By Allison Schrager
Dec 17 (Reuters) - Americans aren't saving enough to retire. This gap poses a problem for everyone, not just people who will face near-poverty when they can't work anymore. Does that merit forcing people to save more?
Retirement in America is supposed to be financed by three sources: Social Security, employer pensions, and additional saving. Social Security in America makes up the foundation and serves two roles: it's a forced saving plan by making everyone contribute 12.4 percent (the employer and employee contribution) of their income (up to the first $113,700 they earn) in exchange for the promise of income in retirement. It's also social insurance because the lower your income, the larger your benefit will be relative to what you paid in. But for most people, it is not intended to finance all of retirement.
The problem is the other two sources are falling short. Employer pensions, for those who had them in the private sector, have been replaced by private accounts like a 401(k) plan. With these accounts, the individual is left to save enough and bear investment risk. Alas, most people don't contribute enough. That's apparent with baby boomers, the first generation to have these accounts for decades, who are nearing retirement with meager savings. According to the Survey of Consumer Finances collected by the Federal Reserve Board, the median value of financial assets (non-housing saving) of working Americans between age 55 to 65 was just $67,000 in 2010. That means many people will retire almost entirely dependent on Social Security and take a big cut in their living standard.
A big drop in consumption is not only a problem for the individual. Collectively it creates a drop in demand, which can devastate economic growth. Plus without any wealth, more retirees will qualify for Medicaid, in addition to Medicare, to finance end-of-life care. Projections of elder healthcare costs assume seniors will for pay the expenses Medicare doesn't cover, especially long-term care. But if people run out of money, the burden falls on the state.
Does that justify forcing people to save more? Some, like economist Teresa Ghilarducci and Senator Elizabeth Warren reckon so. It is not a new idea. Countries like Australia and Chile already force their citizens to contribute to retirement accounts. I've written before how they, and other countries, finance retirement. We know from their experience that forced saving changes the government's role in our lives and, potentially, its relationship with financial markets.
For instance, the government would have to decide how much people should save and how they should invest. It's been estimated that Americans should be saving at least 10 percent to 15 percent of their income. But that may not be realistic for many families living paycheck to paycheck. Ghilarducci proposes a more modest 5 percent contribution. Under her plan new savings would go into an account administered by the federal government. It would also invest everyone's savings and credit their account a 3 percent return each year. The government would make all the investment decisions and bear the investment risk. This has the advantage of being simple and predictable for American savers. But it also turns the federal government into a large asset manager and player in financial markets. It would explicitly own securities other than government treasuries. That has the potential to create an uncountable number of conflicts and unintended consequences.
Instead the government could lean on the private sector to avoid these conflicts. In both Australia and Chile private managers administer the forced saving accounts. People can pick their manager, who also presents them with a menu of investment options. The government may regulate characteristics of the investment options, in terms of fees or risk, but the manager selects the actual investment choices. Their experience suggests America could mandate saving within the employer-based pension account structure it already has.
Senator Warren takes a more progressive approach by expanding Social Security instead of individual accounts. Her plan entails more redistribution. Low earners have little income to spare and fewer forms of saving. There exists a case for more redistribution through forced saving. Under Warren's plan all income above $113,400 would be subject to an additional 12.4 percent tax. In exchange for the new tax, higher earners will receive a small increase in their Social Security benefit (much smaller than the return they currently get from their payroll tax) while lower earners will see a larger relative increase without paying more.
This is not strictly more saving because the new tax revenue would go toward current retirees and not be saved in the economy. But in some sense it is saving, in that many people will put aside some of their income in exchange for an income stream, going to someone else, in the future. Still, Warren's plan alters the character of Social Security. It makes it much less forced saving and protection from poverty and much more welfare for the middle class. Some redistribution may be desirable, but doesn't need to be so radical. Instead the government could subsidize the saving of lower- and middle-income earners by either adding to their accounts or through tax credits.
Given America's recent experience with healthcare - the problems with the mandate to buy insurance and reluctance of politicians to be candid about the redistribution required for it to work - forced saving seems unlikely to happen here. Another, potentially more palatable, alternative to forced saving is nudging. That is what Britain has adopted. The British government requires firms to automatically enroll their employees in a pension account and put 8 percent of their salary into it. But people can opt out of the account if they wish.
Nudging - defaulting people into a saving plan - has been proven extremely effective at increasing participation in pension accounts. Depending on where you set the default saving rate, it can increase the amount people save, too. More nudging increases saving, but still retains an element of personal freedom. Leaving some discretion to the individual is important because everyone has different saving needs at various points in their lives. How much you should save depends on many factors like your health or employment status, income variability, or whether you have children. Some discretion allows people to adjust their finances to suit their needs; forced saving may be too blunt a tool.
Part of a free society is letting people make bad decisions if they wish, provided there is some support to keep them from falling through the cracks. The current scope of Social Security, coupled with Medicaid, does a reasonable job at keeping retirees out of abject poverty. But a comfortable retirement requires more saving, and there a little nudge would be helpful.