Unprepared: Our Flawed Retirement System

Teresa Ghilarducci

The New Yorker cartoon of an older couple talking in their living room produces a chuckle and strikes a chord. To succeed under the current American retirement system, it seems you need to know exactly when to plan your retirement party and when to die. In a system that relies on voluntary, commercial, and individual-directed accounts, getting the retirement income flow right requires that you have a good handle on future rates of financial returns, medical care cost inflation, future costs of home health care and assisted living, and all other factors that will affect your future wages, financial returns, and health until you die.   

     The American way of retiring requires, in other words, superhuman effort. It’s a system built for robots with Excel spreadsheets and crystal balls, not real people who live with uncertain labor markets, volatile housing prices, family members with money problems, and a for-profit money management industry that promises to manage your retirement savings but whose top loyalty is to its Wall Street employers. 

An Untrained Population

     The U.S. is the only industrial country that depends on untrained individuals supplementing their own basic Social Security and long-term savings with a system of voluntary contributions and retail investment products. It’s like requiring everyone to do their own home electrical wiring and dental work. Since the 1980s, the 401(k) and Individual Retirement Account (IRA) system has dominated workplace pensions, yet still only half the workforce has such a pension. In theory, 401(k) and IRAs plans were meant to be convenient for employees, a way to beef up their pensions. In practice, they shifted complex decisions and a great deal of risk from employers to workers. There has been no improvement in workplace retirement account coverage in 30 years.1

     Although a 65-year-old man has a one in five chance – and a 65-year-old woman a one in three chance – of living until 90, we are advised to save as if we will in fact reach our ninth decade, because no one wants to run out of money. To plan properly under the American system is to hoard a lot of cash. And, because the system requires individuals to save in individual retirement accounts that can be tapped at any time, people are forced to invest short term in liquid, high-priced mutual funds. The rates of return are much lower than they could be because 401(k) plans and IRAs are retail product managed by for-profit firms with large sales forces.

     Also, the system is highly subsidized with taxpayer money. Policymakers exempted regular pension and 401(k) and IRA contributions from tax, hoping to ensure that all workers had enough savings for retirement. But because those tax advantages are tax deductions rather than refundable tax credits, the highest-paid employees with the highest contributions and highest tax rates get the most subsidies. Eighty percent of the tax breaks for retirement accounts go to the wealthiest 20 percent of taxpayers.2 

     But the problem of most Americans is not too much cash in retirement accounts. As 70 million Americans aged 50-64 head into their retirement years, we need to stop pretending the American system works. Less than 30 percent of older lower-middle class individuals – those with less than $20,000 per year – have any kind of retirement account. Meanwhile, 75 percent of Americans nearing retirement age in 2010 had less than $30,000 in their accounts. If an elder needed to stretch that money over 20 years, it would be $4 a day, not adjusted for inflation. “Nothing” is a better description of what most people save for retirement. 

     Because of the tax break, the richer you are the more likely you will have a retirement account. Nevertheless, a big chunk (23 percent) of older Americans earning in the top quarter of the income distribution have no retirement savings. Using simple algebra and making reasonable assumptions about interest rates, employment rates, and mortality tables, most people at age 50 or so should have ten times their annual salary in a retirement account. The average person between 50 and 64 has $30,000 in her accounts when she should have half a million. 

Who to Blame? 

     Who or what is to blame? The lack of knowledge about saving? That’s impossible to believe. A multi-billion dollar industry that advertises the need for retirement savings is growing. Media gurus abound – Suze Orman, Dave Ramsey, and others.

     Is it that average Americans spend too much and don’t care about retirement? Lots of pundits will blame the victim. Financial planner David Bach3 made a splash when he suggested the root cause of the retirement crisis was a “daily latte factor” – flawed humanity’s need for small luxuries and a reluctance to delay consumer gratification. To make the point that their lack of planning and budgeting is the reason people don’t have savings – and not low wages or an inadequately designed national retirement savings structure – McDonald’s and Visa have featured a “Practical Money Skills” website that shows how saving for retirement is in reach of a fast-food worker. (Critics pounced because the budget allows nothing for children or extra heat in the winter and it budgets $20 per month for health care.) 

     But wages are the only source of savings for most people. Over the past year, hourly earnings have risen only 1.9 percent and minimum wage was last raised in 2009 – now $7.25 an hour, which, adjusted for inflation, is 20 percent less than in 1968.

