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Alicia Munnell: 3 Workable Ways to Save U.S. Retirement System

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Addressing attendees at Sage Advisory’s Perspectives on the Future 2015 conference in Austin in Monday, Alicia Munnell, director of the Center for Retirement Research at Boston College, described three ways to improve retirement outcomes for Americans: working longer, saving more through changes to Social Security and employer plans, and considering investors’ homes as part of their retirement assets.

“We don’t need to rip down what we have and try to build something new because that’s not how change happens in the United States,” she said.

Working Longer

Americans are healthier and living longer than they have been in the past, so it isn’t a stretch to consider longer careers as part of the solution to then retirement crisis. Munnell said that to maintain the same ratio of working years to retirement years today as in 1940, the retirement age should be 70. Coincidentally, she said, that’s already the age at which retirees can claim their highest level of benefits.

Between 60% and 70% of Americans could probably work longer than they do, she said, and those workers would stand to gain a Social Security benefit that’s as much as 76% higher than if they retired at 62.

Fixing Social Security

Munnell called Social Security “terrific money. That is inflation-indexed money. It lasts as long as you live. It’s such a good base to build a totally secure retirement.”

She said that while Social Security is in need of reform, it doesn’t need to be completely overhauled. As it stands now, the Social Security trust fund will be exhausted in 2034, at which point benefits will be cut 25%. The average person’s replacement rate will fall to 30%, she said.

One of those reforms is to address the legacy debt, she said: then first generation of retirees who received benefits without paying into the system.

“If you were setting up a system today to provide people with a $15,000 benefit, the average benefit retirees receive today, you would not need such a high tax rate,” Munnell told ThinkAdvisor in an interview Monday. “The reason the tax rate for Social Security is so high is that it also incorporates the payments necessary for interest on the debt. It seems like all the people who receive those benefits are dead, but it has to be paid off. You can’t just wish it away.”

Social Security actuaries estimated that in 2013, the closed-group unfunded obligation, or the obligation for current participants only, amounted to $23.7 trillion, according to a blog post Munnell wrote in early 2014. Munnell suggested that to resolve the legacy debt issue, the Treasury could put that money in the Social Security trust fund. “It would produce some income, which would allow tax to go down,” she said. But the Treasury needs to take that money from somewhere, which Munnell said “would require an increase in the income tax rates. That seems like a fairer allocation of the tax burden than putting it on the payroll tax, which has no deductions, no exceptions and a cap, and is burdensome for workers.”

The average income tax rate would increase from about 19% to about 23.6% of personal income, according to the 2014 estimates.

It’s important to make some kind of change, Munnell said, because the current system that taxes workers “makes the system, which is very important, look very expensive, when it really is a very modest benefit that people are getting.”

Workplace Plans

Employer-sponsored plans also need to be addressed. Munnell said in her session during the conference that 401(k)s were intended to be supplemental to defined benefit plans.

According to EBRI, as of July 2014, less than half of employees work for an employer that offers a defined contribution plan, and of those, just 39% participate. Furthermore, only half of sponsors use automatic enrollment and of those, only one-third have automatic increases in contributions, according to Munnell. She proposed requiring sponsors by law to use automatic enrollment and escalation in their plans.

“That shouldn’t be that big a deal,” she said. “If employers want to provide these plans, they should really want their employees to end up with some money. It’s in the interest of employers to have people prepared to retire.”

Real Estate

Clients’ homes should also be considered a retirement asset, Munnell said, either by downsizing – actually downsizing by moving to a cheaper home, not just a smaller one – or by using a reverse mortgage.

Downsizing forces clients to leave a home they may have spent many years in, but they do get some cash, Munnell said. A reverse mortgage will require up-front fees to be paid, but clients can continue living in their homes.

Fear of Going Broke

Munnell told ThinkAdvisor that her initial concerns over 401(k) plans were that “when people got to retirement and they had their $100,000 they would go on a cruise around the world and use up their $100,000. That’s not what I’m worried about any longer.  What I’m worried about is that people are not going to spend their money,” she said.

Munnell gave three reasons for that.

First, she said is the “endowment effect.” People value what belongs to them more than it may be worth, she said. “These piles that we’ve all built up over time are valuable, and you don’t want to mess with them.”

Bequests are another reason people hold onto money they could be safely spending, she said. “People may say they are not interested in leaving a bequest, it they really do want” to, she said. “It gives you some sense of immortality to pass on something.” Finally, and probably unsurprisingly, is fear, particularly that at the end of your life you won’t be able to maintain your independence, she said.

Munnell suggested advanced life deferred annuities as one way for advisors to help clients manage anxiety over spending down their retirement assets, “something that you put money into at 65, let’s say – 15% of your money and promised you a benefit at 85. They’re not perfect,” she acknowledged, “because the benefits are nominal and prices do go up, but if people knew they were going to have some security at 85, they’d feel freer to spend their money during this period.”

For example, she said, pension beneficiaries don’t worry about spending the money they receive from their defined benefit plan every month. “That doesn’t seem like you’re digging inappropriately into accumulated assets.”

An annuity provides that regular payment, she said, and provides security for clients.

A ‘Workable System’

“We have a very workable system that we have handled very irresponsibly,” Munnell said. “We should put in the money that is required to fund the benefits that are promised. There’s no free lunch, but especially if you don the transfer that’s legacy cost, it’s not that bad. In fact, most of the cost goes away.”

Even so, Munnell said “it’s hard enough [to get] Congress fixing the system without doing something that demanding, that it’s workable tax increases. In the wake of the financial crisis, the administration lowered employees’ payroll tax by two percentage points and nobody noticed. Then they went along and increased it by two percentage points and nobody noticed. It seems like if we did that, two percentage points on both the employee and the employer, it’d be way beyond 75 years. You’d be in great shape. It seems like these are really feasible tax increase.”

Munnell was skeptical that any such change is forthcoming, though, because there’s no political incentive for lawmakers to do so.

“Congressmen are re-elected every two years,” she lamented, “and they get no reward for causing pain immediately for a problem that’s so far down the road.”

Update: A quote has been updated to fix a transcription error.

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