CHAPTER 1
AMERICA’S RETIREMENT SAVINGS CHALLENGE
The only thing we have to fear is fear itself.
America’s retirement future can certainly seem terribly threatening. In every media outlet—from books to blogs, TV to Twitter, magazines to think-tank white papers and academic studies, a host of troubling reports suggest that we’re on the cusp of a pervasive retirement “crisis.” They warn of a coming wave of elderly poverty and bitter intergenerational conflicts that pit America’s boomers against millennials, their own children.
These grim scenarios are exaggerated. But they are not wholly groundless. America’s retirement savings challenge is very real. Here are some points to consider:
- About two-thirds of private sector workers have access to any kind of employer-sponsored retirement savings plan, according to the Pew Research Center.
- 52 percent of Americans are at risk of a substantially reduced standard of living in retirement, according to Boston College’s most recent National Retirement Risk Index.
- U.S. households headed by men and women between the ages of 25 and 64 face an aggregate retirement savings deficit of some $4 trillion, according to the Employee Benefit Research Institute (EBRI).
- Only about 50 percent of American workers between the ages of 25 and 64 actually take part in employer-sponsored retirement plans, whether defined benefit or defined contribution.
- A typical U.S. household retires with only $111,000 in 401(k) or IRA savings, in addition to any traditional pension, Social Security, or nonretirement assets (notably private business assets or real estate) they may own.
- Roughly one-third of American households have zero retirement savings and will be forced to rely on Social Security as their only financial resource in retirement, according to Social Security’s own database.
- 46 percent of American households cannot come up with $400 cash for an emergency without borrowing from credit cards, friends, or family, according to a recent survey by the Federal Reserve.
- Roughly 46 percent of senior citizens in America die with less than $10,000 to their names, according to a 2012 study for the National Bureau of Economic Research (NBER). The “oldest elders,” those in their late eighties, nineties, and beyond, are often totally destitute.
- Empower Retirement’s own annual Lifetime Income Survey (LIS), developed in collaboration with Brightwork Partners, finds that, at the median, working Americans are on track to replace only 62 percent of their previous income once they stop working.
The LIS is one of the most comprehensive analyses of retirement income prospects. It includes virtually all sources of potential retirement income, from all forms of retirement savings, plus Social Security, home equity, and business ownership. Its overall finding, that Americans can replace just 62 percent of their preretirement income at the median, suggests that many millions of future retirees will have to dial back their spending significantly once they stop working, or face severe financial stress.
All of these findings, and others like them, tell us that Americans’ savings are too low and that the threat of future distress is too serious to ignore. But averages and system-wide data don’t necessarily tell the whole story. Nor do they point to useful strategies for action. To find potential solutions, we need to dig below the headlines and draw vital distinctions between the categories of workers, types of savings plans, and plan designs that generate vastly different retirement outcomes. When we do, a much more nuanced picture emerges, a mosaic of widely varying levels of retirement readiness.
At the upper end of the retirement readiness scale are millions of workers in large and midsize companies who are well on their way to successful retirements. They will be able to replace close to, or even more than, 100 percent of the income they earned while working. These workers are typically, but not exclusively, above average in income. But what drives their success is not higher income per se, but the fact that they have access to, and take full advantage of, well-designed, largely automated payroll savings plans on the job.
Just below these highly successful savers is a retirement-readiness middle ground of workers who also have access to workplace savings plans but whose plans may lack some of the most effective automatic design features. Some of these midrange workers may also not fully engage with their plans or not maximize their savings. Many face competing financial demands, such as housing costs or student loans. Others simply choose to save less and spend more.
At the low end of the income scale are tens of millions of workers who lack access to any form of payroll deduction plan on the job. Too many low- to moderate-income employees in small companies simply have no payroll deduction savings options. Millions more self-employed workers, part-timers, or those involved in contingent labor or the “gig economy” are also outside the tent when it comes to retirement savings.
For these Americans, Social Security will provide the vast majority of retirement income. And the good news is that the system can provide enough income replacement to help workers of modest means avoid outright poverty. But we can, and should, do much more than that baseline minimum.
We can clearly see that America’s payroll deduction retirement system already has the potential to deliver successful retirement outcomes because it is actually doing that for millions of households today. And this made-in-America system of defined contribution savings plans is fully funded and economically sustainable, unlike many seemingly more generous public retirement systems around the world.
