The very question of whether the nation faces a retirement crisis was repeatedly called into question during the Senate Finance Committee hearing on retirement reform earlier this month.
To one of the most notable figures in the mutual fund industry who testified, there is no doubt of that crisis and that the primary culprit is Wall Street.
But another expert, an academic, categorically dismissed the idea that any such crisis exists at all.
The value of tax breaks — the primary way current policy attempts to incentivize savings — was called into question during the hearing. And there was much support for many aspects of Sen. Orin Hatch’s SAFE Act, particularly the idea of opening multiple employer plans for more small employers.
The chairman of the committee, Sen. Ron Wyden, D-Ore., opened the hearing by noting that “something is out of whack” between the $140 billion in annual tax subsidies for retirement savings and the number of people who lack much retirement savings.
The committee, he said, would “take a good look at fixing this issue” as it considers tax reform ideas.
“It’s pretty clear this committee is going to have some tough choices to make,” Wyden said.
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The ideas it heard included finding ways to encourage more smaller employers to sponsor 401(k)s, establishing immediate financial incentives for workers who start saving, automatic enrollment in low-cost index funds and raising contribution levels.
Exactly how the committee might respond and when it might act are unknown. With midterm elections in November and a new war in the Middle East, the best guesses are next year at the earliest. But what follows is a summary of the testimony of the five individuals who offered their views on the system today and what they believe can or should be done to address what at least some believe is a very real problem.
John Bogle, founder of the Vanguard Group
The well-known Vanguard founder and former CEO joined the mutual fund industry in 1951, when it was a “mom-and-pop” industry, as he described it his testimony, overseeing about $4 billion.
These days that figure is closer to $15 trillion. Bogle, striking a more-than-familiar note, told the lawmakers he believes the “mutual fund industry has lost its way” over the years.
The root of the problem, he said, stems from a 9th Circuit Court of Appeals decision in 1958 that allowed fund management companies to go public. Bogle said that led to a spate of fund company acquisitions that brought us to today’s investment culture, where 40 of the 50 largest fund management companies are publicly held.
That means they must answer to Wall Street’s expectations. The push to fatten returns over the decades has meant enormous losses to individuals and their retirement savings as fund companies have aggressively marketed actively managed funds and the high fees associated with them, he said.
Bogle presented his own data that suggested an investor who spent 40 years directing income into a tax-deferred retirement plan would have earned $561,000 in an actively managed fund compared to $927,000 if he had relied on a cheaper index funds.
That disparity, in Bogle’s mind, creates the “absolutely essential need to reduce the costs of investing for investors in both corporate defined contribution plans and IRAs.”
Bogle didn’t limit his criticism to managed funds alone.
He also testified that the rules for IRAs — which account for the largest portion of DC assets at $6.5 trillion — create some of the biggest problems for the country’s retirement prospects.
Limited contribution rates and lax penalties for early withdrawals and hardship loans discourage appropriate savings rates, he said.
“I expect you’ll hear from some experts who will argue that ‘all is well’ for our retirement system,” Bogle told the committee.
But such reports aren’t to be trusted, he said. The answer to the question of whether the country is adequately prepared for retirement is an “unequivocal no,” he said. Brian Reid, chief economist, Investment Company Institute
Representing an altogether different viewpoint, Reid noted that Americans have more saved for retirement today than ever.
“Since 1975, the amount of assets earmarked for retirement per household has increased seven-fold, after adjusting for inflation,” explained Reid. “The share of retirees receiving private-sector pension income has increased by more than 60 percent, and the median private-sector income retirees received after adjusting for inflation has increased by nearly 40 percent.”
Reid also applauded Congress’s role in establishing tax incentives to increase savings rates. While the majority of his testimony amounted to a defense of the system, he did say there is room for improvement.
The ICI, he said, supports legislative efforts to promote retirement savings, put Social Security on a sound financial footing, foster innovation in the voluntary retirement savings system, and help smaller employers by granting more access to multiple employer plans.
“What is central to these ideas is that they build upon — and do not undermine or replace — our current retirement system,” said Reid.
Scott Betts, senior VP, National Benefits Services
Representing third-party administrators, Betts said the best way to improve today’s retirement system is to do more of the same.
