Seven Steps Toward a New Paradigm for Retirement

By Benjamin H. Harris and Martin Neil Baily

Conventional wisdom on retirement is misguided. The approaching exhaustion of the Social Security and Medicare trust funds has stoked anxiety over the disappearance of these programs’ support, while dire statistics about Americans’ lack of retirement assets have propelled a belief of chronic under-saving. In the aggregate, neither view is quite right — and this mischaracterization has unearthed calls by some to dismantle the entire system. While the current system has serious flaws, however, it is still worth saving. To do so, policymakers need both an accurate assessment of the system’s shortfalls and a menu of plausible options to improve them.

We set out to do just that in our recently published book, The Retirement Challenge: What’s Wrong with America’s System and a Sensible Way to Fix It (Oxford University Press, 2023). Here, we propose a series of policy reforms that maintain the best aspects of our current system while improving its most egregious shortcomings. Collectively, our proposals form a “new paradigm” for retirement: a system that will ensure a comfortable retirement for all Americans, built by enhancing the most popular and successful aspects of today’s retirement framework rather than pushing for politically infeasible alternatives.

These seven guideposts define this new paradigm.

1. 1. Acknowledge the current system’s successes. From an economic perspective, an adequate retirement can be defined as one where a retiree can enjoy a similar standard of living as experienced during their working years. By this measure, retirement is working well for tens of millions of households who receive a steady stream of income from Social Security, typically backfilling about 40 percent of wages surrendered in retirement (more for lower-wage workers), plus Medicare benefits that cover a sizable portion of healthcare costs. Still, the system is imperfect: Poorly designed and unequal retirement savings incentives often mean that large shares of retirement-age workers have no or limited liquid assets, and about 10 percent of older Americans live in poverty. But overall, America’s retirement system works well for the bulk of workers. This modest success, coupled with the popularity of entitlements and workplace saving accounts, means that rebuilding the entire system is neither realistic nor advisable. Instead, we need incremental reforms.
   2. Acknowledge the current system’s two key shortfalls: unequal saving incentives and poorly designed markets for reducing risk in retirement. Let’s take these in turn.

On saving incentives, the current system for accumulating retirement savings — largely through individual employer accounts — confers a complex set of tax benefits based on an initial exclusion of the contribution from taxation, a build-up period where investment returns are tax-exempt, and a distribution period where withdrawals are added to taxable income. This system is both expensive — costing roughly $250 billion in foregone revenue annually — and regressive, with about two-thirds of the tax benefits going to the top one-fifth of taxpayers.

On markets for reducing risks, there are few options for workers to translate their wealth into security. While the bulk of retirement-age households have appreciable wealth, typically in the form of financial assets or housing equity, the system offers few opportunities for converting that wealth into a dependable stream of income or benefits. Situations where retirees need long-term care or live well past their life expectancy can mean sharp downturns in living standards, causing many retirees to hoard wealth as a precaution. This not only means spending less in retirement on enjoyable pursuits, but can also lead to excess saving during working years. A better design of the markets for private insurance-like products — namely income annuities, long-term care insurance, and reverse mortgages — can reduce these risks.

1. 3. Make tax incentives for retirement saving equitable without dismantling the entire system. A first step to helping more workers accumulate wealth is to expand access to retirement saving accounts. Fortunately, policymakers at both the federal and state levels have increasingly embraced an “automatic” approach to retirement, which makes saving decisions like enrollment, annual contributions, and investment allocation the default outcome — requiring an active decision to opt out. Yet, automatic accounts are not wholly sufficient: Low- and middle-income savers should also be offered relatively more generous tax benefits for each dollar they contribute to each account. While the recent Secure 2.0 legislation makes progress on both measures, the work is far from over.
   4. Help retirees benefit from an improved annuities market, specifically longevity annuities. Unknown longevity is perhaps the greatest risk in retirement, with retirement-age individuals facing extreme uncertainty over their remaining lifespans. Longevity annuities — products that offer guaranteed streams of income roughly 15 to 20 years after initial purchase — are ideally suited to helping retirees sustain their finances in the face of unknown lifespans. Yet, despite the appeal of these products, few retirees purchase longevity annuities. Reforms to encourage more employer-based offerings would both increase accessibility and improve market functioning, while perhaps also making the product’s appeal more mainstream.
   5. Create a better system for long-term care insurance (LTCI). The current market for this private insurance suffers from adverse selection, where consumers with a higher likelihood of needing long-term care are much more likely to buy it, which drives up insurance premiums and forces many consumers out of the market. The result is a situation where under 9 percent of workers approaching retirement age have purchased LTCI, and instead rely on either their nest eggs or unpaid caregivers (often working-age women) to provide care. The market would work better with higher enrollments from workers, which can be encouraged through revised tax incentives and improved distribution channels for insurance.
   6. Provide access to housing equity in retirement for a subset of retirees. For older Americans with substantial housing wealth but limited financial wealth, retirement presents an agonizing choice: Sell your home and live off the proceeds, or “age in place” without access to a primary source of wealth. One solution is to offer better access to reverse mortgages, which allow retirees to age in their residences while accessing the money in their homes. Reverse mortgages, however, are both costly and prone to high rates of foreclosures; offering conversions between traditional and reverse mortgages, preventive serving, and less costly “small dollar” reverse mortgages can help.
   7. Encourage working longer. Longer working lives can help alleviate many of the stresses and drawbacks of retirement. A few extra years of full- or part-time work can often meaningfully improve a worker’s financial outlook and generate additional income for retirement — and the benefits of longer working lives can potentially extend into health and wellness, perhaps helping to mitigate intellectual decline and loneliness experienced by so many in old age. A combination of legal and economic reforms can boost the labor market participation rate if they are designed to mitigate age discrimination and reduce financial disincentives that prevent longer work lives.

Overall, these reforms are both incremental in isolation and enormously powerful in the aggregate. This “new paradigm” would lead to low- and middle-income workers accumulating billions more each year for retirement saving and open better pathways for reducing risk in old age — leading to happier, healthier retirements. Calls for an entirely new system, while well-intentioned, can be counterproductive to more concrete reforms since they are politically unlikely. Instead, policymakers should use the tools they have to make a flawed but promising system better.

Benjamin Harris is Vice President and Director of Economic Studies at the Brookings Institution. He recently served as Assistant Treasury Secretary for Economic Policy in the Biden administration. Martin Baily is a Senior Fellow Emeritus and Brookings and a former Chair of the Council of Economic Advisers.

November 2023, 23-07