The economic status of the elderly has improved dramatically over the last several generations thanks to government programs such as Social Security and Medicare and the rising prosperity enjoyed by the mass of Americans throughout much of the second half of the twentieth century. But going forward, America is threatened with a retirement crisis.
The Center for Retirement Research at Boston College estimates that 53 percent of working-age households in 2010 were at risk of being unable to maintain their current standard of living in retirement, making the outlook for many Baby Boomers and younger Americans far more challenging than it is for most current retirees. In 2013 among American households headed by someone between the age of fifty-five and sixty-four, half had a net worth of less than $166,000—including home equity and money held in retirement accounts such as 401(k)s and individual retirement accounts (IRAs). The median net worth of such households, adjusted for inflation, declined by 14 percent between 2010 and 2013, according to Federal Reserve data, despite an officially recovering economy and a roaring stock market. Meanwhile, the percentage of Americans with retirement accounts continues to fall, slipping below 50 percent last year.
Unless measures are taken now, increasing economic insecurity and inequality among the coming generations of elderly Americans will harm not only millions of individuals but also the performance of the economy as a whole. To be sure, there is a small but growing class of Americans who will do extraordinarily well in retirement, reflecting a long era during which those at the top of the income scale were growing much richer. But for most Americans the trend is the opposite.
Many will need to give up on dreams of turning their skills and experience into productive new ventures later in life. They will volunteer less in their communities and places of worship. They will hang on to jobs even as ailing health diminishes their productivity. They will cut back their consumption of everything from health care to travel, thereby reducing the economic demand needed to create jobs for younger Americans. They will turn increasingly to public programs and private charity to help pay their utility and household bills. They will move in with their children and have to rely on them for financial assistance, even as younger Americans increasingly struggle with their own economic security challenges, such as rapidly rising student debt.
The retirement crisis has little to do with the financing of old-age social insurance programs. Social Security can be rendered even more secure with minor changes to its tax base. Rising health care costs do pose a challenge to the financing of Medicare as well as private health insurance, but all evidence suggests that policy—in this case measures enacted under the Affordable Care Act—can have a positive influence in slowing the growth of health care prices without compromising health care quality. Rather, the mortal threat to a dignified retirement is the stagnating or falling real earnings of most workers, combined with their massive debt and loss of secure ways of savings for retirement such as defined-benefit pensions.
The growing economic problems of most American families during their working years foreshadow their coming struggles in old age. As America’s manufacturing base shrank and unions lost much of their bargaining power in the 1970s and ’80s, many late-wave Baby Boomers, particularly among the majority who never went to college, wound up working for far lower real wages and health and retirement benefits than the previous generation of workers had enjoyed in the 1960s and ’70s. Workers consequently found it more and more difficult to prepare for the costs associated with retirement.
That pattern of widespread shaky wages and disappearing benefits among all but the most affluent of each new generation gathered momentum as the members of Generation X came of age. This age group will be particularly vulnerable in retirement not only due to stagnant real wages and reduced or nonexistent pensions, but also because many of them borrowed heavily, often on predatory terms, to buy houses at what turned out to be at or near the top of the market. According to the Federal Reserve, every cohort of Americans born between 1930 and 1995 is now more indebted than were people who were the same age in 2000, but Gen Xers have seen the comparatively largest increases in debt. One study by the Fed labels Americans born between 1965 and 1980 “Generation Debt,” by virtue of their now owing 60 percent more than did Americans who were the same age in 2000.
This pattern of growing economic instability and rising inequality across the generations finds its culmination in today’s young adults. Millennials are not only substantially more likely than were Gen Xers at the same time in their lives to be encumbered by large student debts, they are also starting out with even lower real wages. The median family headed by someone under the age of thirty-five earned 20 percent less in 2013 than its Gen X counterpart did in 2001, raising the prospect of America having two “lost generations” in a row.
Compounding these trends has been a steep decline in the share of Americans who are covered by retirement plans at work—either traditional defined-benefit pensions that pay a lifetime benefit or retirement savings accounts that accumulate a lump sum based on their financial luck and acumen. One reason is the rise of long-term unemployment and the growing share of contingent or contract workers who receive no benefits. Yet even among wage and salary workers, pension coverage continues to decline. In 2001, approximately 51 percent of wage and salary workers were part of a retirement plan. That was low to begin with, especially considering that the labor market boom of the 1990s made 2001 a relatively good year for benefits. Today, the share of wage and salary workers covered by pension plans has fallen to 45 percent.
Worse, even among those companies that still offer pensions to their workers, there has been a profound shift away from traditional defined-benefit pensions to so-called defined-contribution accounts such as 401(k)s. These accounts require individuals to assume all the responsibilities of managing their money for retirement and thus leave workers with the downside risk of their savings going south. They also require individual participants to make complicated investment decisions even as they wind up losing much of the value of their investments to high fees charged by brokers and mutual funds. Unlike traditional pensions, defined-contribution plans also do not guarantee benefits for life—or, indeed, guarantee any benefits at all. This means that participants in these plans still run the risk of outliving their savings even if their investments turn out well—a risk that can only be mitigated by purchasing expensive annuities from life insurance companies.
