Bridging the Retirement Gap | Kent Smetters

Understanding the U.S. Retirement Savings Gap

Dan Loney: One of the concerns around retirement savings is the gap between the haves and the have-nots. How do lower-income households secure that level of retirement finance that they’re going to need? It’s an area that has been focused on by the Penn Wharton Budget Model, and we’re pleased to have the faculty director, Wharton professor Kent Smetters, joining us here in studio. Ken, why is this component so important when we think about retirement, especially to do the research that you’ve done on this?

Kent Smetters: About half of households in the United States really don’t have a lot of material savings toward retirement. One could argue that could be optimal if you believe that Social Security benefits, Medicare benefits, and Medicaid — ­­­ because that actually pays for the long-term care component in retirement — if you think that those are going to pay as scheduled. Not having a lot of saving may be OK for a lot of these households. But those programs are under a lot of pressure right now, and they are contributing to large shortfalls in our projected finances for the country. And it’s always good to have your own nest egg.

I think that’s why, on one hand, things get embellished by some people who said that there’s a huge, huge problem here. On the other hand, there is a problem still. Some of it is caused by government policy itself.

Loney: This is something that policymakers are aware of, or at least they want to get more information about, so we know a potential path that we need to go down.

Smetters: That’s right. In particular, policymakers are certainly aware that a lot of the low-income households in their districts are not saving that much for retirement. If we ask why are programs like Social Security, Medicare, and Medicaid the third rail of politics, it’s partly because people become so dependent on those programs, no one wants to touch them. But at the same time, there’s no question going forward, we’re going to have to figure out another approach.

Increasing Retirement Savings for Low-income Households

Loney: A total of $200,000 was the number that you used in the research. Take us through why that’s important in terms of determining the retirement savings that people would have.

Smetters: The thought experiment was as follows. People don’t think we do necessarily a lot of direct subsidy for retirement income in the United States. In fact, we do. When you calculate your AGI, your adjustable gross income, the A component there doesn’t get a lot of attention. But there’s a big, big tax write-off there, and that’s through the fact that you could put in your contributions to a traditional 401(k) on a pre-tax, or as a post-tax for a Roth 401(k). Both are tax subsidies.

We spend, as a country, about $1.25 trillion over 10 years for that subsidy, the combination of the traditional and the Roth. If we just said, “Okay. We know who’s benefiting from that is typically higher-income people.” We also know that it doesn’t have a huge impact on how much they actually save for retirement. That’s what the research seems to suggest. In nerdy language, they don’t have a big elasticity response to the tax incentives there.

If we took that money and set up automated retirement accounts for our lower-income households — and the idea would be, we just simply use the current administration of the earned income tax credit. Basically, the same qualifications, the same rules, different phase-outs in terms of all that — but essentially, we do a 10% contribution of income. So, it’s not like freebies here. You still have to work and so forth. We could use that money to really boost up low-income household savings accounts.

If you’re a younger person, 25 years old, and you’re on one of these low-income paths, we could, over time, get you, on a risk-adjusted basis, closer to around $200,000 of retirement savings that can be annuitized or converted in some type of income. And that could then top up Social Security and things like that.

The same budget costs could be redirected toward lower income, and ultimately totally expand. Since we know the high-income [earners] are not going to cut back a lot in their saving, the low-income [earners] now are going to have saving, and the net saving in society is going to go up.

Loney: What do you think that does to debt overall?

Smetters: What we tried to do is construct it in a way that’s roughly revenue neutral over 10 years. The idea is that we have these different options: small, medium, and large. And different phase outs, different matching rates and so forth. Obviously, we’re not going to be subsidizing 10% of income for really high-income folks, but this is for lower income.

The idea is that the medium one is revenue neutral over a 10-year period. The low is less than — you actually will now make money as the government, save some revenue. And the high costs you a little bit more than current revenue costs associated with the 401(k) and 403(b) type of deductions. Technically speaking, those are adjustments rather than deductions. As a result, we can get low-income households a pretty nice egg. And that’s not playing tricks with crazy returns. This is on the risk-adjusted basis.

