Opinion: U.S. retirement savings options are a disaster
The complex options available for retirement savings have made the ability to save very confusing for the average saver.
We can all agree that building our retirement savings is an important goal. Statistics make it clear that we are living longer and when we combine that with the fact that we want to retire sooner leaves a decades-long gap that few people are prepared to deal with. While Social Security was once the intended funding source for people’s retirement, today you might just be able to count on that to pay your monthly rent or mortgage. With a well-thought-out plan and a bit of planning and years of savings, you may be able to afford to retire at some point. Americans have done a poor job at saving for retirement, but it isn’t completely their fault. The options available for saving have become extremely confusing over time. Americans are offered either corporate or individual retirement savings options, each with their own set of rules, regulations, and contribution limits. With more and more Americans choosing to manage their own investments, selecting the best retirement account(s) is a daunting task. It is time to simplify the retirement account landscape.
Not only can it be very confusing to chart a course and pick a plan, but with so many different retirement plan options available, savers need to focus on which plans they qualify for, which they’ll get the most benefits from, and how taxes affect each type of plan and payout once they are ready to make withdrawals in the future. Do you know the contribution amount you are limited to in your account? If you said $6,000, $7,000, $19,500, $26,000, $58,000 – you are right and you are wrong – it all depends on the type of account you are contributing to.
Let’s take a step back and do a quick refresh for anyone who has lost track of some of the retirement options available to them. For starters, you are either self-employed or you work for someone else. If you work for a company that offers a group retirement plan you likely have two options: a defined benefit or defined contribution plan. Defined benefit plans are contributed to by your employer on your behalf, as a benefits package. They offer a specific amount of money each month after retiring. It can be a dollar amount or a specified formulaic salary percentage. It’s predefined and won’t change over the course of the payout. These are known as cash benefit plans or pensions.
Defined contribution plans are a bit different in that some combination of you and your employer on your behalf will contribute a percentage of your annual salary and invest it, allowing that money to grow over time. When you retire, you’ll recoup your contributions and gains, barring any losses. These plans are common, and you’ve probably heard of them. They’re the 401(k) plans, 403(b) plans, employee stock ownership plans (ESOP), and profit-sharing plans. Each have their own rules and contribution limits.
What if your employer doesn’t offer a corporate retirement plan, or you don’t work for a large employer? You may be eligible for a Traditional or Roth IRA, SEP-IRA, Simple-IRA or Solo 401(k), each with their own rules and contribution limits. Confused yet?
Over time, the government and the agencies governing taxes and investing have established new types of accounts to accommodate various workers: salaried employees, owners, self-employed persons, and gig workers. As more accounts have been created, the more complex and confusing retirement planning has become. An overhaul to retirement savings accounts is long overdue. Contribution limits, eligibility and catch-up contributions should all be revised.
According to USA Today, at age 65, Americans are expected to live an average of another 19.4 years, and the typical retirement-age American spends $50,220 a year. Multiply those figures and add in a little extra for unforeseen expenses and additional financial security, and a comfortable retirement costs an estimated $1,120,408 in the United States.
According to data compiled by the Federal Reserve in 2020 (see chart 1 below), the median account balances in retirement accounts are not looking great. That is due in part to American’s doing a poor job saving, but likely compounded by offering Americans such poorly designed and confusing retirement planning options.
So how can we fix the problem of over-complexity and simplify retirement savings? Keep it simple. Whether you are participating in a group retirement plan or an individual retirement plan, the new max contribution limit should 25% of gross earnings. Over 50 years old? You can contribute 35% of gross, capped at $100,000 and increasing each year based on inflation. If you are self-employed or own a single member corporation, you get to choose the employee and employer contribution breakdown at year end.
If you are contributing to an IRA, there are ONLY two options – a Traditional IRA or a Roth IRA.
Why should someone only eligible for a Traditional or Roth-IRA be limited to $6,000/year if their employer doesn’t offer a group retirement account? Why should a sole proprietor have to wait for their accountant to compute their eligible SEP-IRA contribution at year end? And how come the contribution limits are so low currently especially given our current inflationary environment, along with increasing costs of medical care in retirement?
What exactly would this look like in year 1 following the proposed overhaul to retirement plan options? Chart 2 below outlines the breakdown, along with the $100,000 cap.
A few things are clear when evaluating the current state of retirement in the United States: American’s have done a poor job of saving, the data suggests American’s believe they need more than $1 million to last them during retirement, and the complex options available for retirement savings have made the ability to save very confusing for the average saver. There is no easy solution that would satisfy the government, the IRS, employees, and employers, but something must be done before the problem gets worse.
