and the automatic enrollment 401(k) are excellent solutions for employers who are willing to offer them. However, the GAO found[27] that smaller employers can pay much higher administrative costs than those paid by larger employers. In addition, they can be complicated and require employers to play a more active role than many are willing to do.

Three other plans, the SEP IRA, the SIMPLE IRA, and the safe harbor 401(k), are either totally financed by employer contributions or require employers to make contributions. In addition, another of the seven options—a profit-sharing plan—is both completely financed with employer contributions and doesn’t require regular funding. While this plan does allow for profit sharing in good years, it does not necessarily include regular contributions that an individual can use to finance a retirement income.

The seventh type of retirement savings account available to small businesses is the payroll deduction IRA. It does not require (or allow) any employer contribution, or saddle the employer with complex regulatory burdens or impose significant costs. All the employer has to do is make it available to employees, deduct the contributions from their paychecks, and then send it to the financial provider. Unfortunately, it is not widely available or sold, as it offers financial services companies only limited income potential. Oregon can help to change that situation.

Another type of retirement savings tool, MyRA, was announced in President Obama’s January State of the Union speech. MyRA has some very positive features,[28] but it is not a solution or a substitute for anything Oregon might decide to do to help more people to save for retirement. A key weakness is that an individual can only have a maximum of $30,000 in MyRA. That is not nearly enough for any appreciable improvement in financial security. Second, MyRA savings will be deposited only in government bonds. While that investment is completely safe, it does not allow any real investment growth. An individual with just a MyRA is likely to get little more than the inflation-adjusted amount they contributed.

Why Oregon Should Be Concerned about This Problem

This is a state problem because doing nothing will mean higher state and local taxes for your children and grandchildren. Low-income retirees will need state and local services financed by state and local taxes for health care, housing, senior centers, and a host of other services. As Oregon ages and the baby boomers retire, the demand from this population for additional state government services will only grow. However, there is a simple, low-cost alternative to taxpayer-funded government services.

What Oregon Can Do to Help

The statute that created the Oregon Retirement Savings Task Force includes the limitation that you cannot recommend anything that might be contrary to the federal Employee Retirement Income Security Act (ERISA). Some would have you believe that this limits you to proposing additional employee education. This is not the case.

While ERISA as it is currently written does limit Oregon’s options, there are still avenues open to the state that would help to directly increase the number of Oregonians who can save for retirement at work. Oregon could still sponsor a payroll deduction IRA[29] that could be available at low cost to every resident of the state who is not currently covered by another retirement savings or pension plan. Such an account could be available through either state-managed investments or one or more private sector providers chosen and monitored by a state agency.

The state, the employer, or any private sector provider would not be responsible for the performance of the savings, and there would be no promised retirement benefits. All of the savings would come from and be owned exclusively by the individual saver. It would be up to the saver to monitor his or her eligibility and compliance with contributions rules. The small costs of such a program could be paid out of fees assessed on the accounts, or the start-up costs could be subsidized by the state.

A key fact is that the only liability faced by the employer would be to collect and forward individual contributions to the provider or agency on a timely basis. In theory, such contributions could be forwarded using the same schedule as the state currently uses to collect its income tax revenues. Federal law limits the role of the employer to encourage its employees to save for retirement through providing general information about the payroll deduction IRA program. The employer is also allowed to answer any questions about the program or to refer them to the IRA provider and provide any informational materials written by the IRA provider, as long as no endorsement by the employer is provided. At all times, the employer must remain neutral about the provider.

This is not a perfect plan, and it does not include features that many who support increased access to retirement savings would like to see. However, we believe that such a plan would be legal and, if combined with an educational program, could increase retirement savings among Oregonians. As federal law either changes or is reinterpreted, additional features and services could be added. This would be a starting place, not a final destination.

Automatic Enrollment

At this point, any Oregon plan would probably not require the use of automatic enrollment. However, as both state and federal law evolve, it would be helpful to explore encouraging that feature in any retirement savings plan. Under automatic enrollment, an employee continues to have total control over his or her retirement savings decisions, but unless the employee decides otherwise, he or she is enrolled and saves a set percentage of income in a specific investment choice. Automatic enrollment uses behavioral economics to make inertia work for the employee. These features work. The five groups mentioned earlier that are most likely to undersave (women, younger employees, small business employees, lower-income employees, and minority groups) all see their participation rates climb from very low levels to close to 90 percent.