     Continuing the argument that modern personal behavior is the reason the faulty system is faulty, the Investment Company Institute4 (the lobbying arm of the mutual fund industry) shows that humans can attain retirement comfort if they act in ways humans don’t act. The spreadsheets show that if a worker starts saving early, earns 5 percent adjusted for inflation over a 35-year span, and never uses the money for 35 years, he can have enough to maintain a good standard of living in retirement. Yes, a robot with a spreadsheet could save 5 percent of every paycheck for its entire career, but human beings are embedded in social and familiar relationships where a pile of money just sitting there would be immoral to keep if a loved one needed education, health care, or bailing out of jail. 

     We’ve become convinced that the jam we’re in is all our fault. But it’s not. This isn’t just a personal problem. It’s a pension-design problem that will fast become a national problem affecting large numbers of poor and near-poor Americans facing retirement and old age. 

     What is an individual to do with the system we have? First, don’t give up on changing the system: vote for Social Security and Medicare strength and expansion, and support politicians who will regulate and reform the system. One key area of reform is fees. What chips away at your wealth when you invest in an actively managed fund is the fees. So, even before finishing this article, switch out of active funds to index or passive funds. Index or passive management can be done very cheaply, by virtue of its hands-off approach. This savings is passed on to the investor. Active management, by nature, costs more.

     Here’s how it applies to fees. Index funds charge one-tenth of one percent of the assets under management. Your $100,000 over ten years, earning the stock market average of 5 percent, gives you a return of 4.9 percent after fees, or $161,300. But the actively managed is likely to charge 20 times more – 2 percent. That means it earns, functionally, 3 percent, and you end up with $134,300. That’s a whopping 44 percent less. Over ten years, you’ve lost $27,000 – not to market performance, but just to fees. That’s the math of compounding interest: every 1 percent drop in the rate of return leads to a 20 percent drop in total return.

     Now, a mutual-fund manager will tell you the fees are worth it, because his experts will earn more than the market over 10 years. But statistics tell a different story. Do some managers ever have hot streaks, beating the market several years in a row? Sure. But research shows high fliers last a few years at most. 

Given this, why would you choose an actively managed fund? You wouldn’t. Simply put: low-fee index funds are all you need. If you must have someone to guide you through the investing process, get a fee-only adviser and pay up front for a personalized plan. 

Now What?

     If you’re inadequately prepared for retirement, it’s very likely not your fault. The money-management industry is not on the side of its clients. The voluntary, individual-account business is one of the most profitable but most lightly regulated sectors of the financial industry, and they have a lot of money for lobbyists who are paid to oppose tighter regulations. So far, they’ve done so successfully. 

     What is a person to do with our deeply flawed retirement income system? 

     1. Fire your brokers and advisors who take royalties or commissions. Invest only in index funds.

     2. Eliminate debt, including mortgages.

     3. Vote to regulate retirement savings brokers, make them loyal to their clients.

     4. Vote to expand Social Security, Medicaid, and Medicare.

     Our society has made a commitment to its citizens’ retirements in deliberate and meaningful ways since the sensible construction of Social Security. All workers need a guaranteed pension to supplement their Social Security for the rest of their lives. All workers, rich or poor, need to have some time to themselves, on their own terms, at the end of their working lives. Human beings may be bad at some things, but we’re good at others, like coming together to solve our problems. I believe this can happen, and everyone’s voice needs to be heard. 

Teresa Ghilarducci is professor of economic policy analysis at The New School for Social Research in New York, where she is also director of the Schwartz Center for Economic Policy Analysis. She has many years’ experience in labor economics and as a consultant to union workers. President Clinton appointed Ghilarducci to the Pension Benefit Guaranty Advisory Board, which is charged with protecting the pensions of public sector workers. She is the author of When I’m Sixty-Four: The Plot against Pensions and the Plan to Save Them (Princeton, 2008). 


1.  For workers trying to save for retirement, the picture has dramatically deteriorated. Using the Current Population survey, I find that from 2001 through 2012 there was a remarkable drop in employer sponsorship of retirement plans, from 61 percent to a historical low of 53 percent. Retirement plan coverage rates fell 13 percent between 2001 and 2012. This is a reversal of recent optimistic trends: between 1950 and 1979, retirement account sponsorship rates doubled from 25 percent to 50 percent and leveled off. 

2.  www.americanprogress.org/issues/open-government/news/2011/01/19/8862/tax…

3.  www.finishrich.com/blog/tag/the-latte-factor/

4.  www.economicpolicyresearch.org/index.php/guaranteeing-retirement-income/…