Retirement crisis: DC plans are leaving Americans workers unprepared
America faces an unprecedented retirement crisis with many workers completely unprepared for retirement. See how the shift from DB plans to DC plans contributed to the problem and how companies can fix it.
Many older Americans face a dire problem: they’re nearing retirement age without a penny saved. More than a quarter of people (27%) aged 59 or older have zero retirement savings, even though the average American estimates they’ll need $1.25 million for a comfortable retirement. On top of that, current retirees are increasingly worried about outliving their savings.
Understanding the retirement crisis
What’s driving the crisis? The shift from defined benefit (DB) plans to defined contributed (DC) plans. It started in 1978 when Congress created tax structures to defer compensation, paving the way for 401(k) plans. Before the 1980s, the most common retirement plan was a DB program – offering employees guaranteed lifetime income from their employer. The promise of a pension incentivized employees to stay with an employer for 20, 30, or even 40 years.
Today most Americans have access to an employer-sponsored retirement plan, usually a 401(k). In 2020, 34.6% of working-age Americans had contributed to a 401(k)-style/defined contribution (DC) account, 18.2% had an IRA-style account, and 13.5% had a defined benefit (DB) plan.[i] Yet the median 401(k) balance amongst Vanguard’s more than 30 million investment clients was just $35,345, falling significantly short of the estimated $1M+ needed to retire comfortably.[ii] Without a pension plan, American workers without the ability to save consistently are left relying on Social Security for the bulk of their retirement income. Very few Americans can save the recommended amount of money to retire with a 401(k), especially in their 20s and 30s. A common rule of thumb is that retirees should aim to save around 12% to 15% of their pre-retirement income to a 401(k), including employer contributions, to maintain their standard of living. [iii] The reality is that everyday expenses such as mortgages, health and school expenses, student loans and credit card payments take precedence over retirement savings.
Social security doesn’t pay enough money to live on now and might not exist when the younger generations retire. In 2022, the maximum monthly Social Security benefit was $3,345, with the average monthly Social Security income hovering at just $1,657. Fewer people are counting on Social Security being available in the future, with 73% of millennials and Gen Z concerned that Social Security will no longer exist when they reach retirement age.[iv]
The retirement plan design of the future
With an insufficient retirement system, Americans of all ages consistently find themselves between a rock and a hard place. Lacking a guaranteed income stream and forcing employees to make their own investment decisions, the current DC system is failing Americans. Even if they save enough to retire, people fear outliving their wealth and want guaranteed lifetime income benefits.
Fortunately, the Secure 2.0 Act (passed by Congress and signed into law by President Biden in 2022) is helping usher in a new era of retirement plan design. The law supports market-based cash balance plans, creating guaranteed lifetime income for employees and a cost-efficient path for employers to invest in employee retirement. By implementing an effective retirement program, companies are incentivizing employee loyalty and helping society. This is the future of American retirement.
Be a part of the solution. Contact us today to learn more about using these innovative, modern DB retirement programs at your company. One of our expert actuaries will walk you through all the details and show you how we can customize a plan for your organization.
Sources Cited:
[1] https://www.census.gov/library/stories/2022/08/who-has-retirement-accounts.html
[2] https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_FullReport_2022.pdf
[3] https://www.cnbc.com/2022/07/30/vanguard-how-much-americans-have-saved-for-retirement-by-age.html#:~:text=On%20average%2C%20Americans%20have%20around,k)%20balance%20is%20just%20%2435%2C345.
[4] https://www.stagwellglobal.com/what-the-data-say-gen-z-banks-on-retiring-early-but-not-on-social-security/