And employees like automatic enrollment. A 2007 survey[30] of automatically enrolled workers showed that 95 percent found that it made saving easy. Eighty-five percent started to save earlier than they would have without it. Almost all of the employees who were automatically enrolled and remained in the plan said that they were satisfied with the process (97 percent) and were glad their company offered automatic enrollment (98 percent). Even those who were automatically enrolled and decided not to save liked the feature, with 90 percent being satisfied with the process and 79 percent being glad their company offered automatic enrollment.

Conclusion

Again, thank you for allowing me to testify today. Improving the ability to save for retirement through the increased availability of payroll deduction savings would address a real need both here in Oregon and nationwide. From a policy standpoint, an active program that increases the access that small business employees have to payroll deduction retirement savings plans would help the nearly 650,000 Oregonians who don’t currently have such an opportunity. It would enable them to build economic security through their own efforts.

BEST PRACTICES:

• A universally available payroll deduction IRA that is available to any Oregonian who currently lacks an employer-provided retirement savings or pension plan.
• A very short list of available investments that includes both a stable value fund and a balanced or target date fund. New savers would go into a previously designated investment unless they chose otherwise. Savers wishing other investments would be able to find other IRA accounts.
• Regular statements that clearly indicate investments, earnings, fees, and account balance. A number indicating the monthly retirement income that such a plan could produce if the current amount is saved would be very helpful.
• A coordinated statewide education program that explains the accounts and how to use them as well as the value of saving for retirement.
• Financial literacy classes in every school.

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[1] “Fast Facts and Figures about Social Security 2013,” U.S. Social Security Administration Office of Retirement and Disability Policy. This is the number for new retirement awards. The average amount is slightly lower. http://www.ssa.gov/policy/docs/chartbooks/fast_facts/2013/fast_facts13.html#page5

[2] 2013 Retirement Confidence Survey Fact Sheet #4,” Employee Benefit Research Institute (EBRI). http://www.ebri.org/pdf/surveys/rcs/2013/Final-FS.RCS-13.FS_4.Age.FINAL.pdf

[3] “2014 RCS FACT SHEET #6,” EBRI. http://ebri.org/pdf/surveys/rcs/2014/RCS14.FS-6.Prep-Ret.Final.pdf.

[4] As mentioned, the EBRI numbers are for household savings excluding home equity and defined benefit pensions (if any). The calculations on how retirement savings would affect total retirement income assume that the entire amount of those household savings is used to purchase an annuity for one individual. In reality, only a portion of household savings would be available to be converted into retirement income, and that amount is likely to be divided between two earners, so these numbers probably overstate the effect on retirement income.

[5] These annuitized amounts were calculated at http://www.incomesolutions.com/ on May 9, 2014.

[6] Robert J. Samuelson, “Are We Under-Saving for Retirement?” Washington Post, April 27, 2014. http://www.washingtonpost.com/opinions/robert-samuelson-are-we-under-saving-for-retirement/2014/04/27/6cd02562-cc93-11e3-95f7-7ecdde72d2ea_story.html

[7] According to the 2010 Survey of Consumer Finance (SCF), the median retirement account balance for families headed by a person aged 55–64 is $100,000. This number only includes the approximately 60 percent of those households that have a positive retirement account balance and excludes those that have no positive retirement account balance. See the SCF chart book at http://www.federalreserve.gov/econresdata/scf/files/2010_SCF_Chartbook.pdf, and click on “retirement accounts” and “age of head.”

[8] “2013 Retirement Confidence Survey Fact Sheet #4,” EBRI. http://www.ebri.org/pdf/surveys/rcs/2013/Final-FS.RCS-13.FS_4.Age.FINAL.pdf

[9] John Karl Scholz and Ananth Seshadri, “Are All Americans Saving ‘Optimally’ for Retirement?” Michigan Retirement Research Center Research Paper No. 2008-189, September 1, 2008. http://ssrn.com/abstract=1337653 or http://dx.doi.org/10.2139/ssrn.1337653.

[10] April Yanyuan Wu and Matthew S. Rutledge, “Lower-Income Individuals without Pensions: Who Misses Out and Why,” Boston College Center for Retirement Research working paper CRR WP 2014-2, March 2014. http://crr.bc.edu/working-papers/lower-income-individuals-without-pensions-who-misses-out-and-why/.