Without appropriate policies to reduce inequality and promote opportunity, America’s changing demographics also threaten to worsen America’s retirement crisis. Due to falling birth rates and increased longevity, there will be fewer workers going forward to support each retiree. Still more challenging is the changing composition of the workforce, which includes rising numbers of single parents, as well as members of racial and ethnic groups suffering today from higher-than-average rates of unemployment, disability, and early mortality, as well as lower-than-average educational attainment, earnings, and savings.
In 2010, communities of color comprised more than 36 percent of the U.S. population, and they are projected to make up the majority of the nation’s population by around 2043. Relieving tensions between work and family, as well as shrinking racial and ethnic gaps in economic and health outcomes, can ultimately improve the nation’s overall productivity and create the new wealth needed to finance an aging society. But creating a win-win proposition for members of all generations will not come about without serious broad-scale changes in policy to promote real economic security during working years and in retirement across the board.
We also need specific changes in policies directly affecting provision for retirement, starting with Social Security. Despite much alarmist talk, the financial challenges facing the program are quite modest, even as it becomes, with the erosion of other forms of retirement savings, an increasingly essential pillar of support in old age for more and more Americans. According to the latest annual report by Social Security’s trustees, the cost of its main pension and disability fund, under “intermediate range” assumptions, will rise as a percentage of GDP from barely short of 5 percent today to just 6 percent in 2090.
Nonetheless, Social Security does face a modest funding gap that needs to be addressed. Fortunately, the shortfall between taxes and benefits will remain at less than 1 percent of GDP through 2025, according to the trustees’ latest projection, and will not reach even 1.7 percent of GDP by the time today’s kindergartners are in their eighties, which means closing this long-term deficit is a manageable task.
One key step to do that is to make Social Security’s tax base broader and more progressive. Today, the system is financed by a regressive payroll tax that imposes a far higher marginal tax rate on low- and middle-income workers than on the affluent. Under current law, for example, any wages earned above $117,000 in a given year are exempt from payroll taxes.
Raising or eliminating the payroll tax cap on earnings alone will substantially improve Social Security’s finances. If combined with other measures to boost the income of future workers, broadening the tax base for Social Security could also make it possible to raise benefits for the most needy elders.
Helping American families better prepare for retirement also requires substantially overhauling private retirement savings. The federal government currently spends more than $150 billion offering tax incentives to save for retirement, but the largest benefits go to those least in need. That’s because the value of these tax subsidies depends on the saver’s tax bracket, with high-income Americans getting the most benefits, and low-income Americans the least and in many cases no benefits at all. Those in the highest tax brackets get an immediate value of 39 cents for each dollar they save. In contrast, low-income earners who may have a marginal tax rate of 10 percent receive only a quarter of the value from the tax incentive, and those who don’t earn enough to owe federal income taxes receive no benefit from the savings incentives meant to help them prepare for retirement.
A more efficient and fairer alternative would be to give every saver a fixed tax credit, say 20 percent, for every dollar they save. Such a tax credit also could be structured to give moderate-income earners a greater credit per dollar saved than higher-income earners. Turning existing tax deductions into progressive tax credits would better target existing savings incentives where they can do the most good for both individuals and the economy as a whole.
The same principle could be applied to the broad array of federal tax policies designed to help Americans build assets. These range from the mortgage interest deduction and the preferential tax treatment of capital gains and dividends, to assets held in IRAs and tax-advantaged college savings plans. All told, these and other tax expenditures related to asset building came to over half a trillion dollars in 2013, yet almost none of this money reaches low- and moderate-income households, and the lion’s share goes to the affluent.
Congress should also simplify and better regulate the myriad tax-advantaged retirement vehicles it has created over the years. Today, workers must navigate a confusing labyrinth of different types of tax-favored savings vehicles, from Roth and conventional IRAs to SEPs, Keoghs, HSAs, MSAs, and 457 plans, to mention a few. Congress should streamline the numerous preferred savings vehicles intended for retirement, education, and health care into a single tax-advantaged savings vehicle with one set of rules. Greater simplicity would make it easier for people to save and thus increase both the number of savers and the amount they save.
At the same time, Congress needs to more rigorously regulate the financial services industry so that savers are not hit by high fees on their accounts that are often incompletely and confusingly disclosed. More generally, better regulation of Wall Street could change the pattern of recurring financial bubbles that leave retirees at risk of being stranded just when they need to tap into their lifetime savings.
The economic and demographic trends facing the country have caused some observers to predict an outbreak of generational warfare. But such predictions are based on a frame of analysis that ignores the increasing interdependence of all generations and the common stake of all Americans in restoring economic opportunity and fostering equitable growth.
Return to “American Life: An Investor’s Guide.”