Jonathan B. Forman, Alfred P. Murrah Professor of Law, University of Oklahoma College of Law
Only half of American workers have a pension plan, and only a fraction of those have traditional pensions that replace a meaningful part of their final pay. Instead, most workers with a pension today have a 401(k) plan or an individual retirement account, and according to a recent report by the U.S. Government Accountability Office, only a fraction of those workers will save enough to get a meaningful monthly benefit.
This month the oldest baby boomers started turning 62, and millions more will follow in the coming decades. Before it is too late, we need to adopt policies to ensure that every worker has adequate retirement savings.
Prior to 1980, many workers had traditional "defined benefit" pension plans that provided monthly benefits based on a percentage of their final pay. Since then, most private-sector employers have shifted to 401(k) plans and other "defined contribution" plans. In these plans, workers accumulate money in individual accounts and withdraw it during retirement.
Unfortunately, many of these workers will end up "arriving at retirement with insufficient savings to support themselves." The title of the GAO report says it all: "Private Pensions: Low Defined Contribution Plan Savings May Pose Challenges to Retirement Security, Especially for Many Low-Income Workers."
The GAO found that the typical worker had just $22,800 set aside in a defined contribution plan in 2004. Worse still, only 8 percent of workers in the poorest 25 percent of households had a defined contribution plan.
Even workers age 55 to 64 in 2004 had a median account balance of just $50,000. At age 65, that would buy a lifetime annuity of that would pay just $367 per month ($4,400 a year).
The GAO also estimates that the current defined contribution system could replace about 22 percent of final pay for a typical worker, but replacement rates would vary widely across income groups. The richest 25 percent of workers would get almost 34 percent of final pay, but the poorest 25 percent would get just 10.3 percent of final pay.
Moreover, 37 percent of workers would have absolutely no savings from defined contribution plans when they retire, and 63 percent of those in the poorest 25 percent of households would have no defined contribution savings.
To be sure, Social Security would still provide a basic benefit for older Americans. The typical retired worker now gets around $1,050 a month. But many retirees get far less, and Social Security will provide lower replacement rates in the long run, even if we somehow come up with the $4.7 trillion in new revenues needed to cover the current shortfall.
On the bright side, since 2004 we have made it easier for employers to automatically enroll employees in 401(k) plans, and we have made the retirement savings tax credit permanent. But these small steps will not avert a retirement income crisis for the baby boomers and beyond.
At the very least, we need to make sure that every worker has an easy way to save for retirement. We might, for example, let state government entities create "State-K" pension plans for employers that do not already have pension plans. Or we could require that those employers offer payroll-deduction IRAs to their workers.
Even with universal access, however, many workers simply will not save for retirement. In the end, we will need a mandatory universal pension system.
For example, we might collect another 3 percent of payroll from every American worker and place that money into individual retirement savings accounts. Those accounts could be held by the government, invested in a broadly diversified portfolio of stocks and bonds, and converted into a monthly annuity at retirement. In a new discussion paper for the Urban-Brookings Tax Policy Center, Adam Carasso of the New America Foundation and I estimate that these 3-percent-of payroll accounts would provide 13.8 percent of final wages at retirement for every worker.
Our paper, "Tax Considerations in a Universal Pension System," also shows how targeted tax subsidies could lead to even larger benefits for low- and moderate-income workers.
Millions of American workers have been left out of the current pension system and have no retirement savings. A system of 3-percent-of- payroll individual accounts would ensure that every worker has at least some retirement savings. Altogether, Social Security and these "add-on" individual accounts would guarantee that every worker has an adequate retirement income.