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Key Policy Issues to Watch in the Next Decade

Americans need better access to retirement plans, help with drawdown phase.

This article originally appeared in the 10th anniversary issue of Morningstar magazine. Our director of policy research, Aron Szapiro, explored the key policy issues to watch over the next 10 years. 

Right now, most pundits (which I am not!) have a hard time making predictions about the next 10 minutes, much less the next 10 years, but I do think there are major issues that policymakers will need to address over the next decade that will shape individual investors’ experiences in the United States. In this article, I’ll explore the contours of these issues and how policymakers might address challenges investors face today.

Whenever we think about individual investors, it’s important to think about retirement savers. Seventy-five percent of investors invest exclusively in an individual retirement account or 401(k), according to our analysis of the Survey of Consumer Finances, and as the last generation of traditional pension participants moves to retirement, even more people will rely on defined-contribution plans. So, one key issue is access to retirement plans and whether U.S. policymakers can find a bipartisan way to expand access. Further, policymakers will need to explore how they can make defined-contribution plans work better for people, particularly during the drawdown phase. Addressing these challenges might mean reshaping the U.S. retirement system completely. Finally, will government unleash technological innovation for investors? Critically, how will regulators ultimately treat investors’ data in their investment accounts, savings accounts, and other accounts? Further, how will regulators answer the thorny questions of who owns this data, who can access it, and what third parties can do with it?

Will We Take Bold Steps to Expand Access to Retirement Plans?
The rate of participation in employer-sponsored retirement plans has remained stubbornly stuck at around 50% for years. (Closer to 60% have access to a plan, but some of those workers do not participate.) Part of this is due to small employers. They do not often offer a plan to their workers, who in turn rarely contribute to IRAs on their own. In fact, only about 14% of small employers sponsor some type of plan for their employees to save for retirement, according to the U.S. Government Accountability Office. Over the years, policymakers have tried to address this issue, but they haven’t been able to move the needle on coverage. This lack of savings is a big problem. Many workers will be forced to rely on Social Security for all of their retirement income.

Congress has tried to solve this problem before, without much success. In 1997, Congress introduced Simple IRAs to help small employers provide retirement plans to their workers without taking on the regulatory obligations of ERISA, as they would if they offered a 401(k). Simple IRAs provide a few key advantages to employers because they have no filing requirements, and they do not need to pass “nondiscrimination testing,” as would be required for a regular defined-contribution plan. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act, which tried to further incentivize business owners to set up retirement plans by increasing the amount that owners (along with everyone else) could contribute. These changes have not created a lot of new retirement plans. Although Simple IRAs are popular among small employers that offer plans—about 40% of them use Simples, according to the GAO—more than four in five workers at small companies still do not have a plan at work. And after the 2001 changes, the number of workers covered by small plans did not grow.

Policy experts on the politically left and right often agree that the only way to solve the problem is with some sort of mandate. Many countries, such as Australia and Chile, require workers to contribute to retirement plans. Americans, however, are likely to be less tolerant of such a blunt-force mandate. A more palatable solution might be automatic enrollment— leveraging inertia to automatically enroll workers in a retirement account (such as an IRA) but letting people opt out. Among employers that offer a plan, automatic enrollment has proved to be a boon, dramatically increasing participation. The next step is to explore automatic enrollment among people without workplace plans. The Obama administration proposed these automatic IRAs (without success), but some states are now working on them.

Such an approach would be an intermediary step to a longer-term solution: decoupling retirement plans from employers, at least for people who work for small employers. After all, IRAs have contribution limits that are too low to be a primary savings vehicle for most workers, and employers cannot contribute to regular IRAs. The United Kingdom provides an example with a program called the National Employment Savings Trust, which is available for small employers who don’t offer a plan, combined with a mandate to enroll workers in the plan. The program appears to be an early success and could be a model for the United States.

Will Policymakers Make Defined-Contribution Plans Look Like More Traditional Pensions?
In addition to workers lacking retirement plans during the accumulation phase, what about workers lucky enough to accumulate enough savings? What do they do when they get to the drawdown phase of retirement? Many retirement investors are confused, and their options of what to do are not great right now.

