Next week marks the 10th anniversary of a landmark federal law with a hopeful name – the Pension Protection Act of 2006. Has the law lived up to its name?
The anniversary is an apt time to consider changes still needed to improve the retirement security of American workers.
The track record of the Pension Protection Act (PPA) is mixed. The law imposed more stringent funding requirements for defined benefit pensions. It also spurred important improvements in workplace 401(k) plans – mostly automation features that led to much higher participation rates among workers and put investment choices on auto pilot through widely used target date funds. Still, 10 years after PPA, we are left with a looming retirement security crisis. Sponsors of traditional pension plans have been dropping them like hot potatoes – many do not want to carry pension obligations on their books, and some complain about the rising cost of insuring plans through the Pension Benefit Guarantee Corp.
In 2015, just 20 percent of Fortune 500 companies offered a defined benefit plan to new hires, down from 59 percent in 1998, according to Willis Towers Watson.
Meanwhile, most workers are not saving nearly enough. Among workers aged 55 or older, one-third have saved less than $25,000. The numbers are especially appalling among minority workers – savings for nonwhite households near retirement (age 55-64) average $30,000. That is four times less than white households, according to data from the National Institute on Retirement Security (NIRS).
Expand social security
Social Security is our only universal, mandatory pension program, and it keeps millions of seniors out of poverty. Expansion of benefits offers the best route to improve retirement income for middle-class and lower-income households. The best idea is to increase benefits across the board, but some reasonable legislative proposals call for more modest, targeted increases for vulnerable retirees.
Expansion should be coupled with a funding plan to close Social Security’s long-range solvency gap – the combined trust funds for Social Security’s retirement and disability benefits are projected to be depleted in 2034. Several options are available to fund these reforms, starting with lifting or eliminating the ceiling on wages subject to payroll taxes – now capped at $118,500. Gradual increases in the 12.4 percent payroll tax rate now split between employers and workers could also offset some of the cost.
Expand access to workplace saving
The PPA boosted participation in workplace plans by encouraging automatic enrollment. But roughly one-third of all workers are not offered a workplace plan at all, according to U.S. Bureau of Labor Statistics data – mainly at small businesses that have not set up their own plans due to cost and complexity hurdles.
A recent report on retirement system reform by the Bipartisan Policy Center (BPC) calls for a new national Retirement Security Plan targeting employers with fewer than 500 workers. A national minimum-coverage standard would require employers with 50 or more workers to offer their own plan, auto-enroll workers in the national RSP or enroll them in federally sponsored myRA accounts (essentially a Roth IRA with payroll deduction features invested in conservative government securities.
“The idea is to help small businesses band together and offload responsibilities, so that all employers over a certain size have to enroll in some kind of plan,” said Shai Akabas, director of fiscal policy at BPC.
Improve the saver’s credit
PPA made permanent the Saver’s Credit, which provides a credit up to $1,000 ($2,000 for joint filers) for lower-income households that contribute to an IRA or workplace plan. Unlike a deduction, which reduces the amount of taxable income you claim, a credit is a dollar-for-dollar reduction of federal income tax liability.
Unfortunately, in order to take advantage of the credit, you must have an income tax liability in the first place – and most households eligible for the credit do not. Thirty-five percent of households eligible for the credit do not file for it, according to the Congressional Budget Office.
The credit should be made refundable – in other words, available no matter what your tax liability. And it should be deposited straight into the accounts of low-income savers, just like an employer match.
“We have to find a way to make it an integrated part of retirement saving,” said Diane Oakley, executive director of NIRS.
Focus on income
PPA’s encouragement of automation made it easier to accumulate savings, but it failed to do much to help retirement savers convert their nest eggs into income streams at retirement.
One way to accomplish that is through greater adoption by plan sponsors of managed accounts services from third-party advisory firms hired by plan sponsors. These services can provide financial planning guidance beyond portfolio management, including help on drawing down funds in retirement.
“For younger workers, target date funds have played a huge role,” said Paul Gamble, executive vice president of Financial Engines, one of the leading managed account providers. “But as people age and get closer to retirement their situations get more complex, and they need different types of help with managing income.”
Another option is to make it easy for retired workers to convert some portion of their 401(k) savings into annuities, which provide a guaranteed stream of lifetime income. Plan sponsors have been reluctant to do this due to concerns about fiduciary liabilities in the event that an annuity provider in the plan goes belly-up; that could be addressed by giving sponsors “safe harbor” protections.
David Blanchett, head of retirement research at Morningstar, thinks that allocating part of a nest egg to an annuity would benefit a majority of savers – so long as the decision takes into account the individual’s situation. “It really depends on how much other guaranteed income they can count on from Social Security or a pension – and how much saving is available to invest.”
Blanchett thinks the best starting point is to help workers optimize their Social Security benefit. “That’s the largest annuity most people will own – it gives the most bang for the buck.”