The Great Illusion of Retirement Savings

The nation is facing a looming retirement income crisis. Average retirees today are not well off. Tomorrow's average senior is likely to be in worse shape. Instead of addressing this looming crisis, too many of the nation's policymakers and elites propose to make it worse.
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USA, New Jersey, Jersey City, Portrait of woman holding piggy bank
USA, New Jersey, Jersey City, Portrait of woman holding piggy bank

The nation is facing a looming retirement income crisis. Average retirees today are not well off. Tomorrow's average senior is likely to be in worse shape.

Instead of addressing this looming crisis, too many of the nation's policymakers and elites propose to make it worse. They tell the American people that Social Security's earned benefits must be cut, despite their modest size. They tell public-sector workers that their pensions are unaffordable, despite the fact that workers have already earned those benefits, indeed foregoing current compensation in the process.

Rather than proposing the expansion of Social Security and fighting for public pensions, these elites complain that Americans are not saving enough. Americans, they say, need to be more frugal in their habits if they wish to avoid going off their own personal fiscal cliffs when they retire. Spare the lattes; pump up the retirement savings accounts instead, the elites lecture us.

In response to the retirement income crisis, these elites push to require that workers be automatically enrolled in retirement savings plans, financed from deductions from their pay, with automatic escalation of the amount deducted each subsequent year. Meanwhile investment houses compete for retirement savings dollars through massive and expensive advertising campaigns on television and in magazines, assuring us that in return for trusting them with our savings, they will coach us into the retirement end zone.

But what if it is impossible to save enough for retirement? What if the individual savings approach that replaced guaranteed pensions simply doesn't work? How much can a person of ordinary income realistically be expected to save after paying for increasingly expensive houses and college educations for children, not to mention a range of unpredictable other calamitous necessary expenses that can befall anyone?

This blame-the-victim approach, which seeks to force young workers to lock up savings for decades, is a misdiagnosis of the problem. And with all misdiagnoses, the problem is likely to grow, not shrink.

Savings are important. But individually saving and investing for retirement, it turns out, is the most inefficient and least fair way to finance retirement income. The lower a person's income, the more of it that must be spent on necessities and the less available for savings. Moreover, what is saved is likely to be needed well before retirement. A person's savings should be available for more current needs, such as leaky roofs, educational costs, and uncovered health care expenses, to name just a few.

The problem of people of ordinary income not having enough to put into retirement savings is compounded by what happens to whatever they do manage to save. Participants in retirement savings accounts lose, minimally, a quarter of all investment gains too often hidden administrative fees, commissions and other profits deducted by financial services companies that manage the accounts. Then once people reach retirement age and seek to turn their accumulations into life annuities sold by life insurance companies, they find that the size of the annuity payments is further compromised by still-more commissions and other forms of profit taking.

Individually saving and investing for retirement is a poor approach if the goal is to produce sufficient amounts for workers to maintain standards of living in old age. Traditional defined-benefit pension plans, of which Social Security is a variety, are able to deliver substantially higher retirement incomes, guaranteed for a lifetime, precisely because they don't rely on the individual savings principle. Instead, they are insurance.

Like all insurance, they provide protection against loss in exchange for premiums or contributions. In the case of Social Security, the insurance contributions are made primarily by employees -- the aptly named FICA or Federal Insurance Contributions Act payments -- and matched by employers. These periodic contributions are exchanged for protection against the loss of wages when and if it occurs as the result of old age, disability or death.

As a consequence, unlike savings, these benefits are targeted. If one dies before old age without dependents or work-ending disability, no benefits are paid. If one lives to 105, benefits are paid each and every month. One can outlive savings, but not a guaranteed lifetime payment stream. Consequently, traditional pensions can provide significantly higher benefit amounts that are payable for life.

Moreover, with savings, individuals are subject to the vagaries of the stock market. Two people, each of whom save the identical amounts and invest in the identical ways can receive vastly different retirement income simply as a result of when they reach old age. Think, for example, of the difference in the 401(k) account of one person who retired at the height of the stock boom in 2004 versus her younger brother who retired at the height of the Great Recession in 2008. Under Social Security and other defined benefit plans, the siblings would have retired with monthly benefits of the same value (assuming identical earnings).

Instead of enticing more participants into the doomed retirement savings crusade and accusing current participants of not saving enough through an approach that is loaded against them, policymakers should expand Social Security, protect current defined benefit plan promises, public and private, and facilitate the creation of new defined benefit plans by removing the barriers preventing workers from organizing and bargaining with employers on a more equal footing.

They should recognize that many well-intentioned proposals, like the Obama administration's MyRA plan and auto-enrollment, to alleviate the nation's growing retirement crisis are headed down the wrong path. The chief beneficiary of the retirement savings crusade has been the financial services industry, which is awash in profits from managing these accounts. That is why there are so many expensive television and magazine advertisements competing for this business. Money invested in these advertisements is money that will not go to retirees. When was the last time you saw an advertisement from Social Security?

If the goal is to benefit the financial services industry, focusing on individual savings for retirement is the correct approach. But if the goal is to increase the retirement security of all Americans, then expanding Social Security, fighting to protect current employer-provided defined benefit plans, and figuring out the best way to establish new ones is the right cure.

Nancy J. Altman is the co-author, together with Eric R. Kingson of Social Security Works!: Why It Isn't Going Broke and How Expanding It Will Help Us All (The New Press). James W. Russell is the author of Social Insecurity: 401(k)s and the Retirement Crisis (Beacon Press)

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