[11] Alicia H. Munnell and Dina Bleckman, “Is Pension Coverage a Problem in the Private Sector?” Boston College Center for Retirement Research IB#14-7, April 2014

[12] Howard M. Iams and Patrick J. Purcell, “The Impact of Retirement Account Distributions on Measures of Family Income,” Social Security Bulletin, Vol. 73 No. 2, 2013. http://www.ssa.gov/policy/docs/ssb/v73n2/v73n2p77.html

[13] RETIREMENT SECURITY: Challenges and Prospects for Employees of Small Businesses,” Statement of Charles A. Jeszeck, Director, Education, Workforce, and Income Security, GAO-13-748T, July 16, 2013. http://www.gao.gov/assets/660/655889.pdf.

[14] The full list of states is available at http://action.aarp.org/site/DocServer/Workers_without_a_Retirement_Plan.pdf?docID=1961

[15] For more information, including a list of members, please see http://www.retirementinreach.org/.

[16] Robert L. Reynolds, “Three Steps that Could Shore up Retirement,” Putnam Investments blog entry, July 9, 2013. http://www.theretirementsavingschallenge.com/2013/07/three-steps-that-could-shore-up-retirement-security/.

[17] J. Mark Iwry and David C. John, “Pursuing Universal Retirement Security through Automatic IRAs,” Brookings Institution, July 2009. https://www.brookings.edu/research/papers/2009/07/automatic-ira-iwry

[18] Reid Cramer, Justin King, Elliot Schreur, and Aleta Sprague, “Solving the Retirement Puzzle, The Potential of myRAs to Build a Personal Safety Net,” New America Foundation, May 12, 2014. http://assets.newamerica.net/publications/policy/solving_the_retirement_puzzle?utm_source=Assets+Solving+the+Retirement+Puzzle+myRA+release&utm_campaign=myRA+paper+release&utm_medium=email.

[19] “Comments to the Committee on Ways and Means Working Group on Pensions and Retirement,” Aspen Institute’s Initiative for Financial Security, April 10, 2013. http://www.aspeninstitute.org/sites/default/files/content/docs/pubs/Ways%20%26%20Means%20Pensions%26Retirement%20Submission_Final.pdf

[20] See the joint statement on retirement security on page 1 at https://www.uschamber.com/sites/default/files/documents/files/021038_LABR%20Rethinking%20Retirement%20Event%20Summary_final.pdf.

[21] 21 David C. John, “Time to Address the Retirement Saving Crisis,” Heritage Foundation Issue Brief #3759, October 18, 2012. http://www.heritage.org/research/reports/2012/10/time-to-address-the-retirement-savings-crisis

[22] Barbara A. Butrica and Richard W. Johnson, “How Much Might Automatic IRAs Improve Retirement Security for Low- and Moderate-Wage Workers?” Urban Institute, Brief 33, July 2011. http://www.urban.org/uploadedpdf/412360-Automatic-IRAs-Improve-Retirement-Security.pdf.

[23] Unpublished estimates from the Employee Benefit Research Institute (EBRI) of the 2004 Survey of Income and Program Participation Wave 7 Topical Module (2006 data).

[24] Jack VanDerhei, “The Impact of Modifying the Exclusion of Employee Contributions for Retirement Savings Plans from Taxable Income: Results from the 2011 Retirement Confidence Survey,” EBRI Notes, March 2011. http://www.ebri.org/pdf/notespdf/EBRI_Notes_03_Mar-11.K-Taxes_Acct-HP.pdf.

[25] April Yanyuan Wu and Matthew S. Rutledge, “Lower-Income Individuals without Pensions: Who Misses out and Why,” Boston College Center for Retirement Research working paper CRR WP 2014-2, March 2014. http://crr.bc.edu/working-papers/lower-income-individuals-without-pensions-who-misses-out-and-why/.

[26] See IRS Publication 3998, Choosing a Retirement Solution for Your Small Business, for an outline of the seven types of retirement accounts. http://www.irs.gov/pub/irs-pdf/p3998.pdf.

[27] “RETIREMENT SECURITY: Challenges and Prospects for Employees of Small Businesses,” Statement of Charles A. Jeszeck, Director, Education, Workforce, and Income Security, GAO-13-748T, July 16, 2013. http://www.gao.gov/assets/660/655889.pdf.

[28] For an outline of MyRA, see http://www.treasury.gov/connect/blog/Documents/FINAL%20myRA%20Fact%20Sheet.pdf

[29] A brief discussions of payroll deduction IRAs can be found in IRS Publication 4587, Payroll Deduction IRAs for Small Businesses. http://www.irs.gov/pub/irs-pdf/p4587.pdf.

[30] http://www.retirementmadesimpler.org/Library/FINAL%20RMS%20Topline%20Report%2011-5-07.pdf