But however successful America’s workplace savings system is at its best, that success is only partial. Millions of American workers remain outside this exercise in mass investing and wealth creation. They have little or no ownership stake in free enterprise capitalism.
Having dedicated much of my career to building the American defined contribution retirement industry, that raw fact makes me impatient, even angry. Bringing these fellow Americans into our workplace savings system strikes me simply as the right thing to do, morally and economically.
It is also time to recognize that most of the shortfalls and flaws we worry about in America’s retirement picture don’t stem from the structure of 401(k) plans or from the decline of defined benefit pensions, or any other element of retirement policy. Retirement savings shortfalls are often driven by deep long-term trends, most of which are far more powerful than any aspect of workplace plan design or retirement policy itself.
The Chain of Causality
To understand why we face a retirement shortfall, we need to consider forces and trends that have cut across the U.S. economy for decades. Retirement is, let’s recall, the time when a host of economic and cultural forces that have been at work for decades combine to deliver economic and financial outcomes to members of a generation at the end of their working lives.
Thus, retired Americans now in their late nineties have been touched by events as distant as the Great Depression, World War II, and, over decades, the evolution of safety net programs like Social Security and Medicare. By contrast, boomers, now on the cusp of retirement, likely take those safety net programs for granted. But their financial lives have almost surely been meaningfully benefited by the long stock market boom from 1982 to 2000, and then hurt in mid-to-late career by the stock and housing market crashes of 2000 and 2008–2009. Millennials, those born between 1982 and 2004, also lived through two market slumps, the dot.com crash of 2000 and the far more severe Great Recession of 2008–2009. These experiences, along with the market recovery since 2009, have surely shaped their retirement savings behavior.
Among the multiple factors accounting for America’s retirement finance challenge today is a world-historic shift in longevity plus growing disparities in education, health, work, wages, and wealth, and even family structure.
Demographics
By far the most powerful driver of our retirement savings challenge is life itself, specifically the global longevity revolution that we are in the midst of right now.
Every element of America’s retirement system, along with retirement systems in every country on this planet, is being stressed by global aging. This historically unprecedented, massive, and glacially powerful force is transforming nations’ finances, economics, politics, culture, and future growth prospects. The graying of humanity is a daunting, but actually wonderful, problem that has happened in a historical heartbeat.
Over the course of a typical baby boomer’s lifetime, from 1950 to 2025, global human life expectancy is on track to increase by 50 percent, from 48 to 73 years. For the United States and other developed nations, the increase in longevity beyond age 70 will be greater still.
Longer and healthier lives are arguably the most positive socioeconomic development in all of human history. Economic development, nutrition, quality healthcare, new technologies, and better lifestyle choices have created a perfect storm, delivering an extraordinary extension of human life expectancy despite the wars, terrorism, AIDS, and other horrors reported by the media on a daily basis. The prospect of longer life, I have to say, is the ultimate in good news.
But this good fortune comes with a cost, most obviously in the demands that it places on retirement finance systems. Most of these systems, like Social Security, were established decades ago and designed to support people who then lived on average only into their early or mid seventies.
These systems are poorly suited to serve a new generation of elders whose average life expectancy at age 65 will rise by nearly four full years from 81 to 85—a gain of roughly 25 percent—between 1980 and 2020 (Figure 1.1). And since that’s just an average, we’ll see millions of these retirees live well into their nineties and beyond. Based on current trends, this remarkable life extension, and the financial stress it creates, will continue for decades.
FIGURE 1.1 Americans have added 5 years to their life expectancy at age 65 since 1950
Source: Centers for Disease Control and Prevention (data based on death certificates), 2020 Projection from National Center for Health Statistics, “An Unhealthy America: Economic Burden of Chronic Disease” (2007), Milken Institute.
This historic change poses a very specific business challenge. When I began my career in the 1980s, the average retirement lasted roughly 16 years. Now we need to help people save for, and finance, a retirement that may average 25 percent longer and run 25 to 30 years or more. Financing that long a “vacation” is no easy task.
The longevity revolution is a perfect example of what economists call systemic stress. Longevity takes its toll on all of America’s retirement systems: Social Security, traditional pensions, and the emerging defined contribution pension system.
But longer life is not the only thing that’s making successful retirement savings tougher. Rising education and healthcare costs, stagnant wages, and profound changes in family structure all compound the challenge.
