In the past, the primary retirement goal for most Americans was to have an employer provided secure pension and guaranteed healthcare insurance lasting for as long as they lived, writes Martin Neil Baily, senior fellow at the Brookings Institution and former Chairman of the Council of Economic Advisers under President Clinton, in a Barron’s article.

Today regarding retirement, Americans must fend for themselves, relying on their own savings and investments, and figuring out how to avoid running out of money.

With little fanfare, America has moved from a world of traditional pensions, where risks were absorbed by employers, to a system of individual retirement accounts where families must manage uncertainty including the fact that none of us knows how long we will live and what large expenses we may face, especially in healthcare.

There has been transformation in America’s retirement system from traditional pensions to individual retirement accounts and employers’ 401K plans.

The risks for a secure retirement have been partly mitigated by Social Security and Medicare, the foundation of the American retirement system. The programs have, for the most part, been successes, sharply lowering the poverty rate among the elderly and providing a backstop for middle-income households. For decades, Social Security and Medicare have lifted American seniors, survivors, and people with disabilities out of poverty.

Unfortunately, these federal programs are not on a sound financial footing thanks in part to Washington‘s dysfunction. The Social Security* trust fund for retirement and survivors’ benefits is expected to run out of money and reduce benefits to recipients in 2033, while the Medicare** hospital fund could run out in 2028. Thus, older Americans can now add policy uncertainty to their list of risks to retirement.

Social Security will be able to fully pay scheduled benefits until 2033, one year earlier than reported last year https://t.co/Kb9sXRNEe4

— Bloomberg (@business) April 3, 2023

Americans are willing to take on the challenge of managing their own retirement, but they need additional federal government help to do it.

The first step towards solving the ‘retirement dilemma’ is for Americans to save enough, consistently. The best way to do this is through automatic retirement savings plans, like 401(k) plans. Employees would be enrolled in the plan automatically when hired, with contributions taken out of paychecks unless they chose to opt out. The self-employed can set up their own plans but it would help if state governments, or the federal government, would operate retirement savings plans open to everyone.

Current tax law favors retirement savings, but the benefit of this tax break, worth over $250 billion a year, accrues mostly to the rich. Tax reform should redistribute the benefit more equally to encourage middle-income families to save.

Saving a solid retirement nest egg is not enough. Savers don’t know what returns they will earn on their savings. Family members don’t know how long they will live (people often underestimate their lifetimes). They don’t know if they will need in-home care, or if they will have to enter an expensive nursing home. (Many families hoard their financial assets for fear they will need all their savings for end-of-life care).

What may be needed to help fix retirement is a good financial advisor, and a reformed retirement system.

Annuities are a way to avoid market and length-of-life uncertainty, but at present it is hard to find the right annuity at the right price. Employers should negotiate with providers to offer their employees the option of putting some of their retirement savings into an annuity that guarantees regular monthly payments, either throughout retirement or to protect against running out of money at the end of life. It is a way of creating an individualized “pension” plan.

Today’s workers need a retirement plan that is flexible and can move with them. The downside means that retirees are exposed to a lot of economic and market risks. Yet, reasonable policy reforms can invigorate insurance markets to help ameliorate risks. Employers owe it to their employees to make it easier to build a secure retirement.

References:

1. Martin Neil Baily, The Way Americans Retire Has Changed Forever. Why Saving a Nest Egg Isn’t Enough. Barron’s Magazine, February 17, 2023.

* Social Security is a federal benefits program that pays benefits to retirees and workers who are disabled, as well as their family members and survivors. It is financed through a 12.4% tax split among employers and employees; self-employed individuals pay the entire 12.4%.

This tax money is deposited into the two Social Security trust funds: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. The Social Security Administration pays current benefits and administrative costs out of these trust funds.

As early as 2034, Social Security trust fund will no longer be able to pay full benefits scheduled under current law. Although the trust funds’ projected shortfalls are typically attributed to lower birth rates and increased life expectancies for workers.

** Medicare has been a successful component of the American social safety net.

As of September, 65.1 million people were covered, 85 percent of them elderly. 
It is also expensive: During fiscal 2022, the program accounted for $710 billion in federal spending, which was 11.4 percent of the $6.2 trillion total, according to the Congressional Budget Office.

By 2028, the Medicare trust fund, which pays for hospitals, skilled nursing facilities and hospices, and is financed by payroll taxes, is expected to be exhausted.