Addressing the retirement coverage gap
Editorial Note: This post originally appeared on our companion blog, Fiduciary Matters, on September 3, 2015.
A big majority in favor of expanding retirement coverage
Saving for retirement should be mandatory, according to a poll of attendees at Russell Investment’s recent institutional summit.
Even though the room was in favor of the idea, it was split on the likelihood of it actually happening. In response to the follow-up question “How likely is this to happen?” few respondents (just 9%) felt that a true mandate was likely. However, 45% chose “Yes, but with opt-outs,“ i.e. auto-enrollment. In a sense, auto-enrollment (with opt-outs) offers the best of both worlds: we know – from the experience of corporate 401(k) plans who have adopted it – that it is very effective at increasing participation in retirement programs; yet participation remains voluntary, and nobody is forced to save who does not want to do so.
Several pots on the boil
A big question that arises, if coverage is to be expanded, is the question of the right savings vehicle: what should people be auto-enrolled into? Look around the world from, among others, Sweden in the north to New Zealand in the south, and there are plenty of examples to learn from. Australia has required an employer contribution to retirement plans since 19922 (the required contribution rate is now 9.5% there) and the superannuation (or “super”) system there now exceeds A$2 trillion3; that’s an average of about US$60,000 for every man, woman and child in the nation. When the UK mandated auto-enrolment in 2008, the National Employment Savings Trust (NEST)4 was created to accommodate those previously outside the retirement system.
There is no shortage of ideas that have been floated for addressing the coverage gap in the U.S. Several are listed in a recent report by the Savings and Investment Bipartisan Tax Working Group5 of the U.S. Senate Committee on Finance, including: encouraging multiple employer plans; tax credits for small businesses who offer plans; auto-enrolment; bringing part-timers into the system; and reducing leakage.
The past couple of years have also seen the MyRA introduced, and the creation of programs in Illinois, California, Oregon and Washington – with a line of other states following in their wake – all intended to address the coverage gap either directly (via auto-enrolment) or indirectly (by making it easier to access existing savings vehicles.)
Bringing more people into the retirement system is not the end of the story, however. If savings rates are too low, or the money saved does not stay in the system, or costs are too high, then savers could still end up with inadequate income in retirement.
So any broadening of participation in the retirement system would force consideration of the system’s efficiency. The typical account balance of someone brought into the system under a mandatory saving regime would not be large. Thus, the fixed costs of administering these accounts would have a proportionately larger impact. Leakage of retirement assets out of the system (for example, if account balances are cashed out on a change of employment) would potentially undermine the effectiveness of the system. Fees – already a major area of focus – would take on even greater importance. These and other issues of efficiency would take on greater importance in a mandatory system.
1 Based on 86 responses.
2 http://www.treasury.gov.au/Policy-Topics/SuperannuationAndRetirement/supercharter/Report/Chapter-1 /> 3 Source: The Association of Superannuation Funds of Australia (ASFA). www.superannuation.asn.au/
4 http://www.nestpensions.org.uk/schemeweb/NestWeb/public/pensions/contents/new-pension-rules.html /> 5 http://www.finance.senate.gov/newsroom/chairman/release/?id=e9eefc66-7e11-4276-939f-3eca6fd6d959