Americans rely on Social Security to help make ends meet in retirement, with the majority of benefit recipients getting at least half their regular income from the program. The importance of Social Security in the financial survival of tens of millions of participants means it is crucial that they make the smartest decisions possible on benefits.
But a vast swath of the American public approaches retirement with little or nothing in savings, and policymakers are struggling to come up with viable solutions to the problem.
One group believes that a two-part strategy could help reduce the challenges that many retirees face. By making it easier for workers to save using IRAs, researchers at the Pew Charitable Trusts showed that the typical American would be able to delay taking Social Security beyond the earliest possible opportunity. That could have several long-term advantages, but some are skeptical that the strategy would have its intended effect.
IRAs, automatic enrollment, and Social Security
The key part of implementing Pew's suggested strategy is establishing what it calls an auto-IRA. Many 401(k) participants are familiar with auto-enrollment, in which new employees are automatically enrolled in employer-sponsored retirement plans immediately upon their initial hire without having to do anything to get started. The 401(k) automatic enrollment has boosted participation rates substantially, because it takes an active decision not to participate in order to opt out.
The problem with 401(k) plans is that many people don't have access to them. Many employers don't offer a retirement plan, and many other workers have positions as independent contractors that don't provide benefits. Moreover, with frequent job-switching, 401(k) plans that are linked specifically to an employer aren't very portable.
Auto-IRAs aim to change that. In states that have adopted these IRAs or are considering them, workers who don't have access to a 401(k) or other workplace plan would have an IRA automatically established, with a preset percentage of wages sent to the IRA. This in turn would create a retirement nest egg that wouldn't be linked to any one employer and instead would stay with the worker throughout a career.
Where Social Security comes into play
Having outside savings for retirement will help make workers' retirement finances more stable, but Pew suggests a way to essentially reinvest those savings. Its study looked at using the money saved in auto-IRAs to pay for living expenses early in retirement, with retirees spending down that money before claiming their Social Security benefits. By doing so, the monthly Social Security payments that retirees receive once they claim them would be higher for the remainder of their lives, providing greater financial security. For instance, retirees who would ordinarily be entitled to a $1,500 monthly benefit at 67 would get only $1,050 per month if they took benefits at 62, but waiting until 63 would result in a boost to $1,125 per month.
Unfortunately, the results of the study weren't particularly encouraging. Those who saved in a typical auto-IRA for 10 years would only be able to delay claiming Social Security by two to four months. Even after 30 years, typical delay times were six to 10 months, with less than 40% being able to delay a full year and less than one in five people being able to wait on Social Security for as long as two years.
Why auto-IRAs aren't enough
Auto-IRAs can't solve the problem entirely because of their own challenges. As people change jobs, some employers will offer workplace retirement plans, and so those workers won't be eligible for auto-IRAs. The model also assumed that some participants would choose not to participate as fully as the default provisions allowed.
Most important, though, is that default provisions for automatic enrollment generally aren't sufficient to make a huge difference in the financial lives of workers. Most auto-IRAs have a default contribution rate of just 3% of your salary. With most planners suggesting savings of 10% of earnings, the shortfall is evident. If you make $50,000 a year and save 3% for 10 years, you'll have accumulated just $15,000 in contributions -- less than four months' worth of wages. Even allowing for a reasonable investment return in that time span, the impact won't be nearly as large as most people need in order to be financially secure in retirement.
The right combination
The concept of automatic enrollment is a good one, but to be truly effective, it would be better for contributions to be mandatory. Results from countries like Australia that have mandatory systems to save for retirement have higher contribution percentages, and that helps generate enough savings to cover expenses for a much longer period of time in retirement.
Even without those mandatory provisions, workers should make it their goal to be able to save enough to make a meaningful difference in their ability to make smart retirement financial decisions. Whether that involves spending down savings to delay Social Security or taking Social Security early while preserving the tax-deferred or tax-free growth that IRAs can provide, having another source of retirement income opens up options that most people currently just don't have.
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