I think most of us have known for a while that, as a country, we are badly underprepared for retirement. However, only recently did I realize just how far off the mark we are.
According to new research released by UC Berkeley researcher Dr. Nari Rhee, the median working-age American household has only $2,500 in retirement savings.
There's a key reason for this: Over 45% of workers aged 25 to 64 don't have access to a retirement plan such as a 401(k) or a 403(b) at work. If you remove that group and look at folks with workplace retirement plans, savings jump to $50,000 overall -- not great, but much better than $2,500.
The lack of workplace retirement plans is a big hole in America's retirement framework, and it's a crisis for workers who are stashing very little away for their golden years.
Three states have decided that it's time for a change.
How three states are fighting back
As originally reported in The Wall Street Journal, California, Illinois, and Oregon are in the process of setting up retirement accounts for these vulnerable workers. All three states expect to automatically enroll all eligible workers into these accounts and to make automatic 3% deductions from workers' paychecks into these accounts. Beneficiaries will have the option to opt out if they do not wish to participate.
In many ways, it's a great idea. Automatic enrollment in retirement plans has been shown to increase workers' nest eggs. When the path of least resistance becomes saving, people have to go out of their way not to save. The states don't match contributions, but at least this gives workers an easy avenue to contribute.
Unfortunately, it's not nearly enough to solve the problem.
There's more to be done
The first and most obvious problem is that only three states out of 50 have taken this step so far, although a number of other states are discussing similar solutions. And the required savings amount isn't nearly enough: Most folks need to save a lot more than 3% of their income each year to live comfortably in retirement. The exact number differs based on whom you ask, but 10% to 15% is a common rule of thumb.
These programs are in the very early stages, and policymakers should consider making a number of tweaks to these accounts in order to boost savings rates and help people make effective investing decisions.
A few cheap or free ideas immediately come to mind.
1. Increase the automatic deferral to at least to 6%. As I noted, 3% isn't nearly enough for people to save if we're hoping to fight back against this retirement crisis. The Defined Contribution Institutional Investment Association suggests a minimum 6% deferral in 401(k) plans -- and I see no reason states can't target the same number for their retirement plans. Workers should, of course, have the option of scaling back down to 3% -- or even opting out -- if their financial circumstances don't enable them to save that amount.
2. Implement automatic contribution escalations. Building in automatic increases in retirement savings rates each year has been proven to work. In one study, 31% of 401(k) plans that did this reported participant savings rates of 10% or higher, compared with about 20% of 401(k) plans without the escalation built in. These increases don't have to be big, either: Just a 1-percentage-point bump per year is a near-painless way to encourage workers to gradually increase their savings rates.
3. Financially educate participants. It's not enough to force people to save with automatic deferrals. States also need to teach people about saving and asset allocation. Dartmouth professor Annamaria Lusardi's 2002 research suggests that seminars on finance are particularly helpful for lower-income, lower-wealth workers. She notes that financial education particularly "affect[s] those who save the least." This is also an excellent opportunity to talk about the benefits of low-cost index funds, tax savings in retirement plans, and so on.
More to come
This is an early stage of the fight to boost retirement savings rates for workers without a retirement plan. Hopefully, these three states will implement and scale improvements to their initial plans to help address the gap between what these workers need for retirement and what they're saving. The important thing is that states are recognizing this crisis for what it is, and they're working to help Americans achieve the retirement we're all seeking.