Finished The Real Retirement Crisis by Andrew Biggs. It’s is a very informative and thoughtful book by an expert in the field, made all the more important by the fact that a lot of research and reporting on retirement is faulty. A must read for anyone interested in understanding the state of retirement readiness in the US and the policy choices facing the country to right the ship.

Highlights:

1. People are better prepared for retirement than the usual “sky is falling” articles would suggest. Most save reasonably well in their retirement accounts. The weak point in the system is underfunded government pensions and Social Security.

2. People spend less in retirement than when working. This appears to be voluntary rather than due to reduced circumstances: They spend less on food, but caloric consumption stays the same—the reduced spending comes from preparing food at home instead of eating at restaurants. They have lower transportation costs and spend more time price shopping. Higher health care costs are more than offset by lower spending in other areas. They devote a larger share of their budget to giving to charitable causes and to friends and relatives, so don’t seem cash strapped.

3. Social Security replaces a large enough fraction of low income worker salaries that they don’t need to save for retirement. Higher income workers will need to supplement Social Security to maintain their living standards in retirement, and they do save more.

4. Survey data shows that retiree satisfaction with their own finances is high, and has increased over time. Retirees report doing better than non-retirees, and older retirees better than younger retirees. While retirees believe that there is a retirement crisis, they usually think that others are in crisis, not themselves.

5. There was never a golden age of traditional pensions in the private sector. The participation rate was about 20% in 1950 and peaked at 39% in 1975. Even among those who were ostensibly covered, strict vesting rules meant that many would not go on to collect the pension. This in fact was what made pensions attractive to employers. When ERISA increased funding requirements and liberalized vesting requirements in 1974, traditional pensions became too expensive for employers and they started shifting away from it.

6. Unlike the private sector, pensions are common in the public sector. This is because funding requirements are more lax than in the private sector. So public pensions are usually underfunded. Accounting rules permit state and local pension plans to pick inappropriately high discount rates to value their pension obligations. This causes pensions to be even more underfunded than what’s reported. It also incentivizes risky investments.

7. Social Security, being a pay-as-you-go program, is vulnerable to declining birthrates and an aging population. Taxes will need to rise or benefits will need to fall eventually. If taxes don’t rise, benefits will need to be cut by 20% after the trust fund runs out around 2035. This has been well known for decades, but there has not been the political will to fix it. With each passing year without a fix, the size of the required adjustments gets larger and the pain becomes more concentrated on a smaller group of future generations.

8. Democrats and President Trump oppose Social Security cuts, so Biggs does not think that there will be cuts in the immediate future. But he believes that the 1983 Social Security reforms—even though it addressed a smaller funding gap and took place in a different political environment—suggests that the fix will eventually include significant benefit cuts, not just tax increases. A 2020 survey shows that people strongly prefer saving more in their retirement accounts over paying more into Social Security and receiving a higher benefit.

9. Biggs’ proposal for Social Security reform involves a more limited role for the program that meets the needs of lower income households, and reduces benefits for middle and upper income households. He proposes a flat benefit of 28% of the national average wage for single retirees and 41% of the average wage for couples, as is done in Australia. For 2024, that would translate to $19,216 for single retirees and $28,137 for couples. This would reduce costs for 2024 beneficiaries from 14.5% of the payroll to 11.8%. Adding a means test to the program that would reduce or eliminate the benefit for about half of the population (as Australia does) would further reduce costs to 7.1% of wages. This would be enough to close the gap without having to increasing payroll taxes—retirement, survivors and disability benefits could be paid with the 12.4% payroll tax that is currently in effect.

10. To help tide Social Security over till the benefit cuts phase in fully, Biggs suggests eliminating the tax advantage of retirement plans. This would subject the growth of the retirement account to capital gains tax. This would effectively be a tax on savings, which would in principle reduce saving rates. But Biggs argues that in practice it would not impact savings behavior by very much.

Some thoughts:

• I wonder how much of retiree satisfaction with their finances has to do with the extraordinary returns from stocks in recent decades. This might also be driving the preference for investing on their own vs paying into Social Security.

• I think that means testing Social Security and sharply reducing or eliminating it for higher income retirees will be too much of a hit to people who have come to expect benefits and feel that they have paid into the system and have been cheated out of their due. Reducing benefits by increasing the full retirement age, freezing benefits in real dollars instead of wage indexing, and switching to flat benefits all seem much more do-able to me.

• I suspect that eliminating the tax advantage of retirement accounts will also meet a lot of resistance, though maybe not as much as means testing Social Security.

Link to the book:

The Real Retirement Crisis: Why (Almost) Everything You Know About the US Retirement System Is Wrong, by Andrew Biggs