U.S. Department of the Treasury

​WASHINGTON - Thank you, Christian, for the gracious introduction and for inviting me to participate in this event.  I am so glad that the Center for American Progress is engaged on the question of what public policy can do to promote retirement security and, in particular, higher personal saving.  Having sufficient saving is important both to the long-run performance of the overall economy and to individual household financial security, both in the retirement context and in other contexts that I will explain in a moment.  I am especially interested in this issue because my roots as a researcher were in questions related to household spending and saving.

Let me start with the macroeconomic reasons for interest in this question.  The U.S. personal saving rate—which is loosely defined as saving net of new borrowing divided by after-tax income—has declined markedly over the past several decades.  Americans saved about 12 percent of their after-tax incomes on average in the 1970s, about 9 percent in the 1980s, and about 7 percent in the 1990s.  Since 2000, the personal saving rate has averaged just under 5 percent, which is about where it is today and a very low level by historical standards.  Researchers do not entirely understand the source of this long-term decline in the personal saving rate, but some have pointed to lower interest rates, higher aggregate household wealth, and a greater ability and willingness of households to borrow as possible contributing factors.

Whatever the reason, low personal saving can be problematic for growth of aggregate income and living standards over the longer run.  Higher saving would have been detrimental as the economy struggled to recover from the Great Recession because it would have held back private demand.  However, over the longer run, higher saving will increase our capital investments and, in turn, increase the income we receive in the future.  That statement is true even with substantial international capital flows, as some of the additional saving would increase the capital stock in this country, which would raise productivity and wages.  The remainder would increase the capital we own overseas and therefore the returns that we receive on this capital.

Personal saving also plays a crucial role for individual households, for several reasons. 

First, individual households can better cope with unforeseen disruptions to their income and unanticipated consumption needs if they have some assets accumulated.  Even before the financial crisis, household income volatility was trending up, increasing households’ exposure to declines in income.[1]  The high rates of job loss and underemployment experienced as a result of the Great Recession served as a particularly painful reminder of the need for these sorts of precautionary reserves.

Second, saving provides individual households with opportunities.  Funds accumulated through saving can be used to pay for college tuition and to purchase big-ticket items such as cars.  Saving puts households who wish to establish businesses in a better position to do so.  And, given the tightening of credit standards in the wake of the financial crisis, saving is now even more important to attaining homeownership than it has been in the past.  A 2014 Federal Reserve Board survey provides evidence on the importance of saving in this context:  Of the 87 percent of young adults who were renting but said that they would prefer to own if they could afford it, 59 percent cited a lack of a downpayment as a factor holding them back.[2] 

Third, saving is important for individual households because it allows them to enjoy a better standard of living in retirement.  Although most people will receive Social Security benefits when older and some will receive regular payouts from defined benefit pensions, these sources of income are often not sufficient to make up for the step-down in earnings that occurs at retirement.  As a result, many older households will need to supplement these types of income with accumulated wealth if they wish to maintain the consumption levels they had when younger.  And, the need for retirement saving has increased over time given rising life expectancy.  Today, more than three out of five 65-year-olds will reach age 80, a considerably higher share than in previous decades.[3]

Unfortunately, for all of the potential benefits associated with saving, many households seem to have a great deal of trouble doing so.  According to the 2013 Survey of Consumer Finances, only 53 percent of households reported having saved over the preceding year.[4]  Low- and moderate-income households have especially low levels of accumulated assets.  Among households with heads between the age of 45 and 54—that is, around the age when saving often peaks—the typical household in the lowest quintile of the net worth distribution had financial assets that amounted to approximately one week of income and had liquid assets that amounted to only a few days of income.  The typical household in the next highest quintile had 5.6 weeks of income in financial assets and just over one week in liquid financial assets.[5]  While these latter households are in a better position to weather a temporary disruption to income, the amount of financial assets that they have accumulated could support only a very short period of retirement in the absence of considerable pension income.

There is also a wide range of indirect evidence that suggests that many households have insufficient savings.  For example, a 2011 Brookings paper examined survey data on people’s ability to withstand financial shocks and determined that one-quarter of U.S. respondents were “financially fragile” in the sense that they were certain they could not come up with $2000 in 30 days.  Including respondents who reported being probably unable to do so, nearly half of respondents would be viewed as financially fragile.  Low saving was a key underpinning of this result, as people reported that they most often turned to their own assets to deal with shocks.[6]

In addition, many Americans report that adequate saving for retirement is a challenge.  In a 2014 Gallup poll, only half of respondents reported being confident that they will have enough money to live comfortably in retirement.[7]  Research validates this concern and suggests, in particular, that households in the lower part of the income distribution are most likely to be squeezed:  Lower-income households are much more likely to experience a material drop in their consumption at retirement than their higher-income counterparts.[8] 

This brings us to the crucial questions of why people do not save enough and how federal policy could encourage them to save more.

To start, it is not uncommon to hear people say that they “can’t afford to save.”  We lack research that concretely documents this phenomenon, and surely it is the case that at least some of these people are just not prioritizing saving for one reason or another.  However, it does seem plausible that some households are simply stretched too thin to be putting any money aside.  This problem has likely been exacerbated by the stagnation of wages in the lower and middle parts of the income distribution over the past several decades.  Although my remarks on policy will be focused on initiatives that directly encourage saving, this consideration just adds to the need for policy measures, like many of those proposed by the Administration, that are designed to support income growth for households in the lower and middle parts of the distribution.

