By Investing Across Borders, Special for USA Today
Three past presidents have tried in vain to fix America’s woefully underfunded retirement system.
Presidents Bill Clinton, George W. Bush and Barack Obama tried to push retirement plans through Congress. All of them failed, most recently President Obama’s plan, which was to be called the Retirement Enhancement and Savings Act, died in Congress when President Trump took office.
Trump currently has no plan to fix America’s retirement system. Messages to his office from USA Today were not returned. Trump plans to overhaul America’s tax system, but the 401(k) was not changed as part of any recent House Republican bill on taxes.
Why do we need change?
The current retirement system in America hinges on the 401(k) plan, which replaced pensions as the go-to source of retirement income. But over the past 35 years that effort has been failing because participants are not contributing enough, asking for withdrawals and not repaying 401(k) loans. More participants are instead treating their 401(k) as a checking account and making very little effort to learn how to manage their investments. The chart below outlines how less than half of Americans now participate in retirement plans And those that do have an average of $14,500 in their retirement accounts, when they will need between 20 and 30 times that amount.
“What we really need is a national plan to address leakages, to reach the half of Americans who are uncovered workers and to address high fees and drawdowns,” says Anthony Webb, economic policy research director at The New School. In a nutshell, there are three ways to fix America’s retirement system:
- Tweak the current 401(k), IRA and other retirement accounts.
- Replace the 401(k) system with something new.
- Look at the broad picture and try to fix America’s retirement system.
Tweak the current system
There are people who are happy with their 401(k) and see no reason to change. But for the nearly 50% of Americans who don’t have a retirement plan, solutions are needed. Too many are resorting to fund drawdowns and getting hit with early-withdrawal penalties. More ideas are needed to broaden access to 401(k) accounts. And we need to end confusion about how Americans should invest their retirement funds.
One suggestion is to eliminate the 10% IRS penalty on withdrawals from a 401(k) or IRA. There was a time when that penalty was needed to discourage people from withdrawing funds from their retirement accounts. However, that 10% penalty hits mostly the middle class, those who have enough cash to open a 401(k) but not enough money to leave it in the account. Most people resorting to a withdrawal have either lost their job or need the cash for emergencies.
We could also expand ways to encourage companies to contribute a matching amount to employees’ retirement accounts, or expand small business retirement plans and individual retirement plans to cover more companies and more people. Or we could expand the private sector’s participation in managing 401(k) accounts, rather than leaving it up to the individual.
Replace the 401(k)
There have been several attempts at replacing the 401(k). The latest to gain traction in the media and in Washington is a plan devised by Theresa Ghilarducci, a professor of economics at The New School, and Hamilton James, president at Blackstone.
Their idea is to create a new Guaranteed Retirement Account for everyone who has a job. It would be mandatory, managed by a government-appointed board, and everyone would contribute 1.5% of their salary and another 1.5% would be contributed by their employer. The funds would be invested in stocks and bonds until they retired, and then would pay out an annuitized stream of income until death or until his or her beneficiary dies.
However, it could run into legislative and public opposition. First, people are reluctant to a take a mandatory amount from their paycheck, even if it’s just 1.5%. Second, people tend not to trust the government to manage their money, let alone private financial companies.
“Many people distrust a big government program. But this isn't one,” says Ghilarducci. “We have found in focus groups and surveys that people like the simplicity of the plans. It is a personal savings plan that relies on individually-owned accounts and not a government.”
If the plan ever makes it to the legislature, there is likely to be a jockeying for control of the investments and the structure of the annuities between the private financial sector that would manage the investments and the insurance industry, which would argue it should manage the annuities.
Look at the broad picture to come up with something new
U.S. Sen. Bernie Sanders, I-Vermont, made headlines last year with his proposal to simply expand Social Security. People are living in fear that their Social Security is going to be eliminated, when in reality we should be doing to opposite, he argues.
“Our job must be to expand it so that every American can retire with dignity and respect,” Sanders says, proposing to lift the cap on Social Security taxes “so that everyone who makes over $250,000 a year pays the same percentage of their income into Social Security as the middle class and working families.”
The proposal has some merit, but it doesn’t change the fact that Social Security funds are invested in government bonds, which over time have drastically underperformed the market. For Social Security to stop drawing from younger classes to pay for Social Security for older workers, it needs to have better returns.
One suggestion would be to carve out any new Social Security funds that are approved into a separately managed account which would have a government-appointed board, but the funds would be invested in the market. The California Public Employees’ Retirement System — the country’s largest pension system -- has a similar model, and it has managed to return 7% annually over the past 20 years, in spite of some hiccups along the way.
A final suggestion is to resurrect pensions as a retirement tool but, to do so, the U.S. would likely have to pass tax legislation that would encourage employers to resurrect pensions, and it might even require messing with the Employee Retirement Income Security Act of 1974.
Whatever the solution is to America’s retirement system, know that a deep, structural change is needed, whether that means fixing the current 401(k) system, replacing 401(k)s, or creating something new. Now is the time to get a viable retirement plan in front of President Trump and Congress, before they create a system that is not right for America.