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A Happy New Year for future US retirees

This January sees positive changes to the US retirement landscape, with implications for US employers and individuals alike.

24 January 2024 | Author: Tomm Adams

This article considers these changes and asks what the UK could learn to improve retirement outcomes.

A global problem

Throughout the developed world, reliance on social security retirement programmes is unlikely to see most individuals through to a comfortable lifestyle after finishing work. Much of this is driven by longevity increasing faster than retirement programmes are being funded, noting that, in most major markets, social security contributions from the working generations are not directly funding their own future retirement, but rather that of current retirees.

As such, ‘retirement adequacy’ or the relative ability for an individual to maintain a decent standard of living after retirement is a hot topic among employers and employees alike.

According to one study by Insurance Europe, 58% of those surveyed recognised that they need supplementary savings, with women more at risk of under saving than men. And yet, a third are not building these savings up.

At the same time, many people of pensionable age (varying depending on location) nonetheless feel forced to work longer because of income needs. I am not arguing the case for mandatory retirement ages, but there are clearly times when such employees are disengaged and increasing employers’ payroll costs with low return on investment.
The need to bolster long-term savings throughout our careers has arguably never been greater.

US social security pension

The US social security (old-age) pension is, according to OECD figures in 2023, considered to provide an ‘income replacement rate’ (1) of 39.1% for the median earner. This goes down to 27.8% for those earning twice the median income.

If that sounds bad, then it is actually rather higher than the UK income replacement rate (state pension only) of 21.7% for median earners and 10.9% for those earning twice the median income. However, it is significantly behind the EU27 average of 49.5% and 41.6% respectively.

What has changed in January 2025?

On 5 January, President Biden signed the Social Security Fairness Act into law, with bipartisan support.

The main feature of this legislation is that it repeals both the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO), which have been in effect for many decades. These provisions meant reduced US social security benefits for workers and spouses, if the individual was covered by a pension benefit from a public employer that was exempt from Social Security tax withholding, such as a state or local government. The WEP could reduce worker benefits by up to 50%, while the GPO could reduce surviving spouse benefits by up to two-thirds.

This sweeping measure was out of line with most other national systems, and the removal of this provision is welcome. Most will receive a lump sum payment for the money they missed out on due to the two provisions over the entirety of 2024.

US occupational pensions

So far, there is no federal obligation (2) for a US employer to provide an occupational plan (such as a 401(k) plan) to its employees, although if it does, then generally it must be made available to all employees within a certain ‘class’ (which could be interpreted a few different ways in practice).

Where such plans are in place, the 2023 OECD figures indicate a much healthier income replacement rate of 73.2% for median earners and 61.9% for twice-median earners, which, given the lower expenditure of ‘typical’ retirees whose children have flown the nest and whose mortgages are fully paid off, is generally viewed as sufficient.

What has changed in January 2025?

SECURE 2.0, enacted on 29 December 2022 under the Biden Administration, sought to help Americans save more for retirement.

As part of this, plans established after this date are, as of 1 January 2025, obliged to implement auto-enrolment with ‘escalation’.

This means that, at the very least, employees hired after this date are to be entered into the pension plan automatically, and with employee contribution rates initially between 3% and 10% of pensionable salary. This contribution rate then has to increase by 1% annually until the contribution rate is between 10% and 15%. Participants must be allowed to opt out entirely, or to elect a different level of contribution.

Clearly, this mandatory requirement is very fresh (even if it has been on the cards for two years). Proposals for regulations are currently being tabled, including a proposal to apply auto-enrolment to existing hires pre-1 January 2025, unless they have already opted out. A public hearing on such proposals is scheduled for 8 April 2025.

Will auto-enrolment defuse the ticking time bomb?

Hard to say, but based on recent precedent, it hardly seems likely.

And it seems odd that the current interpretation of SECURE 2.0 provisions seem not to mandate all employers to put in an auto-enrolment plan, but rather apply the auto-enrolment provisions to the in-

scope plans themselves (being 401(k) and 403(b) plans established after 29 December 2022). An immediate improvement would be to mandate all employers to provide access to a plan, as was the case in the UK (phased in since 2012).

In fact, such forms of auto-enrolment have been implemented in a number of other jurisdictions (including Türkiye as from 2017, and Ireland is set to finally implement their escalation-based auto-enrolment regime from 30 September 2025 after several delays). Switzerland has had a mandatory occupational pension system in its current form since 1985, but still only provides, in conjunction with the state system, a low-income replacement rate of 18.7% for median earners, per the OECD.

The fact that the US mandate only stipulates employee contributions is concerning – although employers are able to contribute and may indeed gear their contribution to that of the employee via a matching formula.

But in Türkiye’s case, only employees can contribute to their auto-enrolment plans (as at the time of writing); here, the majority of employees have simply opted out, unmotivated by governmental subsidies/bonuses and perhaps reassured by the comparatively high value of their state pension.

Nonetheless, any system that defaults employees to providing for their long-term future gets a tick in my book, and the escalating nature of the contributions structure eases the transition, albeit affordability may be of concern.

At Blick Rothenberg, we help individuals and employers navigate the complexities of pension regimes and employee benefits across the globe.

Would you like to know more?

If you have any questions about the US retirement landscape, please get it touch with your usual Blick Rothenberg contact or Tomm using the form below.

Disclaimer:

This article is intended to give you an insight into the changing retirement landscape in the US, for general interest only.
It is not a comprehensive technical paper and should not be relied upon in deciding what to do with pension or other investments.
Please note that we cannot provide investment advice, and you should consider seeking advice from an independent financial advisor before committing to any course of action that affects your investment portfolio.

We are not responsible for the content, advice, or information provided by external websites linked on our platform. These links are for informational purposes only, and we do not endorse or guarantee the accuracy or reliability of any external content.

(1) Income replacement rate example: an annual pension income of $20,000 against a final salary of $100,000 at retirement age would represent a 20% income replacement rate

(2) Many states are individually looking at enacting mandatory plans

 

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