Time to Read: 11 minutes

The American retirement system is in crisis. Workers don’t save enough. They draw down their nest eggs too soon and too quickly. And even professionals face enormous challenges in determining how to ensure someone’s savings will last their lifetime.

Beyond that, pension income is increasingly rare and there are few assurances Social Security payouts will remain at current levels. Meanwhile, every member of the massive baby boomer generation—some 73 million people—will be over 65 by the end of this decade. People are living longer, healthcare costs are rising sharply and the financial markets are unusually volatile—all factors complicating how people plan to live in retirement.

ADDRESSING THE U.S. RETIREMENT CRISIS

There is hope, though. Policymakers are beginning to expand their focus from simply ensuring people save enough to also making that savings last. It’s becoming easier for employers to offer workers what they need to achieve a secure retirement, and there is a growing acknowledgment that employers need to focus on what happens after employees retire.

At the 2023 TMRW client conference, Beverly Goodman, TIAA’s editor in chief and a CERTIFIED FINANCIAL PLANNER™, sat down with three of the retirement industry’s leading thinkers and researchers to discuss the main challenges—and potential solutions—employers and employees need to consider.

The conversation included Christine Benz, director of personal finance and retirement planning at Morningstar, Inc.; Anqi (Angie) Chen, senior research economist and assistant director of savings research at the Center for Retirement Research at Boston College; and Michael Finke, professor of wealth management and Frank M. Engle Chair of Economic Security at The American College of Financial Services.

WHAT’S CAUSING THE AMERICAN RETIREMENT CRISIS?

TIAA: Let’s start with the broad problem: At least 40% of American households risk running short on money in retirement, according to the Employee Benefit Research Institute. Can someone break down what that means?

Anqi Chen: There are two components to being able to maintain our same standard of living in retirement: saving enough, and then drawing down that savings so it lasts a lifetime.

Michael Finke: Many workers often have no idea how much they’re saving, and some of them don’t even know that they’re saving: More than half of workers are defaulted into target-date funds. That’s an improvement from the past, and people have saved more as a result.

But then they get to retirement and we dump maybe a quarter of a million dollars in their lap and say: “Good luck! You’re on your own!” 

Christine Benz: There’s the savings problem, and then there’s the problem of helping people sort out how to manage their savings once they hit retirement. The saving phase is like being on a bus. Someone provided the vehicle and we’re all heading in the same direction to the same destination.

Then, at retirement, we get dropped off in a big parking lot with lots of cars, but many of us don’t know which direction to take. Some of us don’t even know how to drive.

CHALLENGES OF SOCIAL SECURITY AND GOVERNMENT POLICY

TIAA: Doesn’t Social Security help ensure a certain standard of living?

Benz: You hear a lot that Social Security replaces a higher percentage of income for lower-income workers than it does for higher-income workers. That’s true, but the average Social Security benefit for a 65-year-old in 2022 was about $2,400 a month; the average monthly benefit for all current retirees is even less than that—around $1,800 a month.¹ In many parts of the country, that’s simply not enough as a sole, or even main, source of income.

TIAA: So an overreliance on Social Security means that many people, even higher-income workers, face a diminished lifestyle.

Finke: Yes, there are lots of what I call upper-middle class workers in their 50s, 60s and 70s who largely missed out on the pension era [because they were too young], and didn’t benefit as much as younger workers from regulations that helped people save by defaulting them into defined contribution retirement plans, like 403(b)s and 401(k)s.

There’s a lot of variation in the amount of money these people saved, and a lot of people simply did not save very much.

TIAA: Most government policy has been aimed at fighting inertia on the saving side, such as provisions allowing auto-enrollment into retirement plans, auto-escalation of contributions and defaulting into a target-date fund instead of a money market fund. Are these policies necessary?

Chen: They matter a lot. Many workers don’t save for retirement on their own, and don’t make the right choices with their savings, so plans with auto-enroll type features will always help on the savings side.

SOLUTIONS TO THE SPENDING CHALLENGE

TIAA: What about the challenge of helping people turn their savings into income that lasts throughout retirement?

Finke: In some ways we’ve insulated people from making any active decisions about saving or investing, and now they are tasked with the responsibility of making a very complex math calculation, which is: “How do I turn this money into a lifestyle?”

Benz: Longevity is a factor, too. There have been incredible strides in how long people live. People being retired for 25 or 30 years creates an enormous financial challenge. Newer policies recognize this challenge: The first SECURE Act, passed at the very end of 2019, made it easier and safer for employers to offer an annuity in a 401(k) plan. [Annuities have long been offered in 403(b) plans.]

Chen: Exactly. The main benefit of an annuity is longevity insurance.

TIAA: I like the term “longevity insurance.” Can you explain further?

Finke: With an annuity, you’re transferring market risk to an institution that is willing to provide you income even after you would have run down your savings account. If the market goes down, or if you live a very long time, you know that you’re never going to run out of income.

TIAA: What else do you find notable about SECURE Acts 1.0 and 2.0?

