A few weeks ago I finished a paper arguing for mandatory retirement contributions from both employers and employees. Though arguably the paper will not come close to changing public policy on retirement plans, it did raise some arguments in favor of the United States adopting a mandatory savings plan.
In the paper I explained that research has shown that individuals risk not having enough saved for retirement. This could be due to employees not having a retirement plan through work or because employees face an abundance of mutual fund options in the plan that they don’t know where to begin. Some of these employees choose the default option or simply go with what a colleague recommends.
Another problem the paper addresses is the declination of defined benefit pensions. Such pensions are employer sponsored and funded, thus removing funding an investment risk from the employee. At retirement the employee receives a guaranteed income for the rest of his life. The concerns of these plans are they can be costly for the employer to maintain and in the case of Illinois, can be drastically unfunded.
The majority of employees that have retirement plans have access to defined contribution plans. In these plans the employee is responsible for funding, investing and distributing the money at retirement. The employer only sponsors the plan and may provide a matching sum. Those without any employer plan are left with saving in IRAs, myRAs, or other non-qualified accounts.
Proponents of mandatory savings plans include Froman (2009), David (2007), Statman (2013), and Ghilarducci (2007, 2009). Most notably, Teresa Ghilarducci recommends a 2.5% contribution from both employer and employee to an account maintained for the benefit of the employee. The accounts would have investment options similar to the Thrift Savings Plan for government employees as well as a guaranteed interest account.
At retirement the entire account must be annuitized to provide guaranteed income for the retiree’s life. I agree with this method. This provides at least some guarantee that a retiree will have income for life. This is what annuities are designed to do – provide longevity insurance.
Following in Ghilarducci’s footsteps, I recommended a higher savings rate similar to what Ibbotson, Xiong, Kreitler, Kreitler, Chen, P., (2007) and Pfau (2011). At the very least, I suggest a minimum default savings rate of 10% with gradual 2% increases annually to 20%. This is similar to what Bateman & Piggott (1998) found in Australia’s mandatory plan.
A mandatory plan will remove the need for employers and financial planners to “nudge” employees and clients to save for retirement. Under a mandatory plan, the decision is made for them. In this case, some income for retirement is guaranteed.
References
Bateman, H., & Piggott, J., (1998). Mandatory Retirement Saving in Australia. Retrieved March 20, 2015, from
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.196.2562&rep=rep1&type=pdf
David, D., (2007). Mandatory Retirement Plans? Not Quite, but Close. Journal of Pension Benefits. 56-58.
Forman, J. (2009). Should We Replace the Current Pension System With A Universal Pension System? Retrieved March 24, 2015 from
http://jay.law.ou.edu/faculty/jforman/Articles/2009UniversalPensionsJPenBen.pdf
Ghilarducci, T., (2007). Guaranteed Retirement Accounts: Toward Retirement Income Security. Retrieved April 10, 2015 from http://www.gpn.org/bp204/bp204.pdf
Ghilarducci, T., & Arias, D. (2009). The High Cost of Nudge Economics and the Efficiency of Mandatory Retirement Accounts. Retrieved April 17, 2015 from http://www.economicpolicyresearch.org/images/docs/retirement_security_background/The_High_Cost_of_Nudge_Final_FINAL.pdf
Ibbotson, R., Xiong, J., Kreitler, R., Kreitler, C., & Chen, P., (2007). National Savings Rate Guidelines for Individuals. Retrieved April 9, 2015 from https://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/NationalSavingsGuidelines.pdf
Pfau, W. (2011). Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle. Journal of Financial Planning, 24(5).
Statman, M., (2013). Mandatory Retirement Savings. Financial Analysts Journal, 69(3), 14-18.
Sterling Raskie, MSFS, CFP®, ChFC®
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