You’ve probably heard some of the dire statistics.
According to a 2018 Northwestern Mutual study, 1 in 3 Americans have less than $5,000 saved for retirement, while 21 percent of Americans have no retirement savings at all. Research from Kellogg visiting associate professor of finance Enrichetta Ravina finds that just one quarter of Americans are saving enough in their 401(k)s to maintain their current standard of living.
Ben Harris, executive director of the Kellogg Public–Private Interface and former chief economist to Vice President Joe Biden, is particularly concerned about how the middle class will fare.
After all, those who are already used to living on a very low income can likely rely on Social Security and Medicare to maintain their living standard, while the very highest earners should be able to afford a comfortable retirement.
But anyone who falls between these two extremes might be in trouble. From rising costs of living to unexpected medical expenses to a lack of financial literacy, many middle-class workers are struggling to save enough to maintain a comparable quality of life once they retire. Add to this the fact that people are living longer, and it’s hard to even know how much to save.
“We have no idea how long we’re going to live,” he says. “When it comes to retirement savings, the biggest source of uncertainty is that no one knows their own life span. It’s almost an impossible planning situation.”
Despite these challenges, there are steps that both individuals and policymakers can take to help America’s middle class lead a better retirement. Harris has suggestions for both groups.
Take an “All Hands” Approach to Retirement Savings
The best time to start saving for retirement is early. Really early. Like at birth.
Ultimately, building a retirement fund means more than ensuring financial security for those golden years, says Harris. It also helps to make those years more golden.
“You get to a point in your life when working is no longer a strong option because you become less productive or because you want to make yourself happy,” he says. “The only way you can make that happen is to have some sort of income during that period.”
The first step in that journey is for people to learn nuts-and-bolts financial literacy as early as possible.
“Get into the weeds about how to be financially literate,” Harris says. “It’s not about understanding compound interest, or even math equations. It’s knowing how to open and IRA by your 18th birthday. It’s knowing how to select mutual funds.”
Another part of that literacy is knowing that you should always meet your employer’s 401(k) matching contribution. Otherwise you are leaving money on the table.
“If I told you there was a stock that returned 100 percent the next day, you would buy it,” Harris says. “That’s what matching your 401(k) does. It immediately doubles your money. It’s the best investment you can make.”
People can also find huge savings by negotiating over fees for services such as realtors and financial advisors.
“It’s uncomfortable, and people don’t like doing it,” Harris says, “but these things are open for negotiation, and you’re going to save yourself a ton of money if you’re willing to do it.”
Find Advisors Who Don’t Charge Excessive Fees
Middle-class workers also need to be savvier about the fees paid to their financial advisors. Advisor fees can vary substantially and are charged on top of other fees savers might pay—such as management fees or sales charges—in addition to the administrative charges associated with a brokerage account. While the fees charged might seem small, they can really eat away at the account’s earnings.
Say your portfolio has a rate of return of 6 percent annually. Inflation might eat up 2 to 3 percent of that. Another percent might go to taxes, leaving you with 2 percent. If your brokerage fees total 1 percent, you’re giving a big chunk of your return to your advisor.
“If I told you there was a stock that returned 100 percent the next day, you would buy it. That’s what matching your 401(k) does. It immediately doubles your money. It’s the best investment you can make.”
“That starts feeling crazy, right?” Harris says. “It shouldn’t be thought of as 1 percent of your overall assets, but as what share of your expected return are you giving up.”
While fees are, in general, going down, reviewing your advisor’s fees sooner rather than later can save you a lot of money. If you think your fees are too high, consider purchasing low-fee mutual funds or working with a company that uses robo-advisors—software programs that select investments and build portfolios.
“People just need to really think hard about fees and be as diligent as they can about making sure they’re getting the value they deserve.”
Get a Longevity Annuity
For individuals worried about running out of money, Harris suggests considering a longevity annuity. These annuities take some of the guesswork out of retirement planning by paying retirees a set income once they have reached an advanced age—such as 80 or 85.
“They’re insurance against being in your late 80s and 90s, unable to return to the labor market and without any income,” Harris says.
The longer the retiree waits to start the annuity, the larger the monthly cash payout. As a rule of thumb, Harris cites research recommending retirees invest about one-fifth to one-seventh of their wealth in a longevity annuity.
Rules forcing retirees to withdraw a set amount from retirement accounts at age 70 ½ used to be a formidable barrier to these products. But in 2012, the government changed the rules so that workers can invest up to 25 percent of their IRA and 401(k) balance or up to $125,000 (whichever is lower) into what’s called a qualified longevity annuity contract (QLAC) without facing penalties. The hope was that this change would jumpstart sales, but they have yet to catch on.
So why aren’t more people buying longevity annuities? One reason is what Harris calls “the annuity puzzle.” Rather than tying their money up in an irreversible annuity, people want control over their assets. Others bristle at the insurance analogy. Why spend your retirement on an annuity you might not collect?
“It’s driving some economists absolutely mad,” Harris says. “I’ve never heard anyone complain that their house didn’t burn down and therefore they wasted their money on homeowner’s insurance.”
Policymakers Should Replace Income-Tax Breaks with Upfront Credits
On the policy side, the middle class faces a big hurdle in the way tax deferred retirement accounts such as 401(k)s are incentivized. In these accounts, workers make pre-tax contributions; once they retire and start drawing from the funds, the money is taxed at a rate that depends on their income that year.
That’s great for high earners, who can see a substantial tax savings if they end up in a lower tax bracket later in life. But studies show that the deferment has a more modest benefit for workers with lower levels of income.
“If I’m a high-income individual right now, I’m in the 37 percent bracket. Every dollar I give to my 401(k), I get to write off 37 cents,” he says. “But if I’m in a lower-tax rate or a zero-tax rate, my tax break is close to nothing or nothing.”
That becomes more disturbing when you consider that the United States spends more than $200 billion a year on retirement subsidies, part of which includes the 401(k)-tax deferment.
Harris suggests that rather than spending federal money on ineffective deferments, Congress direct that money toward a 25 percent credit for every retirement dollar saved, regardless of income. This would give middle-class workers a benefit—either immediately or when they file taxes—regardless of tax bracket.
“The person who is getting a 37 percent write-off will now only get 25 percent like everybody else,” Harris says. “People at the top get a little bit less, but a lot of people in the middle will get a bit more.”
While he hasn’t 100 percent bought into the idea, Harris recommends policymakers consider a pilot program to distribute federally subsidized child trust accounts—also called “baby bonds”—to newborn children in America, with larger bonds distributed to children from poorer families. These government bonds would not mature until the child turns 18, but could then be used for a variety of qualifying expenses such as college or buying a home.
Child trust accounts have a number of potential benefits. They provide children with a “nest egg,” available once they reach adulthood. This nest egg could be invested in their own future earnings—or at the very least assist with costs like student loan debt that make saving for retirement difficult. They also promote financial literacy from a young age.
“As a child, you’d know about this account and learn about saving for the future,” he says. “But the main idea is from literally the first day of a person’s life, you get them saving.”