We Need a Bold Solution to Fix the Retirement System

Our retirement system is broken.  The average American isn’t saving enough to comfortably retire, and the fault lies in our reliance on defined-contribution (DC) plans, such as 401(k)s.  Tinkering with DC plans won’t solve the problem, and the other extreme – a federally mandated guarantee – isn't likely to gain support.  But a number of compromises that lie between those approaches offer a better way forward for future generations.

Robert Huebscher weighed in on this dilemma In the September 11, 2012 issue of Advisor Perspectives.  His article focused on proposals from Teresa Ghilarducci, a professor at the New School in New York, who advocates scrapping the 401(k) system in favor of guaranteed retirement accounts (GRAs), for which the federal government would guarantee a minimum 3% real return. Huebscher argued that we should instead focus on mandating certain changes to 401(k) plans, such as requiring that all plans offer, as their default option, very low-cost, passively managed target-date funds.

I agree with Huebscher that we shouldn’t abandon 401(k)s, and his recommended changes to that system have merit. But asking workers to shoulder all of the investment risk won't do the job. If we truly want to mend the retirement system, we need another layer of retirement security that falls between Social Security and 401(k)s.

I'll use an example to illustrate the problems with relying on 401(k)s alone, but first let me offer some background on government initiatives to make retirement savings programs work better.

Federal government involvement

In recent years, when the federal government has turned its attention to retirement matters, it has focused on improving 401(k)s. Ghilarducci and some other economists have advocated more extensive changes, but that has not been the government’s priority.

Recently, the federal government has tried to encourage automatic enrollment to increase participation, to require reporting of fees to make costs more transparent, and to make it easier for participants to convert retirement savings into annuities.

Perhaps the biggest challenge has been finding a way to increase participation at the corporate level; only about half the American labor force works for an employer that offers a retirement plan. In response, the Obama administration has proposed the "Auto-IRA," which would require employers who do not currently offer a retirement plan to automatically enroll employees in payroll-deduction IRAs. The administration has been promoting Auto-IRAs since 2009, but the mandate for employers has been a sticking point, and the legislation has languished in Congress with few supporters.