by Tim Gosling
| 19 Jan 2023
We come back, time and time again to the US and Australian retirement systems, mainly because the challenges and solutions facing these countries and our own are so similar.
In this article, I am returning to the US as one of President Biden’s last acts of 2022 was to sign the SECURE 2.0 act into law. Passing with bi-partisan support, SECURE 2.0 is a substantial evolution of the US retirement system. It contains some 92 different measures, some major, some minor. I’m going to focus on three here.
While the US pioneered automatic enrolment as a joining mechanism for DC schemes, most of the evidence relating to the success of AE Stateside comes from large paternalistic employers. It took off in the corporate sector well ahead of its adoption by individual state legislatures. Previous efforts to mandate auto-enrolment at the federal level in the US had failed.
Securing the future for a generation of workers
SECURE 2.0 mandates that new 401k plans established after 31 December 2024 should automatically enrol members. Pre-existing plans are exempt from this requirement and there are exemptions for government organisations, employers with fewer than 10 workers and employers that have been in existence for less than three years. Eligible employers will be required to enrol employees with an initial 3% contribution, rising every year by 1% to at least 10%, before hitting a ceiling of 15%.
This is a robust implementation plan, and a much faster timeline for phasing in an increase to minimum contribution rates than here in the UK. While it’s not an exact comparison, it’s entirely possible that by the end of the decade early adopters of the new arrangement in the US will have higher mandatory minimum contributions than comparable AE arrangements in the UK – despite the UK having completed staging in 2018.
Is annuitisation the answer to decumulation in the US?
I then come to decumulation. In common with other countries where it isn’t mandatory, annuitisation is unpopular in the US. Much the same is also true in Australia. Annuities have also acquired a bad reputation, due to historic mis-selling scandals tarnishing the product class. The problem of converting a pot of capital into an income, though, is as acute for Americans as it is for UK savers and Australians. Industry observers expect technical challenges in SECURE 2.0 to lead to more retirement plans offering partial annuitisation inside the plan, effectively turning the product class from a retail to an institutional one.
This is strikingly like post-freedoms decumulation models that have been talked about in the UK for some years. There are key differences, deferred annuities exist in the US in a way they don’t in the UK – prudential requirements blocking the development of the product class in the UK. But it’s a similar answer to the same problem – decumulation through DC is hard and no one claims to have cracked it yet.
Tackling the problem of small pots
The third and final area of focus is the enabling of automatic transfer of plan balances below $5,000 to the new plan unless the saver chooses otherwise. This measure is strikingly similar to proposals by Steve Webb when he was pensions minister for “pot follows member” in the UK. Under the Webb plans, deferred pots under £10,000 would have automatically transferred to a worker’s active pot. The reasons for the failure of the proposals are long and complex (I should confess I served on the DWP working group), but the administrative cost and complexity was the main root of the problem.
The difference with the US approach is that clearing house services exist, which can facilitate the required transfers. Similar services just do not exist in this country and, while considerable theoretical progress has been made on small pots consolidation, the UK pensions sector is years behind the US on administration of transfers. We expect the US experience to figure large in discussions of the forthcoming DWP call for evidence on small pots consolidation.
The next item in this series will dig further into SECURE 2.0 and look at differences in the taxation of retirement accounts, the self-employed and the introduction of liquid savings accounts tied to retirement saving. The latter bears enormous similarity to the sidecar proposals being trialled by NEST Insight. There is a huge amount to learn and, potentially, apply to the UK retirement savings’ landscape.