Economics of Retirement

This is a repost from Forbes. 

America romances low wage jobs and obsessively depends on work as the answer. No friends? Answer: work. Lack structure in your day? Answer: work. No pensions? Answer: work.

The consequence of this relationship is U.S. old age poverty and old age labor force participation rates standing out in unusual ways.

Retirement income security is weak, so American retirement policy encourages paid work among the elderly and Americans live with unusually high rates of old age poverty. The two are related because we do have a failed retirement system that leads to inadequate balances as I argued in a previous blog.

• According to the OECD, America leads the club of rich nations in the provision of low wage jobs. According to the OECD over 1 out of 5 jobs pay very low wages (two thirds the median wage). In comparison, less than 1 out of 7 of New Zealand’s jobs are low wage.
• The Social Security system rewards people for delaying claiming their Social Security benefits until the age of 70. Lifetime benefits rise by 70% if you delay claiming for 8 years between 62 and 70. But only 8% of Americans get the reward, most claim before 65.
• Most older Americans retire by the age of 65 according to our calculations.
• The educated work more than the less educated; 53% of college-educated men of age 66-69 work more, compared to 27% of those with high school educations.
• But, Americans retire at far lower rates than elders in other rich nations. Older Americans work hard – only American and Japanese elders and those in emerging nations have elder labor force participation rates over 30%.

• The jobs older Americans have aren’t great, 15% of older Americans with college educations earn less than $15 per hour.
• Despite the work, or because of it, American elder poverty rates top most nations, few nations exceed 20%.

The unusually high rates of old age poverty and high rates of elderly work is related to federal pension and old age policies. Republican President Ronald Reagan’s deputy labor secretary Malcolm Lovell told Congress that older Americans will need to work because Social Security was slowly being cut as the retirement age was increasing and employers were eroding their workplace pension plans. Ever since the 1980s, Americans are expected to save, work or make do.

ReLab’s backgrounder, The Retirement Crisis, spells out the causes of the severe retirement crisis and proposes solutions.

The Problem: Lack of Adequate Retirement Savings

1. Inadequate Account Balances

ReLab’s backgrounder, The Retirement Crisis (add pdf link once final), spells out the severe retirement crisis and proposes solutions.

Most workers approaching retirement do not have enough saved to maintain their living standards in retirement, regardless of income. The typical older worker in the bottom 50% of the income distribution (earning less than $40,000/year) has nothing saved for retirement.  The median savings of worker in the middle 40% (earning between $40,000 and $115,000/year) are only $60,000. Among workers in the top 10% of the income distribution (above $115,000/year), the median amount saved is $200,000.

2. Lack of Needed Retirement Income

Low savings mean that all income groups fall short of their target replacement rates – the percentage of pre-retirement income needed to maintain one’s standard of living in retirement – by over 20 percentage points. The typical worker in the bottom 50% of the income distribution needs 85% of their pre-retirement income in retirement to maintain their standard of living. However, they can expect to have only 60% based on their current savings and Social Security benefits. In the middle 40%, older workers need 75% of their pre-retirement income, but will be able to replace only 54%. Even older workers in the top 10% are likely to experience a shortfall. As retirees, they will need 65% of their pre-retirement income, but will be able to replace only 40%.

 3. Downward Mobility in Retirement

The systemic problem of inadequate retirement saving leaves retirees at risk of experiencing a sharp decline in their living standards. With less income in retirement, many will have no choice but to cut back. For some, this deprivation means falling into poverty or near-poverty when they retire.

ReLab defines workers as downwardly mobile if their and their spouse’s current income is more than twice the 2014 Federal Poverty Level ($23,340 for a single individual and $31,260 for a couple), but projected to fall below this level in retirement. Relab projects that out of 21.5 million older workers ages 50-60 and their spouses who are not poor or near poor, 8.5 million - or 40% - will fall into poverty or near poverty when they retire at 62.

The CAUSE: The “Do-It-Yourself” Retirement System Has Failed

1. Lack of Coverage

Inadequate retirement savings result from systemic failures of the American retirement system. Workers do not have access to employer-sponsored retirement savings plans. Half of all older workers in the bottom 50% of the income distribution do not have access to a retirement savings plan at work. In the middle 40%, a fifth of workers do not have access. And in the top 10%, 15% of older workers do have access to a plan at work.