Loney: Is the belief that being able to reach that $200,000 plateau is something that can provide lower-income households not only that nest egg, but a level of comfort that maybe they haven’t had in the past?

Smetters: That’s right. And there’s a couple things that can happen with it. One is that, yes, Social Security is going to be there in some form. But Social Security doesn’t guarantee that you will stay out of poverty in old age. It’s possible that your benefit is not going to be that big. And who knows what the future brings, given that the trust fund is going to deplete within a decade.

Also, what we’ve heard from a lot of low-income households over the last 20 years, when I was with the Bush Administration and since then — is that they want to leave something that’s bequeathable to their heirs. We especially heard this coming from Black households, and the Black members, for example, of the Social Security Commission under President Bush, was that there’s this great need for, how do we create intergenerational wealth? And these types of accounts, they will be fully bequeathable. They’re designed in a way that you can’t tap into them before retirement, because you can’t top them up. These are purely non-contribution. The government does the full contribution. Therefore, there’s no right for you to tap into these before retirement. They are truly retirement accounts.

On the other hand, they are fully bequeathable, unlike Social Security. You can’t bequeath your future Social Security benefit after you die. I think this idea of being able to build up intergenerational wealth — helping your kid put a down payment for a house — can create a lot of value for people.

Achieving a Fuller Retirement and Building Generational Wealth

Loney: How do you think that concept tackles the larger issue of being able to build up retirement savings and the understanding of how to go about doing that?

Smetters: There’s stuff in here that I think both sides of the political spectrum should really like. One is a much greater tilt toward low-income houses, building up wealth, and so forth. On the other hand, if I were on the opposite side of the political spectrum, I would say, “You know what? This also means a little less pressure on Social Security, Medicare, and Medicaid.” Some people view this as kind of this camel’s-nose-under-the-tent strategies. There’s no tent there. But the point is, why have half of the population rely so heavily on those sources of income, of Social Security, Medicare, and Medicaid, for long-term care, when I think they’re looking for some more independence.

I think people’s sense of their ability to rely on the government to deliver in the future — especially where our federal debt is exploding right now. We are now making higher interest payments than we’re spending on the military. That does not bode well in history for countries that do that. Given the great uncertainty going forward, this is kind of a more decentralized way of creating comfort.

Loney: Is this a path to trying to get lower-income households the concept of fully-funded retirement savings programs?

Smetters: Well, it certainly can augment that. It’s $200,000 in today’s dollars. Could you live in retirement on $200,000? You probably could. It wouldn’t be a super comfortable standard of living. I think this is more of a top-up for Social Security. But even if Social Security, over time, really focused on poverty relief rather than just this kind of image of the pension-like type system — I mean, that could actually be done really slowly over time, so that people who are age 50 and above today, for example, are not impacted at all. But slowly change the retirement age. Slowly change the benefit structure so that it focuses much more on poverty relief, and so forth. You could save money there, but you could also make sure people stay out of poverty. But they’re not going to have a great life just on Social Security.

But this could actually give them a fuller retirement. And again, for a lot of low-income households, what they really care about is — and I don’t think this gets enough attention. Especially in the Black community, Hispanic community, is where we’ve heard this from, is they really want something that is the idea of bequeathing wealth to the next generation. That shouldn’t just be the rich white people thing. That should be something that’s universal.

Loney: What’s the reaction that you get to this idea from the policymakers right now?

Smetters: I was shocked. Some of the policymakers were really gung-ho about it. They thought this was really cool. On one hand, right now they’re all focused on extenders for the Tax Cuts and Jobs Act and things like that. But nonetheless, the reaction from both sides has been positive. People are often nervous about, is there a hidden agenda here and so forth? And it’s, no. It’s just a way of trying to secure more retirement.

From the industry, we’ve gotten some feedback. Some of the industry trade groups, they always have to attack every idea out there, because that’s how they rationalize their existence. But from the industry players themselves, they actually agree with the statement that higher-income people are not going to really reduce their retirement saving that much from losing this tax benefit from the 401(k) deduction. And low-income people, that are this is definitely going to boost up retirement, so overall retirement saving should actually increase. And that’s something that they can they feel like they can really tap into and provide things like streams of income, annuities, and so forth.