In employment system pensions and complementary private pensions, there is the United States and then there are all the others.
Why do I make this statement?
The US is by far the largest private pension market in the world, with more than 62% of total assets under management in developed countries (source: Global Asset Study-Thinking Ahead Institute).
In 2020, pension funds and instruments accumulated 20.1 trillion dollars in assets under management (source OECD). These assets managed in pension funds represented 95.8% of the GDP of the United States, a percentage that increases to 164.8% if we consider the assets managed in all social security instruments (not only in pension funds).
Pensions in the United States
The United States pension system is based on three pillars:
- A basic public pension is provided by Social Security (Pillar I).
- A voluntary, but widespread, employment-based pension funded through employer and employee contributions to corporate social security systems (Pillar II).
- Retirement savings on an individual basis in individual pension instruments (Pillar III).
Occupational pensions supplement the public pensions of many US citizens. According to the Social Security Act, the replacement rate for public retirement pensions must reach on average around 40% of the pre-retirement salary. The average replacement rate in the United States was, at the end of 2019, 49.4% for net public pensions and 39.4% for gross pensions (OECD). Note that the average salary for full-time jobs was $71,456 in 2020 (Source: Statista).
While employer-based pensions are a major contributor to the retirement income of Americans, in many cases they alone are not sufficient to meet the retirement income goals of many Americans: they must be supplemented by individual savings.
Regulation of employment pension instruments
In the United States, the private pension industry is subject to regulation by the Employee Retirement Income Security Act of 1974 (ERISA), administered by the US Department of Labor.
A voluntary, albeit fiscally incentivized, system
ERISA does not require an employer to have an occupational pension plan, but it does regulate minimum standards for employers that do have one. Nor does the law usually regulate what contributions must be made on behalf of pension plan participants.
The occupational pension system is voluntary, but it is strongly encouraged, which helps to produce this significant trend towards savings: The Treasury Department saves approximately $100 billion annually from tax savings (tax deferral) for workers participating in pension plans.
Except for certain pension products, the employee generally defers tax payments until the time of receipt of the benefit (EET), with contributions being exempt up to certain limits and benefits subject to tax. The contributions made by the company are deductible from its corporate tax.
But the drivers of savings by workers are different from tax incentives: default behaviours
However, not all that glitter is gold in American social security.
Only 15% to 20% of savers are active (contribute regularly). Nearly half of American households with people over 55 have no retirement savings.
Taxation in the United States is important, but what attracts people to save, more than taxation is the intelligent design of the corporate pension system. For example, the introduction of techniques in retirement plans that “nudge” savings, such as automatic enrollment by default.
Less than 40% of companies automatically enrol their employees in pension plans. However, nearly 90% of those workers who are automatically enrolled remain in the Pension Plan without leaving it.
Behavioural Economics research and applications, such as the “Save More Tomorrow” program by professors Richard H. Thaler, Shlomo Benartzi and others, have helped millions of Americans save.
Based on the empirical fact that people have difficulty making decisions about long-term matters and that we prefer short-term gratification to long-term happiness, Professor Thaler and his colleagues developed the “nudge” theory. According to this theory, people were “nudged” to save, although they were not forced to do so, by replacing the employee’s expressly requested enrollment with an automatic enrollment by default. The employee, if he did not want to continue saving, had to expressly request to leave.
The proactive decision that the worker had to make was not to save, but to stop saving. This led to a significant increase in the number of workers enrolled in occupational pension systems.
Professor Thaler’s work in behavioural economics laid the groundwork for the design of the “automatic enrollment” system and other automatic savings-related default behaviour techniques, such as ” automatic contribution escalation ” (*), in the major U.S. employment retirement plans (such as 401(k) and 403(b).
(*) The automatic escalation plan implies that a worker, unless he or she chooses to leave the Pension Plan in which he or she is a participant (opt-out), will be automatically enrolled in a program that includes a schedule of annual increases in his or her contributions, by which the contribution percentage will be increased annually (1% additional each year), until reaching a certain contribution percentage at the end of the period (10%), after which it will remain constant unless he or she wishes to make additional voluntary contributions.
