The U.S. retirement system isn’t working for millions of American workers. They need more help in preparing for a secure retirement.
These two powerful statements were the underlying messages of President Obama’s executive action to implement "myRA" accounts, and Senator Tom Harkin’s (D-IA) proposal to establish USA Retirement Funds, both of which were announced last week. And there’s one more insightful conclusion: Behavioral finance concepts are making their way into the mainstream of retirement program design, but not soon enough to address the looming shortfall.
Most likely you’ve heard there’s a significant shortfall of retirement savings needed to fund a secure retirement for millions of American workers. Harkin claims this shortfall is $6.6 trillion and that 75 million working Americans don't have a retirement plan at work. While some people may argue about the magnitude of the problem, there’s no doubt that millions of Americans aren’t even remotely close to having retirement savings that will make any significant difference to their retirement.
The problem? Most people don’t get around to saving much money for retirement, for a variety of reasons. For many low-income earners, all of their income is devoted to current needs and there’s just no money left for saving for the future. And while many middle-income and affluent workers have room in their budgets to save, inertia and spending habits shaped by our consumer culture are getting in the way.
All workers who aren’t eligible to participate in a savings plan at work could set up a deductible or Roth IRA, but according to the White House, only one in ten Americans who are eligible actually contribute to an IRA each year. While some of these employees fall into the low-income group and simply don't have enough the extra money to set aside, many others should be able to save through an IRA, but don't.
President Obama's myRA accounts: a very small step in the right direction
President Obama’s myRA proposal attempts to entice people to begin saving for retirement by allowing any worker to make small contributions through payroll deductions. They can get started with an initial contribution of just $25 and subsequent contributions as low as $5. These amounts are far below the minimums required by many financial institutions to establish and maintain IRAs, so new savers can use a myRA to get started. MyRAs are available for single workers making up to $129,000 per year and couples making up to $191,000.
A myRA will introduce new savers to the power of payroll deduction. A substantial amount of behavioral finance research shows that people will save if the money is automatically deducted from their paycheck, making these amounts "out of reach" to spend on current needs.
Investment in a myRA account is limited to the same investment as in Fund G of the federal Thrift Savings Plan, which are U.S. treasury notes and bonds with maturities of four years or more. These notes and bonds are currently earning about 2.5 percent per year and are backed by the federal government. This addresses another behavioral challenge for new savers – it prevents them from losing money with their investments. When a new saver gets slammed by a stock market decline, they often become discouraged and give up on saving.
The myRA accounts will be established as Roth IRAs. When money in the myRA account reaches $15,000, it can be transferred to a regular Roth IRA with any financial institution that sponsors Roth IRAs.
Unfortunately, it's likely that myRA accounts won't make much of a dent in the impending retirement savings shortfall. That's because employers aren’t required to set up myRA accounts for their employees, and even when they’re offered, workers must voluntarily sign up for payroll deductions. Inertia will prevent employers and workers alike from utilizing these accounts, no matter how well intentioned they may be. But President Obama’s action draws attention to the retirement savings problem and hopefully sets the stage for more comprehensive and effective legislation in the future.
Senator Harkin's USA Retirement Funds: A bold proposal
On January 30, Senator Harkin proposed the Universal, Secure, and Adaptable (USA) Retirement Funds Act of 2014, which would create retirement savings funds that wouldn’t require sponsorship or action from employers, other than collecting and forwarding contributions through payroll deductions.
These funds would require legislation that needs to be adopted by Congress, so a natural cynical reaction is that the proposal won’t go anywhere in our current political climate. Nevertheless, Harkin’s proposal has received acclaim from many retirement policy experts and advocacy groups, including the Pension Rights Center, the American Academy of Actuaries and former Secretary of Labor Robert Reich.
Key features of the USA Retirement Funds are:
- Universal coverage. USA Retirement Funds would be available to everyone, including the more than 61 million people without access to a workplace retirement plan and the 14.5 million people who are self-employed.
- Automatic enrollment. Employees would be automatically enrolled at a rate of 6 percent per year, but they could choose to raise, lower, or stop their contributions.
- Secure lifetime income. Benefits would be paid monthly for life, and participants would be shielded from market volatility and other risks.
- Lower costs. Pooled professional management and risk sharing will reduce the cost of retirement by up to 50 percent.
- Portability. People would be able to take their benefit with them as they change employers.
- Simple for businesses. Small businesses can easily participate and wouldn't have to take on risk or administrative burden.
USA Retirement Funds address key hurdles that often block saving for retirement -- ease of adoption by employers, access to reasonably priced savings vehicles, and automatic enrollment at contribution levels sufficient to accumulate meaningful savings over a working career.
While millions of workers are eligible for retirement plans at work, they face another big challenge when they reach retirement age -- lack of help generating lifetime retirement income from savings. USA Retirement Funds address this major flaw by providing a lifetime retirement paycheck from savings.
If adopted by Congress, USA Retirement Funds could make a big difference in retirement security for millions of Americans. President Obama and Senator Harkin are to be congratulated for sending messages that saving for retirement is an important goal for our citizens, for raising the debate on these critical issues, and for suggesting solutions that could make a difference. Are we listening?