By: Eric R. Elmore
While Congress waivers on whether to reduce retirement savings deductions, all pillars of our retirement system appear to be under stress. A recent Government Accountability Office (GAO) Report highlights the challenges faced by each component of the U.S. "retirement system" and argues the case for a fundamental re-evaluation to better promote future retirement security. And, though the Republican-led Congress rarely follows the GAO’s lead, if you have a 401(k), you should be paying attention to what it is saying.
The GAO says fundamental changes have occurred over the past 40 years to the nation's retirement system, which comprises three main pillars: Social Security, employer-sponsored pensions or retirement savings plans, and individual savings. These changes have made it increasingly difficult for individuals to plan for and effectively manage retirement.
- The GAO found that 34% of households age 65 or over received 90% or more of their income from Social Security. As structured, Social Security replaces about 40% of an average wage earner's income after retiring, and most financial advisors say retirees will need 70% or more of pre-retirement earnings to live comfortably. But, cutbacks may be needed in the Social Security program as this program is projected to not pay full benefits beginning in 2035. If you’re 50-years old and reading this, you care a lot about that prediction!
- Employers have shifted from offering traditional defined benefit (DB) pension plans to offering defined contribution (DC) plans, such as 401(k)s, as the primary retirement plan. In 1975, there were about 103,300 DB plans, compared with about 207,700 DC plans. By 2015, the number of DB plans had decreased to about 45,600, while the number of DC plans had increased to more than 648,300. This shift to DC plans has increased the risks and responsibilities for individuals in planning and managing their retirement. And many individuals are not saving enough in these plans to provide an adequate retirement. What's more, the insurer of most DB plans, the Pension Benefit Guaranty Corporation (PBGC), faced an accumulated deficit of more than $79 billion at the end of fiscal year 2016.
- Outside of employer-sponsored plans, individuals' retirement savings are often low or nonexistent. The personal saving rate in the U.S. trended steeply downward between 13.9% in 1975 to 2.2% in 2005. The rate has recovered somewhat, to 5.3% in 2017, but is far from its pre-1975 level. The GAO Report points out that if individuals do not save enough to provide for a secure retirement, they may need to rely more heavily on safety net programs for various types of services, with fiscal implications for all levels of government.
In addition, economic and societal trends may make it difficult for working-age individuals to contribute to DC plans and retirement savings accounts and plan effectively for retirement.
First, average real wages remain near the levels they were in the 1970s for most individuals, adding to the difficulty of increasing their level of saving. While mean household-income has increased for the top 20% of households (and for the top 5%, in particular), it has stayed relatively constant for the bottom 80% of households. If wages continue to stagnate for most workers, the GAO Report says future generations of retirees will continue to find it challenging to provide for a secure retirement.
Second, the median real value of debt has grown substantially. For example, from 1989 to 2016, the median real value of debt grew 67% (in constant 2016 dollars) for households headed by someone age 35 through 44, and by 104% for households headed by someone age 45 through 54. Also, analysts at the Federal Reserve said the make-up of debt has changed over time, with declining home ownership debt and rising education debt, which increased substantially between 2013 and 2016. The increase in debt loads could impede a household's ability to save for retirement during an important stage of the prime working years.
Third, paying for rising health care costs during one's working years can make it more difficult to allocate income to save for retirement. In addition, rising health care costs can increase the overall amount individuals may need to save to ensure they have an adequate income once they retire. The GAO says many retirees spend large shares of their income on health-related expenses, including out-of-pocket costs and premiums, and that out-of-pocket spending generally rises as people age. For example, on a per person basis, in 2012, out-of-pocket health care spending was nearly 3.5 times higher for individuals age 65 or older compared to those ages 19 to 64.
The GAO Report says the rising cost of health care later in life could be daunting for younger generations given increases in average life expectancy and health care needs in a person's final years, making retirement planning even more important. As greater responsibility is shifting to individuals for assuring their own retirement security, some societal trends -such as increases in life expectancy and changes in household composition-have the potential to increase economic vulnerability for retirees.
So, given their concerns, what does the GAO recommend? The GAO Report calls for Congress to consider establishing an independent commission to comprehensively examine the U.S. retirement system and make recommendations to clarify key policy goals for the system and improve how the nation can promote more stable retirement security.
In particular, the GAO calls for action to address these policy goals:
- (1) Promoting universal access to a retirement savings vehicle, as about one-third of U.S. workers do not have access to an employer-sponsored retirement plan.
- (2) Ensuring retirement income adequacy, as many Americans are at risk of relying solely on Social Security in retirement.
- (3) Improving options for the spend-down of savings in retirement, as retirement plans may not provide sufficient tools to aid retirees in achieving this goal.
- (4) Reducing complexity and risk in retirement plans for both participants and employers, as decisions related to managing retirement savings and plan sponsorship have reached a level of complexity that participants and plan sponsors, respectively, find difficult to navigate.
- (5) Stabilizing fiscal exposure to the federal government, because as the number of retirees increases, so does the financial stress on government programs serving the aging population.
Tax Warrior Perspective
Would Uncle Sam ever consider a “matching” contribution to your retirement account? Current retirement saving credits are for very low income. Providing a match may be better than a credit since the Treasury wouldn’t have to pay it until you’re retired, though they’d must figure out a way to eventually fund those obligations.
Or they might reduce your student debt 50 cents on the dollar for IRA/401(k) contributions. Again, it promotes saving for those who are less likely to save, and it may help the student debt crisis. Just some ideas to consider.
No one knows what a new tax law would look like. Though the President and Congress agree on some ideas, there is still much debate between them. As always, The Tax Warriors® will follow developments, offer our take on progress and be ready to plan for our clients as changes develop over the next few months.