Barry’s Pickings Online: No More Happy Talk

Art by JCiardielloSome talk about there being a retirement savings “crisis.” I think that may be a little hyperbolic. But saving for retirement has gotten a lot tougher over the last15 years. And, with a huge hole where the federal budget used to be, our policy options have gotten a lot more limited.

Here’s my take—beginning with the three basic facts I think are critical to our understanding of the current situation.

Fact #1 – long-run decreases in returns have significantly driven up the cost of saving for retirement 

The returns to savings are going down. And because of that, it costs more to save for retirement. A lot more—like 25% to 50% more than it used to. The effect is easiest to see in defined benefit plans, where decreases in interest rates have, since 2000, doubled/tripled the cost of providing $1 of benefits.

The long-term decline in interest rates—largely driven (I believe) by the aging of first world populations—has been followed by a (more or less permanent) decline in returns generally. This long-term decline in returns means that $1 saved today produces a significantly smaller account balance at 65, and buys a smaller annuity, than it did, say, 15 years ago.

Bottom line: It used to be that saving 6% to 8% a year over a career would produce an adequate retirement income. Now you need save at least 10% to 12%.

Fact #2 – employees will have to pay for any additional retirement saving

Pretending that “the employer will pay for increased retirement saving” is naïve. In any reasonably efficient market—that is, as long as you’re not dealing with a public utility or the government—increased retirement benefits can’t be paid for by the employer, because the employer’s cost of capital and the price of its goods are both determined by the market.

You could “make the rich pay,” but there’s kind of a long line of “virtuous policies” we’re already going to make the rich pay for—like education and infrastructure and medical care. Sooner or later you are going to run out of other people’s money. And Republicans are going to fight you every step of the way on this.

Fact #3 – workers don’t have any “additional” money to save 

According to Pew, the real wages of American workers haven’t increased in 40 years. So any increased retirement savings is coming out of a fixed pie: inducing workers to save more for retirement is going to result in them spending less money on other things. We don’t know what those other things are. How can we possibly know that it is better for them to save more for retirement than to spend money on those other things?

We have to face the fact that retirement savings and policies to encourage it exist in a world of tradeoffs—if you have more retirement savings you are going to have less of something else. Crudely: for most workers, increased retirement savings equals a cut in their current standard of living.

These brute facts limit our retirement savings options. And require us all to think more creatively.

Getting more workers in plans and increasing the savings rate 

There are two “increasing savings” challenges that should be addressed. First, and most urgently, we have to get workers who are not saving for retirement “in the system.” And, second, we may (in some cases, at least) have to increase their savings rate.

One policy lever that is relatively easy to pull is: getting workers to begin saving early in their careers. Getting workers to save when they are in their 20s reduces the amount they have to save later (when they are also saving and paying for, e.g., children, a house, and their children’s education).

This is one area in which “nudge” works. Indeed, it may be the only area in which it works. I think most of us accept as a fact of human nature that people should save for old age but often don’t. So—more or less and imperfectly—the best way to encourage retirement savings is to default people into it, always leaving them an opportunity to opt out if they believe they have a better use for those savings—like, say, piano lessons for their children.

Connecting these dots, it seems to me the case for a federal “auto-something” (e.g., auto-IRA) to get un-covered workers into the system is pretty compelling. As is the use of auto-escalation provisions to increase savings rates.

Just as important (if not more)—we have to find ways to reduce the cost of retirement. In the current context—stagnant wages and lower returns—that is the only “free money” available.

I see four areas as promising:

Re-thinking adequacy. We need to stop talking about replacement income and re-think adequacy from the ground up. What do spending patterns in retirement look like? What sorts of retirement spending actually work—as in, make people happy and contribute to their well-being? How much is “enough?”

Reducing the cost of investment. The Department of Labor (DOL) has been in a years’ long battle with the mutual fund and brokerage industry over the cost of investment. Litigators have been waging their own battle, targeting revenue sharing and, more recently, index funds. In my lifetime we have made enormous strides in reducing the cost and increasing the efficiency of investment. And yet these markets remain “uncompetitive” in many respects.

The basic “market problem” presented by the typical 401(k) plan—the employer is buying services that the participant is paying for—seems incorrigible. There may not be a market solution here—large plans seem to be able to “get a better deal” even when they aren’t fully exploiting their market power. (The latter—the failure to fully exploit a large plan’s market power—is what the 401(k) fee lawsuits are all about.) At this point I see no market solution to this problem—if you let the individual do the shopping, she will generally get a “worse” deal.

Reducing the cost of administration. There are several efforts, both in the private-sector and through public policy, to reduce the administrative and fiduciary burden of maintaining a workplace retirement plan: everything from Australian-style USA Retirement Funds proposals to state-run plans to open multiple employer plans (MEPs) to outsourced chief investment officer (OCIO). Work in this area can, I believe, be productive.

Reducing the cost of aging. At a more strategic level, getting control of the “natural” cost of aging—medical costs and the cost of long-term care—can also reduce the cost of retirement. According to the Employee Benefit Research Institute (EBRI), “taking into account the costs arising from nursing home and home health care expenses, the percentage in the second-income quartile … projected to run short [of money by the 20th year in retirement] more than doubles.” For those in the third-income quartile it quadruples. Addressing long-term care risk and (please, somebody) getting control of health care costs will directly reduce the cost of getting old.

Support for working past retirement age. Finally, giving workers the option to work past 65 gives them a viable Plan B, if they prefer to spend their money on something besides more saving for retirement. In this regard, the best policies are those that support a dynamic employment market. Gigging for Uber may mean the difference between a dignified versus an impoverished old age—and may also provide a human connection that many older persons value.

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Most of our retirement policy tools—and all of our thinking—were built for a different time—say, 1999, when the yield on 10-year treasuries ended the year at around 6.45%. It’s now less than 2%. We have to re-think the retirement savings project. Face up to some basic realities. And adapt. We’re humans. We’re good at that.

Michael Barry is president of the Plan Advisory Services Group, a consulting group that helps financial services­ corporations with the regulatory issues facing their plan sponsor clients. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.