December 24, 2022
Since coming to Washington more than three decades ago, I have spent much of my time working on retirement income. The biggest part of that story was defending Social Security, which leaders in both parties were anxious to cut. This defense was largely successful, as the efforts to privatize it in the 1990s and under President Bush were beaten back, and the efforts at cuts often focused on the annual cost of living adjustment, were similarly derailed.
Defending Social Security was crucial, both because tens of millions of people depend on it for most or all of their income, but also because it was a model social program. The administrative costs are minimal, with the total program’s costs coming to less than 0.6 percent of annual benefits, with the costs of the retirement program alone coming to less than 0.4 percent of benefits. By comparison, the fees from private 401(k)s run in the neighborhood of 15 to 20 percent of annual retirement benefits.
There is also very little fraud in the program. The Washington Post, which has long been one of the leading advocates for cutting Social Security in both its opinion and news sections, once devoted a major investigative piece to exposing the fact that 0.006 percent of benefit payments went to dead people, more than half of which were later recovered. It lately decried Social Security as a “mess” in the headline to a full-page article.
I always felt that it was essential to defend Social Security because it could serve as a model for other programs, like universal Medicare or child care. But, as necessary as Social Security is, I also recognized the need to have some additional retirement income for much of the population.
Supplements to Social Security
The traditional story about retirement income was that it was a three-legged stool. Workers were supposed to have Social Security as their core retirement income. In addition, they should have a workplace pension, and also personal savings. That story could reasonably accurately describe the situation of millions of middle-class workers in the years after World War II to the 1990s, but in recent decades the other two legs of this stool have been largely removed.
Traditionally defined benefit pensions (DB) have been eliminated mainly in the private sector. While current retirees can still often count on income from DB pensions, this will be less true going forward. And, most middle-income and moderate-income households have little by way of traditional savings to help support them in retirement. Also, the story of a middle-class household reaching retirement with a paid off mortgage is far less common today than four decades ago.
All of this pointed to the need for some supplement to Social Security. For the lowest income workers, it is not plausible that they will be able to accumulate substantial savings for retirement. People struggling to pay the rent are not going to have tens of thousands stashed away in retirement accounts. The best solution here is an increase in benefits for low-paid workers.
There have been many proposals for increased benefits for lower income workers over the years, some of which had some bipartisan support. For example, giving surviving spouses 75 percent of the joint benefit (compared to the current 66.7 percent, which is often the case now), would be a substantial benefit boost to many of the elderly, generally women. This change can be structured in a way where the cost would be minimal, while providing more than a 12 percent increase in the income of many people who can really use it. There have been many Republicans who have indicated support for this sort of benefit change, although sometimes paring it with cuts that make it unacceptable.
Anyhow, while increased benefits for lower paid workers can drastically improve their well-being in retirement, substantial increases in benefits for middle income workers would be costly. A Social Security program that, by itself, allowed middle-income workers to sustain their living standards in retirement would have to be close to twice the size of the current program. That does not look very feasible.
For this reason, many of us have sought to create a simple low-cost voluntary retirement program that would supplement Social Security. The idea was to make it easy and cheap for workers to save for retirement.
The strategy takes advantage of one of the clearest findings from behavioral economics. When it comes to voluntary retirement plans, workers will overwhelmingly go with a default option. If they are automatically enrolled in a plan, with the option to disenroll, many more workers will stay with the retirement plan than if they have to make the decision to actively enroll in the plan. This is true even when there is money on the table in the form of a matching contribution from an employer.
For this reason, the idea was to make enrollment the default option. If workers decided that it was more important that they have the money to meet current expenses, they just have to opt out of their retirement plan.
That is the simple part. The cheap part was to have a low-cost plan available to all workers. Many 401(k)s and IRA(s) rip-off their participants. Average fees for 401(k)s are in the range of 1.0 percent a year for the company managing the account, with fees for the funds in the account sometimes adding another 1.0 percentage point.
If that seems trivial, consider that a middle-income person can easily accumulate $70,000 in a retirement account towards the end of their working life-time. Imagine paying $1,400 a year, to someone you don’t know, for essentially doing nothing. Taken over a working lifetime, a middle-income worker can easily be throwing $20,000 in the toilet (i.e. providing income to the financial sector) in excess account fees. This is money that will come directly out of their retirement savings.
For this reason, we felt that it was essential that the retirement accounts be coupled with a low-cost investment option. The dream for many of us pushing on this issue is that workers would be able to buy into the Federal Employees’ Thrift Saving Plan, which has fees in the neighborhood of 0.1 percent on its accounts, including the fees charged for individual funds.
