As the new year begins, here are the big retirement policy challenges we’re facing, in my view. Note that these are our long-run problems—as opposed to, say, clarifying the rules on ESG investments or for fiduciaries who provide advice.
The Challenge of the Transitions
We have gone from a Baby Boom in the 1950s to a baby bust today. We are now living with something like an inverted population pyramid—with an unusual number of old people relative to young workers. This will stress any economy and make retirement security and funding retirement income a significant challenge.
Baby Boomers were caught in the middle of the transition from DB to DC plans. For the most part, they didn’t save in their early years. There were no 401(k) plans, and certainly the tools we now use to increase savings—most critically, automatic enrollment/escalation of contributions—did not exist. And many do not have the end-of-career payoff that DB plans once provided.
There is, in many sectors, an (implicit) transition from a PAYGO system to a funded system. When that happens, you have a “double burden” problem—someone is going to have to pay twice, i.e., for their own retirement and for the prior generation’s. We see this vividly in the multiemployer plan solvency crisis, in the public pension plan solvency crisis in many states and municipalities, and in concerns about the long-run viability of Social Security.
These are problems of transition and are a significant element of the retirement savings “crisis.” They will, at some point, go away—the transition will complete itself. In the meantime, many Baby Boomers without sufficient retirement assets are simply working longer.
Covering the Uncovered
Our current system depends on getting individual workers in a default-based system early. However, a large part of the work force—at least 40%—is not covered by a plan. There are a number of issues here—especially including whether many of these under-covered individuals have the wherewithal to save at all. But we need to develop a utility that covers them. To me, that looks a lot like the auto-IRA.
Payout
We have learned how to solve the accumulation challenges presented by the 401(k) system: We “nudge” participants to contribute and toward sensible asset allocation. But we still do not have a solution to the payout problem. We need to do more work here.
First, in my humble opinion, we have not fully understood the problem itself or why participants are so annuity-hesitant. As the Investment Company Institute’s Sarah Holden, Senior Director of Retirement and Investor Research, and Shannon Salinas, Assistant General Counsel–Retirement Policy, explained:
The [“rational retirees should buy annuities”] models do not account for the fact that individuals have other annuitized resources, such as Social Security and defined benefit (DB) pensions. Nor do they incorporate uncertainty about future consumption needs, which would cause individuals to keep a portion of wealth liquid in case of unexpected need. Further, the models typically focus on single individuals, whereas married couples get much less insurance value from purchasing an annuity. In addition, the prediction of full annuitization relies on the assumption that individuals place no value on resources passed on to their heirs, whereas evidence suggests that a large portion of the population desires to leave bequests.
Second, we need more creative lifetime income solutions. We’ve spent a couple of decades trying to get participants interested in a provider-based system—carrier-provided annuity products, often of daunting complexity and carrying significant costs. We should be thinking about how to use an employer-based system, with longevity risk spread across the employee base and other risks (asset performance and interest rates) hedged out.
And third, we need to deal adequately with inflation risk, to which those living on fixed incomes are uniquely vulnerable. If we learned nothing else in 2021, with inflation at a 7% annual rate, we at least should have learned that annuities are not a perfect solution to post-retirement payout risk.
The Challenge of New Technology
Software is going to eat our world. The short version: In financial transactions generally and in retirement plan recordkeeping specifically, blockchain is going to replace current practice. In this regard, let’s remember Amara’s Law: “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.”
Technology-driven changes are going to dislocate a lot of things. The reduction of friction in securities/plan transactions and simplification of the recordkeeping process will reduce the costs of most transactions. However, many of our current tools—e.g., automatic enrollment and default investments—depend on friction for their effectiveness. As friction is reduced, we will have to find new ways to nudge participants toward the choices that (in most cases) are best for them.
The increase in transparency will make many tools more powerful—e.g., targeted communications, fund analysis, performance review—and at low or no cost. Managed accounts, perhaps combined with AI, may replace target date funds as the preferred default. But depending on how the system is implemented, this enhanced transparency may permit greater scrutiny by regulators and even more problematic fishing expeditions by data-driven plaintiffs’ lawyers.
The Move to a Provider-Based System
Given that the 401(k) system is largely participant-driven, a gradual trend towards a provider-based system—from outsourcing, to MEPs/PEPs, to an Australian-like solution—seems like an obvious path forward. However:
- One thing technology is doing (generally) is reducing returns to scale—consolidation of our current system (down to, e.g., 5 or 12 providers) may be an idea whose time has passed.
- We need to rethink the role of the employer—without happy talk.
- It’s not at all clear to me that forcing employers to be fiduciaries is a useful regulatory tactic. But without the employer, who will discipline the providers? Individual participants lack the needed financial leverage.
The Transformation of the Capital Markets
At the beginning of the 20th Century, the capital markets largely managed upper class wealth. In 2022, the retirement assets of ordinary American make up a third to a half of our capital markets.
As a result, decisions we make about how to manage retirement assets have consequences for the world economy. One of the virtues of the current system is the variety of decision makers. Concentration—via either a provider-based retirement system or an AI based investment algorithm—is something I personally find disturbing. We can’t just invest in the S&P 500.
Many (most, I would argue) of these challenges will be solved (if they are solved) in the market—by participants, sponsors and providers. It would, however, be nice—if we can restore a workable bipartisan consensus, that is—if we could aid and guide that process through legislation and regulation. That is my hope.
Editor’s Note: Mike Barry discusses each of these issues at length in his book, Retirement Savings Policy—Past, Present, and Future, De|G Press.
Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them.
Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.
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