Originally published in American City Business Journals
By Joe Rankin
In the coming decade, retirement benefits for the average American will change.
Simple math dictates it: More than 9,000 Americans reach the retirement age of 65 every day, and they will need more money in retirement because people are living longer, healthier lives. One number sums up the nature of the challenge facing the aging Americans and our government in Washington. According to the Urban Institute, in 2010, there were 0.25 adults age 65 and older for every adult aged 25 to 65. That ratio will almost double to 0.48 by 2060.
That shift has huge implications for funding such government programs as Social Security, and also the amount of money people will need to save for their elderly years. In the future, retirement benefits will change accordingly.
Here are six ways retirement benefits could change:
1. The end of employer-provided pensions
The private sector has mostly moved away from employer-sponsored defined benefit pension plans to defined contribution plans, typically 401(k)s. Pensions covered 30 percent of adults born in the 1940s and 1950s but only 11 percent of people born in the 1980s have them.
That trend will continue as states and municipalities phase out pensions in exchange for defined-contribution plans. Leading that trend is Michigan, which ended pensions for new state workers in the late 1990s and now puts new teachers in a 401(k) plan. Other states and municipalities will follow suit.
Similarly, while many universities have defined benefit pension plans, they will find it increasingly difficult to sustain those benefits as a component of higher tuition in the age of rising student debt.
2. The rise of annuities
Many Americans are not saving for retirement — only 32 percent of U.S. workers are said to contribute to 401(k) plans — partially because they may be turned off by the dizzying array of options open to them. An alternative that’s growing in popularity is offering an annuity that pays a pre-determined amount every year during retirement until death.
Annuities offered within a 401(k) will appeal to anyone who does not want the responsibility and stress of managing their own investment choices. Annuities are especially popular among millennials, according to the Indexed Annuity Leadership Council, suggesting that their use will increase.
In times of low, long-term bond rates, annuities can be expensive to purchase, thus limiting their availability and use. As the qualified plan annuity market matures, annuities will become more affordable and common.
3. Taxing retirement contributions
There’s every reason to expect that lawmakers will change the tax code that currently allows people to save for retirement in pre-tax dollars and then taxing them when they withdraw that money. Why? With $7.3 trillion already saved in 401(k)-type defined contribution plans and another $8.2 trillion in individual retirement accounts (mostly rolled over from 401(k)s), Washington would gain a windfall if it could currently tax contributions that have already been deposited in retirement savings accounts rather than taxing the withdrawals as taken at retirement.
Capturing taxes on the more than $15 trillion in retirement accounts is such a huge temptation, it’s hard to imagine it being ignored.
Washington could not just tax these monies and walk away — that would mean the end of all U.S.-based retirement plans. There would have to be a provision that allowed for tax-free build up and tax-free withdrawal of the amounts deposited. This is similar to the currently available Roth IRAs and Roth 401(k) plans.
4. Growing Health Savings Accounts
For someone living 20 years in retirement, the cost of health care can be as much as $250,000 per person, or $500,000 for a married couple. Since all retirement savings are taxed, that’s an expense for which Americans cannot efficiently save.
A tax fix could encourage Americans to stash that money away tax free — allowing people to save and withdraw tax-free dollars in vehicles such as HSAs to meet these expenses. Many municipalities already do this, so codifying that kind of benefit and offering it to everyone makes sense.
5. For Social Security benefits, 70 is the new 65
The normal retirement age to commence Social Security benefits used to be 65 but was raised to 66 for those born between 1943 and 1954 and hiked to 67 for those born in 1960 or later.
In addition, people can choose to draw reduced benefits early (as young as 62) or defer and receive increased benefits as late as age 70.
In the coming years, it makes sense for the Social Security Administration to raise the normal retirement age to 70 without the option to receive greater benefits if the commencement is deferred past normal retirement age.
6. The rise of MEPs (Multiple Employer Plans)
Most Americans work at small companies, but only 50 percent of them have access to a retirement plan. One reason is because small companies pay much higher fees, as much as 3 percentage points of assets annually, compared to less than 1 percentage point for large company retirement plans.
That could be fixed if Washington changed the tax code to encourage MEPs, where companies band together to get the same beneficial prices granted to larger companies.
Numerous states are seeking ways of extending the efficiencies of public retirement systems to offer retirement plans to private-sector workers. State-based plans may be efficient but could fall short elsewhere; the one advantage of an MEP is that the federal protections under ERISA are available to all participants.
Like anything involving complex policy changes in Washington, exactly how all this will play out is impossible to predict. Nevertheless, with Americans living longer and not saving enough for retirement, addressing these issues will head off a societal problem everyone wants to avoid — having a growing, aging population unable to pay for themselves.
Joe Rankin leads Plante Moran’s Employee Benefits Consulting practice.