The State-by-State Strategy
With action at the federal level largely blocked, the focus was on getting states with relatively progressive governors and legislatures to take the lead in both requiring employers to offer workers retirement accounts and to give them a low-cost option. The simple route for the latter was to open up the retirement system for the state’s public sector workers to workers for private employers.
This did not mean co-mingling funds; public sector employees’ pensions would not be affected. The plan was simply to take advantage of the expertise available in the public pension funds to allow workers in the private sector the same investment options. The administrative costs of the state plans are in general far lower than for private sector 401(k)s, so this meant substantial savings for workers.
Several states went this route, notably, Illinois led the way in 2018 with its Secure Choice program, with New York and California also implementing comparable programs. As it is, a large share of the nation’s workers now lives in a state where most employers are required to enroll workers in retirement plans managed by the government’s public employee pension system unless they offer their own plan.
Secure 2.0 Makes Default Accounts National
In order to ensure that all workers have a decent living standard in retirement it is necessary to have a national program. The Secure 2.0 Act provisions in the omnibus spending go a very long way in this direction. They will require employers with more than ten workers to put at least 3.0 percent of their pay in a retirement fund each year for their workers. The amount will rise by a percentage point each year, until it hits 10 percent.
This is an optional contribution on the part of the employee, they can choose to have this money in their paycheck, if they would prefer to have the money now. In effect, this is just changing the default option. They will be saving, unless they choose not to, rather than the current situation where they have to make a conscious choice to save for retirement.
Another provision in the bill makes the savers’ credit fully refundable. This is a federal tax credit that matched contributions to retirement accounts by low- and moderate-income workers. The problem was that it was not refundable so most of the people with an income low enough to qualify couldn’t benefit since they didn’t owe any income tax. The Secure 2.0 Act provisions fix this so these workers can get the credit even if they don’t owe any income tax.
The Secure 2.0 Act provisions are a big victory, but they don’t address the cost half of the picture. It would be great if, as part of this bill, every worker had the option to have their money invested through the Federal Thrift Savings Plan. Unfortunately, this is not the case. Workers will have to use private insurance companies and brokerages. This means much of their money will be diverted to the Wall Street types.
That is likely a big factor in how the Secure 2.0 provisions got added to the Omnibus bill. While it is great that workers will have more savings for retirement, this bill can mean big money for the financial industry. If the bill increases retirement assets by $1 trillion after ten years (defined contribution plans already have over $6 trillion in assets), it will mean over $10 billion a year in fees for the industry, if the average cost of an account is 1.0 percent of assets. If it is 1.5 percent, adding in the fees for individual funds, that would come to $15 billion a year in fees.
On the other hand, if everyone had the option to invest in the Federal Thrift Savings Plan, we would likely see much of the $6 trillion in assets currently managed by the industry begin to migrate to the federal plan. After all, not that many people are so enamored of insurance companies that they would be willing to throw away thousands of dollars to keep them happy. In that story, they would have more than $60 billion in annual fees at risk, real money even in Washington.
If neo-liberals actually care about efficiency, as they profess, they would be all over this one. After all, the money saved by having a more efficient retirement system would swamp the money involved in tariffs on steel and other things that get them excited. But no one expects neo-liberals to be consistent.
Allowing people to opt into the Federal Thrift Savings Plan should be an ongoing demand for progressives going forward. The industry will be prepared to kill to prevent this from happening, but they lack a serious argument. After all, we can steal a line from their Social Security privatization efforts, “what’s wrong with giving people a choice?”
The State-by-State Strategy
The passage of the Secure Act 2.0 provisions is also a vindication of the state-by-state strategy that progressives have been pursuing for the last quarter century when action at the national level seems blocked. This has been done with increases to the minimum wage, paid sick days and family leave, support for child care, and a number of other areas.
This strategy is effective in both directly providing benefits to large numbers of people, especially in large states like California and New York, and also making policies seem feasible to much of the country. Many of us have been in the habit of pointing to policies successfully implemented in places like Germany, France, or Denmark, but to much of the country we might just as well be talking about Mars. When we can point to a state that has a $15 minimum wage or paid family leave, it sounds like a plausible option for the country.
In the case of the Secure Act 2.0 provisions, many states had already implemented similar bills without the catastrophic effects that businesses often claim will result from progressive legislation. This could give members of Congress confidence that businesses can easily deal with the requirements in the bill.
It also may be good for many companies since offering a retirement plan may help them retain good workers. It’s true that businesses already have this option, but as behavioral economics teaches us, people may often not do what is best for them.
Anyhow, this is one more vindication of the strategy to pursue policies at the state, or even local level, when the prospects for federal action seem bleak. (Yes, I do talk about this in Rigged [it’s free].) It is nice to see a victory here – a good holiday present for tens of millions of workers who stand to benefit.