Education Costs
Education, particularly postsecondary university education, has become vastly more costly for all Americans. Over the past 30 years, a typical family income has increased by 147 percent and the Consumer Price Index (CPI) has increased by 115 percent. But the cost of postsecondary education soared by 500 percent. For parents, the cost of providing for their children’s education can conflict directly with their own goal of compiling a retirement savings nest egg.
Students, too, face a financially draining explosion of debt. Today, some 44 million Americans owe more than $1.3 trillion in student loans. Some carry student debt for much of their adult life, and a few all the way into retirement. At any given time, nearly half of these loans are delinquent or in deferment, forbearance, or default.
Student loans make it much harder for young workers to get started early on retirement savings. This delay, in turn, deprives young workers of the single most powerful factor that makes for a successful retirement strategy: the time for their investment returns to compound.
Healthcare
Healthcare costs negatively affect retirement savings in the same way as education costs and debt. They divert funds that could be socked away in a 401(k), IRA, or similar savings vehicle. During retirement, out-of-pocket expenses not covered by Medicare can eat up income and even erode principal. And healthcare costs have been outpacing inflation and wages for many years. According to the U.S. Federal Reserve, the CPI has risen by some 235 percent since 1980, while the Consumer Price Index for Medical Care rose by 441 percent (Figure 1.2).
FIGURE 1.2 Consumer Price Index for medical care versus all items
Source: U.S. Bureau of Labor Statistics and Federal Reserve.
Wage Stagnation
But inflation-adjusted real wages for most U.S. workers have scarcely budged since the 1980s. This is problematic since both Social Security benefits and private retirement savings are funded by payroll deductions.
In the three decades after the Second World War, hourly compensation roughly tracked productivity. But over the past 30 to 40 years, productivity has massively outstripped wages, resulting in boom times for capital investment against a backdrop of stagnant wages.
The culprits are well known: globalization, offshoring of industrial jobs, automation of manufacturing processes, dwindling union membership, and the expanding role of less labor-intensive knowledge industries like finance, technology, healthcare, and professional services.
Most of these fast-growing job categories rely on defined contribution retirement savings as their primary retirement vehicle, as compared with government employment or private firms in mature industrial sectors, where most remaining defined benefit plans are found.
As the economy has shifted toward services and knowledge-based industries, employment markets have grown more volatile, with companies staffing up amid growth and then rapidly downsizing, even during mild recessions and stock market dislocations.
Economists appreciate the fact that the United States has a fast-changing, dynamic economy. But this job market volatility, together with the rise of defined contribution workplace savings, directly exposes workers to both a roller-coaster employment market and investment market risk as asset prices move up and down with greater frequency.
Increased personal risk, flat wage growth, and weaker collective bargaining combine to foster a generalized feeling of insecurity among wage earners. This makes many workers reluctant to engage with retirement savings, unless they work for companies that automatically enroll them in payroll savings plans.
Market Shocks
The two major stock market downturns since the beginning of the new millennium have also weakened many Americans’ retirement readiness. As always, there is a painful asymmetry between market losses and recovery: you need a 100 percent rebound to recover from a 50 percent loss, plus the ability to be patient and keep a cool head.
Most 401(k) investors did manage to ride out both the popping of the dot.com bubble in 2000 and the far more serious global financial crisis of 2008–2009. Far from selling out at market bottoms, most American workplace savers continued to make their regular 401(k) contributions, paycheck by paycheck, right through those unnerving market slumps. This steady flow of investment effectively raised their equity stakes while stocks were deeply discounted, thus rebuilding their retirement nest eggs.
But some K-plan participants did sell low and lock in unrecoverable losses. And some retirees who didn’t panic nevertheless found that they had no choice but to sell assets even as markets were falling because they needed to draw income to live on. No one who experienced any such “sequence of returns” risk—having to sell into a declining market—will find much comfort in knowing that markets later rebounded.
Even though the damage that these twin market dips inflicted was limited, not catastrophic, the unprecedented monetary policy responses that followed the 2008–2009 slump are inflicting fresh pain, especially on very conservative retirement savers who rely on bond or bank interest to get by.