2. Switch to 401 (k)s

Since the 1980s, employers have increasingly replaced their defined benefit (DB) pensions with defined contribution (DC) savings accounts such as the 401(k). DC accounts fail American workers for the following reasons: participation is voluntary and conditional on the employer offering a plan, so that many contribute sporadically, if at all; many withdraw funds before retirement; investment returns are eroded by high fees and sub-optimal portfolios; balances are paid out as lump sums rather than in the form of a lifetime income; and the tax preferences for retirement savings disproportionately benefit high earners.

THE SOLUTION: NOT “NUDGES” OR WORKING LONGER, BUT SYSTEMIC CHANGE

Scholars and analysts who view the retirement crisis as a problem of human error and poor individual choices offer two solutions: behaviorial “nudges” to increase savings, such as auto-enrollment into existing DC plans and auto-escalation of account contributions, and working longer.

1. Nudges Are Not Enough

Behavioral nudges are inadequate for the task as they ignore the reality that almost all workers experience swings in income over their careers that make it difficult to maintain the consistent contributions necessary to accumulate enough retirement savings in a 401(k)-type account. Over a working lifetime, almost all workers experience multiple unemployment spells lasting over a year and reductions in earnings of 10% or more, with the bottom 50% of earners more vulnerable to both. When these income shocks occur, DC accounts are often tapped, serving double-duty as both emergency funds and retirement saving and making them less effective at both.

2. Working Longer Won’t Work

If workers with inadequate savings are forced to work longer to avoid deprivation in retirement, the quantity and quality of the jobs available to them is dependent on the whims of the labor market. Currently, the labor market for older workers leaves many suffering from long-term unemployment, low wages, and a lack of employer-sponsored retirement coverage, particularly for older women. Additionally, many older workers cannot continue working due to physical limitations, particularly black workers.

Given these realities of the labor market, a structural change in how we approach retirement security is necessary to solve the retirement crisis.

3. Guaranteed Retirement Accounts

Comprehensive reform includes two necessary steps: 1) strengthening Social Security, and 2) creation of Guaranteed Retirement Accounts (GRAs) as individual accounts to supplement Social Security.

Conceived as “pensions for all”, GRAs are universal, professionally-managed, portable, mandatory retirement savings accounts. Workers and their employers split annual contributions of at least 3% of wages. Additionally, GRAs benefit from risk-pooling, guarantee workers’ principal, provide a tax credit to offset low-earners’ contributions, and prohibit early withdrawals to ensure savings are preserved for retirement.

GRAs are designed to close the gap in retirement savings left by the loss of traditional DB pensions in the workplace, low access to any kind of coverage on the job, and inefficient DC accounts such as 401(k)s. They provide a safe, effective vehicle for workers to accumulate personal retirement savings over their working lives.

Note: With the exception of downward mobility, our analysis of the retirement crisis focuses on individuals, rather than households. The reality of growing divorce rates among near-retirees, and the disproportionate effects of divorce on women’s health and financial security, make it imperative that retirement income adequacy be studied at the individual level. When estimating the risk of downward mobility, we focus on the household, not the individual, because poverty is measured at the household level.

This is a repost from Forbes. 

So interesting that the conception of a retirement crisis among the financial industry and policy makers is so different from what ordinary people in working households think the retirement crisis is.

To the finance and policy elites, the “retirement” crisis is that state and local government entities may have to raise taxes to pay for their pension obligations.

Closer to what ordinary people view as the retirement crisis is the World Economic Forum’s analysis (I was on the advisory board committee). The "retirement crisis" is the gap between what working households need and what they have. The World Economic Forum study showed that the six largest economies (the US, UK, Canada, Australia, China and India) faced a savings gap.

Various vehicles and programs encompass old age income security, totaling $67 trillion in 2015 or about global GDP. That number is large or small depending on a nation’s ability to raise the money to pay for workers’ retirement years.

Working households fund their retirement through a variety of government and private programs. In the US, working households have some mix of Social Security, Medicare, pension funds, 401(k) plans, IRAs, and home equity. The viability of the retirement income mechanisms depends on the assumptions made about returns on assets and liabilities – like health and longevity. The US savings gap – $7.7 trillion in 2013 – is a train wreck ready to happen.

Similarly, the gap between pension funds and promised retirement benefits to current and former employees by US state and local government is either a piece of cake to handle or a painful horse pill. This depends on the assumptions about future rates of return, where the looming bill can be anywhere from $1 trillion or $3 plus trillion. For some state and city governments (Dallas, Illinois, New Jersey), the gap is so large they will have to make politically-difficult choices about benefits or taxes.