Finke: The exciting thing is that we are getting closer to incorporating annuities into target-date funds. Annuities can and should be in a sleeve of target-date funds you can build up over time. [Target-date funds own several stock and bond funds and shift allocations among those funds to become more conservative over time.]

By the time you hit your mid-60s, the annuity might represent 30% to 40% of your total savings. You don’t have to annuitize at retirement, but it does mean that the people in the default—the least-engaged people—will automatically have some of their money in an annuity, which is a crucial piece of retirement planning.

ANNUITIES IN RETIREMENT PLANS

TIAA: Why do annuities belong in workplace retirement plans?

Finke: Employers are required to make sure any annuity they add to a plan is in the best interest of the worker. That’s their fiduciary obligation. Right now, people retire and roll their money into an IRA, and nobody asks them, “How much do you want to turn into lifetime income?”

Benz: There are educational gaps when it comes to retirees making the most of their savings. We’re handing people their life savings at a point in their lives when, for some people, decision-making is becoming progressively more difficult.

Finke: We have got to do a better job to ensure we’re providing either better guidance on how to safely withdraw your money, or on reducing longevity risk. And the way to do that is through annuitization.

TIAA: Why isn’t annuitization more popular? Academics and economists almost universally see the importance of having a guaranteed stream of income, but many investors and advisors remain skeptical.

Chen: There are a multitude of reasons why people don’t annuitize. People with pensions are used to thinking about their benefit in terms of monthly income based on a percentage of their pay. Conversely, the defined contribution world frames retirement readiness around building a pile of money. We should reframe that and instead ask how much income that big pile of money can buy you. That would help people understand the value of an annuity.

But people get attached to their account balances, and sometimes it just doesn’t feel good to give your savings to someone who says, “We’ll give you $600 a month.”

Finke: Market conditions have been a big challenge. In a low-interest-rate environment like we’ve had for more than a decade, it costs a lot to buy income. There’s a general lack of awareness of how expensive income is. It could take $500,000 to produce $35,000 of income every year in retirement.

Benz: Compensation models for financial advisors are in the mix, too. Many people pay financial advisors a percentage of their invested assets. So advice that steers money out of an investment account—whether it’s to pay down a mortgage or buy an annuity—reduces the advisor’s fee.

Chen: Many advisors say they want their clients to have flexibility, in case there’s a health shock or they need a big sum of money for something.

Finke: But part of the puzzle is that most people can spend more if they have an annuity. Their other assets can be invested more aggressively, and they can draw from the annuity without worrying about how removing a chunk of their savings will affect their lifestyle 10, 20, 30 years down the road.

Benz: Also, rightly or wrongly, annuities are inextricably linked to high costs and high commissions for many people.

Finke: The way that sales are regulated and because of compensation issues, there may be an incentive for the products to be mis-sold in the retail space. And that mis-selling can lead to a negative perception and a fear of annuities.

That creates this gap between the way economists think about annuities, which is a very efficient way to generate income, and the way many consumer financial advocates think of annuities, which is that they’re dangerous.

MANAGING RETIREMENT RISKS

TIAA: The annuities offered in workplace retirement plans are different than those sold directly to consumers. You mentioned earlier the employer’s fiduciary duty to choose an appropriate product, which means employees may have better options inside of a plan versus buying one on their own. What else?

Finke: In an in-plan annuity, investments are sold at volume, so administrative costs can be reduced. The other benefit is the average plan participant is probably not going to live as long as the average retail annuity buyer, so the insurance company can potentially provide a more generous quote to participants. Because of all this, plan sponsors can really improve the well-being of their participants by offering in-plan annuities.

TIAA: We’ve talked a lot about income in retirement. How do annuities factor into saving?

Finke: Annuities in the accumulation stage give people more clarity about how much income they’re building over time. If the annuity is in a target-date fund, participants can see how much annual income they’ve been buying, and watch that income rise over time. It can motivate people to save more, because they’ll more easily see how their savings translates into monthly spending.

Benz: If you make ongoing, regular contributions to an annuity over the course of your saving years, you’re able to experience a variety of interest rates in your plan account. That reduces your point-in-time risk.

TIAA: So essentially, you’re dollar-cost-averaging into the prevailing interest rate.

Benz: Exactly. Think about someone who may have wanted to annuitize two years ago, when interest rates were essentially at zero and bond yields were very low. That’s a tough environment for insurers, since they need to invest in a way that allows them to guarantee that income. Annuity rates are tied to bond yields. So if you purchase a simple annuity when annuity rates are low, you’re stuck with that payout.

If you make ongoing, regular contributions to an annuity over the course of your saving years, you’re able to experience a variety of interest rates in your plan account.

Finke: Annuities also provide tax-deferred growth for tax-inefficient investments like bonds, which are what most providers of fixed annuities invest in to guarantee their payouts. They can be a good alternative to investing in taxable bonds.

TIAA: Thank you all very much. This has been a terrific conversation.