“If increasing retirement and financial security is the goal, increasing the availability of workplace savings is the way to get there,” he said.
To make his case, Betts presented data on participation rates in 401(k) plans compared to participation rates in IRAs by those without access to employer-sponsored plans.
“The primary factor in determining whether or not a middle-income worker is saving for retirement is whether or not they have a retirement plan at work,” he said.
Citing data from the non-partisan Employee Benefit Research Institute, he testified that 70 percent of workers earning between $30,000 and $50,000 participated in employer-sponsored plans – when they’re made available.
But less than 5 percent of middle-income earners contribute to an IRA when they don’t have access to a plan at work.
“Because of the effectiveness of these workplace savings opportunities, it is imperative that no harm is done to the current structure of the tax incentives that have motivated employers to voluntarily sponsor and contribute, along with the employees themselves, to these retirement plans,” he argued.
Betts’ suggestions for improvement were in line with the proposals laid out in ranking member Hatch’s SAFE Retirement Act.
Namely, Betts lent his support for Starter 401(k) Plans, flexibility in when employers can claim tax benefits relative to initiating a new plan, simplifying plan communication and documentation, and allowing non-affiliated small employers to form open multiple employer plans. Brigitte Madrian, Aetna professor of public policy and corporate management, Harvard’s Kennedy School
Understanding what incentivizes workers to contribute and save for retirement is essential to any effort to reform retirement policy. But existing incentives have a limited influence on workers’ savings rates, at best.
That was the central message from Madrian, a behavioral economist who noted that “the tax code is particularly ill-suited to generating financial incentives to save.”
The reason? It’s too complicated, she told the lawmakers.
To underscore her point, she said research she is now conducting shows that most investors don’t understand the different tax rules of Roth and traditional IRAs.
Also, the savers credit meant to incentivize lower-income workers is unlikely to be understood without the help of a tax professional — which lower-income workers can’t be expected to afford, she said.
“Individuals are more responsive to immediate than to delayed financial incentives,” Madrian continued. “But many of the financial incentives to save that operate through the tax code are delayed.”
She testified that an immediate financial incentive — like a cash reward upon enrollment — is not allowed under current law, suggesting to the lawmakers that such an approach could be helpful.
While tax incentives have proven to have a nominal effect on savings rates in her research, one policy, she said, has clearly expanded participation: automatic enrollment.
“Expanding the reach of automatic enrollment is the most promising policy step we can take to increase the fraction of Americans who are saving for retirement,” said Mandrian.
She also offered her support for auto-IRA proposals, and rules that would make it much more difficult to prematurely cash out assets.
“If you want individuals to save, make it easy. If you want employers to help their workers save, make it easy. And if you want individuals to spend less, make it hard,” she said. Andrew G. Briggs, Ph.D., resident scholar, American Enterprise Institute
Briggs told the lawmakers that, despite the preponderance of media accounts, “Americans do not face a retirement crisis.”
Rather, he said, modeling from the Social Security Administration presents a much more optimistic picture.
Low rates of poverty among retirees — rates that are lower than for younger demographics — and income “replacement rates” both indicate that claims of a retirement crisis are overstated.
Using Social Security modeling, Briggs said the replacement rate — the amount of income in retirement relative to the average household earnings during working years — for baby boomers retiring today is 116 percent. Which is to say, baby boomers retirement income is greater than their average lifetime income.
A RAND study found 71 percent of Americans aged 66 to 69 are adequately prepared for retirement, said Briggs.
And other research suggests only a quarter of households overall are inadequately saving, he said.
Still, perhaps some changes are in order, he acknowledged.
“Just because we don’t face a retirement crisis does not mean that every retiree will be financially secure,” Briggs said. “Nevertheless, the solutions to a smaller, more targeted problem are different than when the retirement system seems to be failing for the vast majority of people.”
He said advancing automatic enrollment would be the most efficient way to improve upon what he sees as a healthy system.
He also voiced his support for more low-cost index funds, which “could be of great benefit to savers.”
Proposals to expand Social Security raise “problems that are almost too obvious to mention,” Briggs said.
“Social Security is already underfunded by more than $10 trillion over the next 75 years,” he asserted.
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