To ordinary households in the US, the retirement crisis is described by the following:

1. Most people will have little more than Social Security, will have inadequate balances for retirement savings, and will be relatively worse off than their parents and grandparents.The consequences will split us apart, impoverish families, and weaken the economy. Retired baby boomers make up more than 20% of the population and have anemic buying power.

2. Our current voluntary, do it yourself, individual commercial accounts​​ do NOT work for most people, though the well-off are mostly secure having generous wealth to rely on.

Tony James and I have worked hard using wisdom from experts and our own scholarship and practical experience. We have thought through the policy reform principles for practical and efficient recuse of retirement in the United States. We start with the goal of providing everyone with security in old age.

• We want a strong Social Security, Medicare and Medicaid system as no pension supplement is effective without a strong base of funding.
• We don't want to worsen anyone's current arrangements – 401(k) and IRA arrangements work for some – but we do need a good competitor. We need a public option and more fair tax subsidies.
• A streamlined and efficient funded supplement to Social Security the GRA helps everyone accumulate assets, invest them well, and decumulate in the form of a life-long stream of income.

A relevant analogy to the affordability of old age income is how a family assesses its mortgage debt. If you owe $100,000 on your house, that is a lot if you assume your productivity is in permanent decline. Or, this may be fine if you are thriving economically – perhaps earning $200,000 per year in a secure job.

The nation may not have a liability problem, but a revenue problem. I am not calling it, nor am I making a vapid generalization. I am putting the notion of having too many pension obligations in the context of what we want and our capacity to pay.

This is a repost from Forbes. 

Show your kid, your client, yourself this little diagram, and sing the “Saving Song” of the righteous:

“Start saving now, my sweet, a 5% saving rate in your 20s is the same as 22% in your 50s.” 

Why doesn’t advice to save consistently work? Why do most people have no or inadequate retirement accounts (with an average balance of $15,000)? One explanation for low savings is flawed humans:  obsessive consumption and hyperbolic discounting. Sure, from the moment we wake up in the morning until we go to bed at night, we’re part of a machine designed to separate us from our money, including our poor, dopamine-loving brains addicted to the rush of spending and unrewarded for deferred gratification.  Why the surge of dopamine when we spend?

Neuroscientists and anthropologists explain spending is fundamental to human activity – we strut, primp, and display to keep or elevate our social position. Author Wednesday Martin made enemies of her former neighbors in New York’s Upper East Side when she compared the consumption habits of neighbors to bonobos – a type of monkey. Academic Thorstein Veblen in the 1930s described conspicuous consumption – the white suit wasn’t just comfortable it signaled you are privileged – you didn’t have to come near dirt. Karl Marx described the fetishism of commodities. Economists Juliet Schor and Robert Frank focused on the harm of overspending.

Spending and its enabler, credit, are deeply ingrained in American life and commerce, and the focus on faulty human behavior is prominent. Advice on how to trim your budget and slash spending is everywhere. It’s click bait. “Ten Things You Could Do Now to Slash Your Monthly Savings.” There’s so much, in fact, that after clicking on all the advice, you could easily believe it’s your fault you don’t have a pension.

None of that science is false, but overconsumption doesn’t answer why Americans lack retirement savings. Pleasure from spending is real, but our government and financial institutions have shifted. They are better at loaning us money and overcharging for investing than rewarding us for saving. Social Security is eroding not because people are living longer, but because of lack of political will to raise the FICA tax.

Here is the truth. In our society, you are on your own.  It’s your responsibility to save. But it’s not your fault if you don’t have a decent pension. While the math does work -- if you save 5% of your income starting in your 20’s, when you are 60, you will have the same amount saved had you started saving 22% of your income at 50 years of age. So my advice is twofold: save as soon as you start working and don’t spend more than you earn (an unsolicited third - eat less, mostly plants.)

But just as our car-dependent society and the availability of cheap, sugary and fatty foods contribute to the obesity crisis, so the financial environment contributes to the retirement security crisis. It isn’t our human flaws that cause us to have less retirement savings than we need. Rather, the fault lies with the flawed, ‘do-it-yourself,’ voluntary 401(k) and IRA system combined with student and credit card debt. Also, toss in low wages -- higher income folks have more discretionary income than the middle class, spending 30% on housing and 11% on food and lower-income workers a full 41% on housing and 16% on food. Where does the low-income worker cut?  Cutting 10% of 16% by bypassing on avocado toast or latte won’t produce a pension.

Bottom line: Although without fixing Social Security AND creating pensions for all you are on your own and though it won’t matter, you must avoid the overspending. But, hear me, hyper-consumerism is not the cause of inadequate retirement savings – it’s the failed retirement system.