The US pension system gets a “C+” grade, experts say – despite being worth $39 trillion. Here’s why – CNBC | Jewelry Dukan

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The US pension system may appear smooth – but it compares poorly to those of other developed countries.

Overall, Americans had more than $39 trillion in retirement assets at the end of 2021, according to the Investment Company Institute.

However, the US ranks well outside the top 10 in various global pension rankings by industry players, such as the Mercer CFA Institute Global Pension Index and the Natixis Investment Managers 2021 Global Retirement Index.

According to the Mercer Index, for example, the USA received a “C+”. It ranked number 17 on Natixis’ list.

That’s why the US is falling short, according to pension experts.

The US has a ‘patchwork retirement design’

Iceland topped both lists. According to the reports using different methodologies, among other things, the country offers generous and sustainable pension benefits to a large segment of the population, has low levels of old-age poverty, and has a higher relative degree of income equality in old age.

Other nations including Norway, the Netherlands, Switzerland, Denmark, Australia, Ireland and New Zealand also received high marks. For example, Denmark, Iceland and the Netherlands each received an “A” grade on the Mercer Index.

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According to experts, the US lags far behind these countries because its pension system is not set up in such a way that everyone has a chance of a financially secure retirement.

“Even though we’ve invested $40 trillion, we’re working with a very patchy, fragmented retirement patchwork in the United States,” said Angela Antonelli, executive director of the Center for Retirement Initiatives at Georgetown University. “Some people are doing very, very well, but many others are falling behind.”

Consider this statistic: Only three of the 38 countries in the Organization for Economic Co-operation and Development rank worse than the US on old-age income inequality according to the developed countries bloc.

In fact, poverty rates for Americans age 75 and older are “very high”: 28% in the US versus an average of 11% in the OECD.

Many Americans don’t have any retirement plans at work

The US pension system is often referred to as a “three-legged stool” made up of Social Security, workplace regulations like pensions and 401(k) plans, and individual savings.

According to pension experts, one of the main shortcomings of the structure is the lack of access to company savings plans.

Just over half — 53% — of U.S. workers had access to an employer-sponsored retirement plan in 2018, according to a recent estimate by John Sabelhaus, a senior fellow at the Brookings Institution and an associate research professor at the University of Michigan. That’s an improvement from nearly 49% a decade ago, he noted.

Even though we’ve invested $40 trillion, we’re working with a very uneven, fragmented patchwork of retirement in the US

Angela Antonelli

Executive Director of the Center for Retirement Initiatives at Georgetown University

According to an analysis by the Center for Retirement Initiatives, in 2020 about 57 million Americans fell into the retirement “gap,” meaning they didn’t have access to a workplace plan.

The United States has a voluntary pension system. The federal government does not require individuals to save or companies to offer an annuity or 401(k). Individuals are also taking on more personal responsibility to build a nest egg as companies have largely moved away from pension plans.

In contrast, according to OECD data, 19 developed nations require some level of coverage by requiring companies to offer a pension plan, individuals to have a personal account, or a combination of both. In 12 of the countries, the schemes cover more than 75% of the working-age population. In Denmark, Finland and the Netherlands, for example, the proportion is almost 90% or more.

In Iceland, where coverage is 83%, the private sector pension system “covers all workers with a high contribution rate, resulting in significant assets being set aside for the future,” Mercer wrote.

IRAs are not a hodgepodge for workers without a 401(k)

Of course, people in the US can also save for retirement outside of the workplace — for example, in an individual retirement account — if their employer doesn’t offer a retirement plan.

But that doesn’t often happen, Antonelli said. According to the Investment Company Institute, just 13% of households contributed to a pre-tax or Roth IRA in 2020.

Sticking to a plan can help achieve retirement goals

IRAs held nearly $14 trillion in 2021, nearly double the $7.7 trillion in 401(k) plans. But most IRA money isn’t paid directly — it’s first saved in a company pension plan and then put into an IRA. In 2019, $554 billion flowed into IRAs — more than seven times the $76 billion in direct deposit, according to ICI data.

Lower annual IRA contribution limits also mean individuals can’t save as much each year as they can on workplace plans.

According to AARP, Americans are 15 times more likely to save for retirement if they can do so through payroll deductions at work.

“Access is our number one concern,” said Will Hansen, chief government affairs officer at the American Retirement Association, a trade group, of occupational retirement plans. Small business employees are the least likely to have a 401(k) available, he added.

“[However]the pension system is actually a good system for those who have access,” said Hansen. “People save.”

But the retirement savings that those savings provide are geared toward high-income households, according to federal data.

Low earners, on the other hand, “appear to be more prone to having little or no savings [defined contribution] accounts,” the Government Accountability Office wrote in a 2019 report. A 401(k) plan is a type of defined contribution plan in which investors “define” or choose their desired savings rate.

According to a 2017 report by the Social Security Administration, only 9% of the bottom quintile of wage earners have a pension, versus 68% of middle-income earners and 94% of the top quintile.

Overall savings are also “constrained” by low wage growth after accounting for inflation and rising intrinsic costs for items like health care, GAO said. Longer lifespans put more pressure on nest eggs.

Social security has some structural problems

Social Security benefits — another “leg” of America’s three-legged chair — help make up for a lack of personal savings.

About a quarter of senior households depend on these public services for at least 90% of their income, according to the Social Security Administration. The average monthly benefit for retirees is about $1,600 as of August 2022.

“That doesn’t get you much above the poverty line,” Antonelli said of Social Security benefits for people with little to no personal savings.

Social Security Trust Fund well through 2034, SS disability fully funded for 75 years

There are also some emerging structural issues with the Social Security program. Without measures to support funding, pension benefits are likely to fall after 2034; At this point, the program would be able to make only 77% of the scheduled payments.

Additionally, individuals can raid their 401(k) accounts during times of financial need, leading to so-called “leaks” from the system. This ability can provide households with much-needed cash in the present, but can create a bottleneck for savers later in life.

The “leakage” factor, coupled with relatively low Social Security minimum benefits for low-income earners and the projected social security trust fund shortfall, “will have a significant impact on the US pension system’s ability to adequately provide for its retirees in the future,” said Katie Hockenmaier , Research Director for Defined Contributions in the US at Mercer.

“There has been tremendous progress”

Of course, it can be difficult to compare the relative successes and failures of pension systems on a global scale.

Each system evolved out of “specific economic, social, cultural, political and historical circumstances,” according to the Mercer report.

“It’s hard to say that the US is really far behind when there are so many other external policies that countries are making that will impact their citizens and how effective their retirement will be over the long term,” Hansen said.

Flaws in health and education policies affect people’s ability to save, Hansen argued. For example, a high student debt burden or high health care bills may cause an American borrower to delay saving. In such cases, it may not be fair to blame the structure of the US pension system, Hansen said.

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And there have been structural improvements in recent years, experts said.

The Pension Protection Act of 2006, for example, ushered in a new era of savings where employers began automatically enrolling workers in 401(k) plans and increasing their contribution amounts each year.

More recently, 11 states and two cities — New York and Seattle — have introduced programs that require companies to offer retirement programs to workers, according to the Center for Retirement Initiatives. These could be 401(k) plans or a government administered IRA into which workers would be automatically enrolled.

Federal lawmakers are also weighing provisions — like reduced costs versus factors like plan compliance and an increase in tax incentives — to encourage greater adoption of 401(k) plans among small businesses, Hansen said.

“Over the past 15 years – and now considering further reforms in Secure 2.0 [legislation] – There has been tremendous progress in recognizing that there is room to improve the design of our US pension system,” Antonelli said.

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