Policy Aftershocks
In particular, the zero interest rate policy (ZIRP) of the Federal Reserve and other central banks worldwide, which drove interest rates down in the hope of spurring economic recovery, has made it far more difficult for individual investors to find safe and reliable sources of interest income. Interest rates had already been in secular decline in the United States for over 30 years, which helped fuel the long stock market boom from 1982 to 2000. But the Fed’s multiyear limbo dance since 2008—down to near-zero interest rates—is historically unprecedented and potentially dangerous.
For people who are still busy building wealth, ultra-low rates deliver a sharp prod to reach for riskier, more volatile investments in search of higher yield. This accounts in part for the stock market rally we’ve seen since 2009. But for those already retired and drawing down wealth, ultra-low rates slash the income generated by high-grade bonds, annuities, and other low-risk products. This can further dissuade retirees from buying guaranteed lifetime income products and increase the risk that they will outlive their savings.
Ultra-low rates also wreak havoc on the liability-matching strategies most defined benefit plans use to meet their future obligations. With each passing year of these rock-bottom interest rates, the central banks of the world are relentlessly squeezing pension fund managers everywhere, hastening the decline of defined benefit plans in America and raising the risk of pension failures worldwide.
The Social Fabric
Another trend that is hampering Americans’ ability to save for retirement comes from social trends that are well beyond the realm of economics.
The rising incidence of single-person households has very clear and damaging financial impacts. Any financial planner will tell you that divorce, affecting roughly half of marriages, can be a catastrophic financial event for those involved. The savings and home equity of a single household are generally divided between the couple, while living expenses surge for a divided household.
One piece of good news is that America’s divorce rate, after rising for generations, has turned down in recent years. But in this case, the “data behind the data” is not comforting. Divorce rates are falling simply because more Americans don’t marry in the first place, or they don’t remarry or otherwise form couples. Whatever the reason, we are seeing more single heads of household, and this fragmentation of traditional family structures weakens a traditional financial support system and makes retirement savings more difficult.
An even more nuanced take on the structure of our households is that, over the generations, we have developed a marked class divide when it comes to married partners—what sociologists call “associative mating.” Whereas a generation or two ago, educated men or women might marry less educated partners, today highly educated, high-earning men and women tend to marry each other. Lower-earning couples do likewise, thereby compounding the inequality of earnings, wealth, and retirement preparation.
A Challenge, Not a Crisis
As we consider ways to improve retirement savings, let’s first recognize that many of the deficits in our retirement preparation have much more to do with the changing nature of America’s economy and our society than they do with workplace savings plan design. The shift to 401(k)s and similar defined contribution savings has not caused rising healthcare or education costs or the changes we see in family structure.
Today’s very real sense of retirement insecurity is not the fault of the retirement industry or of changes in workplace plan design. It reflects the culmination of multiple trends that get conflated with retirement issues simply because, let’s face it, retirement is the last stop on life’s timeline.
The evolution of our retirement structure, from traditional defined benefit pensions to workplace savings plans, has taken place alongside a cascading transformation of our whole economy and American society. Too often, critics of our retirement savings systems are confusing coincidence with causality.
Some of these critics wish nostalgically for a return to traditional defined benefit pensions. They ignore the fact that such pensions never covered more than one-third of long-term workers—“lifers”—and then, mainly at large companies and government agencies. Today, no corporation or government agency is inclined to initiate, expand, or prolong defined benefit pensions; that’s the reality we must face.
More positively, as we will see, a wide range of research and industry data make it clear that well-structured defined contribution workplace savings plans can successfully deliver reliable lifetime income in retirement.
Despite its manifold imperfections, our retirement finance architecture today is as well funded as it has ever been in our history. In fact, the United States is uniquely positioned among major industrial nations. We have retirement finance systems in place that massively support both capital formation and social welfare. And because we have both a younger demographic and far more robust private retirement savings, America’s retirement system will prove more sustainable over the coming decades than many seemingly more generous systems in other countries.
So, yes, America does face a serious retirement savings challenge. But we don’t face any insoluble or overwhelming “crisis.” America’s retirement services industry has already identified a full tool kit of measures to meet the challenge, ranging from industry best practices that can be spread much more widely, to new public policies that complement and help support private initiatives. So while we do have a tough job ahead, we also have the insights, tools, and techniques that can dramatically improve our workplace savings system and see that it delivers on its full potential.
Before I discuss those changes, though, let me emphasize the urgency of restoring the critical foundation of our entire retirement system: Social Security. Making Social Security solvent for generations to come is, absolutely, job number one in American retirement policy.