American workers today are living longer, which is certainly great news. But that longevity is adding to an already major income gap between what most retirees will need and what they are able to save.
Bridging that income gap is at the heart of a new book published last month from the Center for Retirement Research at Boston College, “Falling Short: The Coming Retirement Crisis and What to Do About It.” Co-authored by Charles D. Ellis, Alicia H. Munnell and Andrew D. Eschtruth, the book examines a number of solutions for the looming retirement crisis.
Using both hard data and anecdotal evidence about retirement preparedness in this country today, the authors note that workers can expect less from traditional income sources in the future. That puts the burden on individuals to save more now and tap home equity later; on the government to shore up Social Security; and on employers to offer fully automated 401(k) retirement plans.
Retirement Wire spoke with author Andrew Eschtruth about the center’s findings, and on what the three see as conceptually simple and eminently feasible solutions to the retirement savings problem.
Retirement Wire: What was the motivation for writing this book?
Eschtruth: The motivation actually existed before we got the idea to put it in a book. This really captures a lot of the research and findings and insights that we’ve been generating here in our center over the past 10 years. In some ways it’s been many years in preparation.
The spark that got us to write the book was that one of coauthors, Charlie Ellis, approached our center director, Alicia Munnell, a couple of years ago and asked, ‘would you like to collaborate on a book on the retirement crisis.’ We said, ‘sure, that’s our game.’
We’ve been studying retirement security at the center for many years – we were started in 1998 – so for the past 16 years we’ve been studying issues related to the income security of the retired population. There are a number of trends that concern us, and those come out in this book, as well as some solutions that we think would make a big difference.
Retirement Wire: What are some of the key retirement trends that you identified?
Eschtruth: The retirement landscape has been shifting over the past decades in a very dramatic way. That is systematically shifting more risk and responsibility away from institutions like government and employers and on to individuals for managing their own retirements. Some of these involve broad demographic and economic shifts.
We like to characterize them in two ways: (1) people will need more retirement income in the future than today’s workers; but (2) they are expected to draw less support relative to their earnings from traditional sources of income like Social Security and employer pension plans.
Retirement Wire: Is it due to longer life expectancy that they will need more earnings?
Eschtruth: The reason that the need for retirement income is increasing is partly due to longer life expectancy, partly due to rising healthcare costs, and partly due to today’s low interest rates — which are expected to continue for a bit.
Low interest rates require you to have a larger nest egg in order to generate the same income at retirement. That’s why the interest rate is relevant.
In terms of the changes in the sources of retirement income, changes in Social Security under current law is expected to provide a smaller share of a worker’s retirement earnings than it has for current and past generation of retirees.
There are a few different reasons for that. The first one is that the programs – what’s called the full benefits retirement age has been in the process of increasing from age 65 to age 67. We’re in the middle of that transition right now. But when you raise the full benefits retirement age it is equivalent to an across-the-board benefits cut, no matter what age people claim it at. It has the effect of reducing the amount of Social Security benefits relative to what you earned while you were working.
People are looking to replace a certain share of what they earned while they were working, so they can maintain a similar lifestyle when they retire. That is the thinking behind the analysis.
Social Security is shrinking partly because of that across-the-board benefit cut and partly due to increases in Medicare premiums, which are typically deducted directly from your paycheck before you get your benefits. The size of the check you see is shrinking relative to your retirement earnings because of this increase in Medicare premiums Part B and Part D.
Another reason is that more people are subject to taxation from the income tax system on a portion of their benefits. When the law was started [in 1983] only a small percentage of people were above the income thresholds. But they are not adjusted for inflation or wage growth. So over time, due to real earnings growth and due to inflation, more and more retirees are retiring with incomes that exceed the thresholds.
Today roughly 35 percent of workers pay income tax on a portion of their Social Security benefits. That number is increasing gradually over time so that by 2030, with no changes in law, we’d expect more than half of the workforce would be subject to taxation on their benefits. That’s another way in which the ability of Social Security to replace your preretirement earnings is going down over time.
I have not even talked about the long-term financing imbalance in the Social Security program so there could be further changes in benefits depending on how policy makers address that.
The pension side is a quicker story. We had traditional defined benefit pensions. Those have mostly gone away in the private sector. In their place we have essentially the 401(k) plan, which could work just fine and has certain advantages over the defined benefit plan — specifically in terms of portability, when you move from employer to employer.
But in practice people have made decisions that every step along the way has undermined the ability of the 401(k) to provide substantial retirement income. Today’s 55 to 64-year-old with a 401(k) has only about $111,000 in combined 401(k) and IRA assets. That may sound like a lot to some people, because it usually exceeds their annual income. As a nest egg to supplement your Social Security over two or three decades it’s actually not very much at all.
Retirement Wire: Did you look at the impact of great recession and the bad economy of the last few years and what that did to people’s contributions to 401(k) plans?