A second problem is that many of the tax incentives that have been put in place to encourage saving have fairly little effect on the return to saving received by lower-income households.  In particular, households in lower tax brackets achieve smaller reductions in their tax liabilities for each dollar of saving in tax-deductible form. And households with incomes so low that they have no federal income tax liability receive no benefit at all from savings tax preferences that are not refundable.

A third and broader challenge is that many people are not making the sort of rational calculations about saving that economists’ models often assume.  The simplest models used by economists predict that a person’s saving—and dissaving—will depend on several factors, including the return to saving as well as how they expect their incomes to evolve over their lifetimes.  However, the available evidence suggests that the incentives that policy has traditionally incorporated to encourage saving by changing the return on saving through the tax system seem to have limited effect on many people’s decisions, including people who benefit from the savings tax preferences.

For example, in a very comprehensive study, researchers examining the Danish pension system—which is very similar to ours—found that only a minority of savers responded to incentives affecting the return on saving in a way that was roughly consistent with traditional economic theory.[9]  Most individuals—about 85 percent—were what the researchers termed “passive savers” who did not respond to such incentives.

What is it that blunts the response of many households to changes in the return to saving?  Probably one significant factor is that people are focused on other aspects of their lives, so they use simple rules of thumb to determine their saving rather than complex calculations.  That is not necessarily irrational; making the theoretically optimal decisions about saving takes both time and financial sophistication, and many households may rationally decide not to spend that time or acquire that sophistication. 

In addition, research has demonstrated that some households lack basic financial literacy, have particular difficulty planning, and are prone to making rudimentary financial mistakes.[10]  These findings can explain both insufficient saving and limited response among some types of households to complicated savings preferences embedded in the tax system.  And, low financial literacy has probably contributed to limited use of retirement savings vehicles like Individual Retirement Accounts (IRAs) not just because the tax benefits are not understood, but also because individuals have to take active steps to research, set up, and maintain  these accounts.  The lack of financial literacy among some households is even more worrisome because of the shift from defined benefit pensions to defined contribution pensions, which has increased the need for personal financial responsibility.  Between 1989 and 2013, the share of workers participating in defined-benefit pension plans fell from 32 percent to 13 percent, while the share participating in defined-contribution plans increased from 25 percent to 38 percent.[11]

Given these findings, what can we do to help people make saving decisions that will serve them better in the long run?  A key step in the right direction is to make saving easier or more automatic.  For example, a large body of research documents that employer-provided retirement saving programs with automatic enrollment or default contribution rates can raise saving, particularly for low-income households.[12]  The challenge is that only about 60 percent of American workers outside the military and federal government currently have employers that offer 401(k)s and similar retirement savings plans.[13]

In the last part of my talk, I would like to build on this point and describe four specific changes in federal policies that would encourage saving. 

First, we should pass legislation consistent with the “auto-IRA” proposal in the President’s budget to ensure that Americans without access to a workplace retirement plan are automatically enrolled in an IRA.  Under this proposal, every employer with more than ten employees that does not offer a plan would be required to sign up their workers for an IRA.  Workers would be allowed to opt out of saving through the IRA if they chose, but many would save and would appreciate having this opportunity without having to figure out the logistics themselves.

Second, we should provide support for firms that enroll their workers in retirement plans.  The President’s budget proposes a $3000 tax credit for any employer with 100 or fewer employees that enrolls its employees in an auto-IRA.  In addition, the budget proposed tripling the existing “start-up” credit, so small employers who create a retirement plan would receive a $4500 tax credit.  And, small employers who already offer a plan and add automatic enrollment would receive a $1500 tax credit.  Those credits would offset the administrative expenses that employers would bear and would provide incentives for more firms to enroll their workers in retirement plans. 

Third, we should ensure that part-time workers who have worked for their employers for sustained periods can contribute to their employers’ retirement plans.  Less than 40 percent of part-time workers currently have access to a retirement plan in their workplace—in part because employers are allowed to exclude employees who work less than 1000 hours per year.  The President’s budget proposes requiring employers to allow employees who have worked for them for at least 500 hours per year for three years to make contributions to their retirement plans. 

Fourth, we should encourage broader participation in the myRA plan program developed by Treasury.  MyRA is a new simple, safe, no-fee retirement savings option designed for people without access to a retirement savings plan at work.  People can arrange for contributions to be made automatically every payday; the accounts stay with them if they change jobs; and there is no cost to opening or maintaining an account.  The investment is backed by the U.S. Treasury and has no risk of losing money.  From a tax perspective, these accounts are Roth IRAs, so contributions are made using after-tax dollars (they can therefore be withdrawn without penalty whenever one would like) and interest accrues tax free until withdrawal.  This year, Treasury worked with a small, diverse group of employers as part of the pilot phase of myRA to get feedback and ensure that the user experience is as simple and straightforward as possible.  We are looking forward to promoting myRA more broadly soon.  You can learn more about the program by visiting www.myRA.gov. 

In closing, I will note that none of these policies alone can entirely solve the problem of inadequate saving by many households.  However, each of the policies can make a difference and together they can make a significant difference in the total amount of saving available for investment in this country and a significant difference in the financial security of many households. 

Thank you again, and I look forward to taking your questions.

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