Broadly speaking, there are three options for investors at retirement: take their money as a lump sum; draw it down gradually with a structured withdrawal plan, or buy some sort of longevity insurance, such as an annuity.

It seems clear that, all else equal, policymakers should prefer more people to have single-premium, inflation-adjusted annuities. After all, annuitants would act as a stabilizing force during economic downturns, as they can continue to spend their regular annuity payments. In contrast, retirees whose income varies based on market returns would act as a destabilizing force during market downturns by spending less. Annuities are also highly efficient because they pool longevity risk and could, thus, represent the least expensive way to convert retirement assets into a steady stream of income—assuming that is a saver’s primary goal. Finally, annuities mitigate the risk that retirees will run out of money and become a burden on government resources.

Of course, annuities are not very popular in the United States and unlikely to become so. Much ink has been spilled among financial experts and economists trying to solve the “annuity puzzle,” but in theory, retirement savers should want to annuitize more of their assets than they typically do. The lack of annuities’ appeal is not confined to the United States. Australians and Canadians also have very low uptake rates for annuities, and retirement savers in the United Kingdom recently got the right to avoid annuitizing—a right most people availed themselves of immediately.

Nonetheless, policymakers could make it easier for people to buy longevity risk insurance— given the probabilities of retirees living to an advanced age and spending decades in retirement. For example, the government could offer regulatory relief to plan sponsors, who are afraid to offer in-plan annuities because of liability concerns. It could also loosen regulations around qualified longevity annuity contracts, the technical name for tax-qualified delayed single-premium annuities. These deferred annuities, which might be offered to a 65-year-old and not start making payments for 20 years in the future, are explicit longevity insurance. If a person lives a long life, there will be a stream of payments. In that way, they look more like other insurance products (such as fire or car), except in this case, we’d want the negative event (living an unusually long life) to happen. Policymakers could also explore other, more exotic forms of longevity insurance, such as tontines, which many academics believe are more efficient than other kinds of longevity insurance.

How Will Policymakers Regulate Investors’ Account Data?
When investors aggregate their financial account data using new technology, it can help them get a comprehensive, holistic picture of their finances. For example, looking at a worker’s 401(k) balance in isolation will likely result in a false assessment of his or her retirement-readiness. Workers with a high level of retirement savings may appear to be on track for a secure retirement—but if they lack sufficient emergency savings, they might be forced to use these retirement assets to cope with an unexpected expense. Workers with other pressing financial goals—such as sending a child to college or purchasing a home—may be very tempted to spend their retirement assets on nonretirement purposes. Indeed, this “leakage” may drain as much as one fourth of assets from retirement accounts. New technology makes it inexpensive to aggregate investors’ financial accounts, including retirement accounts, savings accounts, and credit card accounts. Drawing on this data, new applications can compute the numbers to provide users with holistic guidance, which helps them prepare for emergencies and other expenses, preserving their retirement savings for their intended purpose—retirement.

Another complication that aggregation technology solves is that retirement assets are often spread across many different accounts, such as IRAs or a previous employer’s 401(k). This fragmentation means it is critical to look across all of a worker’s accounts in order to recommend the right asset-allocation strategy and appropriate contribution levels. Technology provides a low-cost way to aggregate data that helps workers with multiple accounts form a good plan for achieving success in retirement.

Although technology has a lot of promise, there is a major debate around data aggregation, and whether investors own their data and can share it with third parties. New financial technology companies generally argue that aggregating investors’ data allows them to improve their financial wellness, for the reasons above. Financial institutions often argue there are privacy or security concerns. Ultimately, privacy concerns can be ameliorated through appropriate regulation. The benefits of account aggregation are too large for it to be simply ignored. But policymakers are often risk-averse, so we will see where they land on the issue.

Hands Full
As we fully transition to a defined-contribution system (outside of the public sector) over the coming decades, policymakers will have their hands full with basic issues (how can we get people into plans), more complex problems (how can we ensure people convert their savings into lifetime income at retirement), and complicated questions around who can own, share, and use financial data to give guidance and advice to investors.