According to a recent study, Gen X and late baby boomers are on track to replace only about half of their current income when they reach retirement—which means they’ll need to seriously downgrade their lifestyles. Most financial planners recommend replacing, at the very least, 70 percent of one’s income.

In contrast, Depression babies, World War II babies and early boomers were on track to replace, respectively, 86 percent, 99 percent and 82 percent of their pre-retirement income.

Why are more recent generations finding it harder to save enough for retirement?

I talked with two economics professors who cite two types of factors—the breakdown in the employer-provided retirement benefits and a wider web of increased debt and lack of financial literacy.

Unfortunately, neither explanation offers a quick-fix solution, though they do hint at ways you can help improve your retirement picture.

The Shift Away From Pensions To 401(k)s

Teresa Ghilarducci, a labor economist at the New School and a nationally recognized expert n retirement security, says there’s only one reason why Gen X and late baby boomers will be less ready for retirement than their parents were: “The reason for the lack of preparedness is because of the collapse of one layer of the retirement cake, which is the employer-provided layer.”

In the last three decades, the number of unions fell, older workers faced higher unemployment and competition began to heat up with countries like China, making it harder for older workers to negotiate for stronger retirement benefits.

Additionally, as 401(k)s were being introduced in the 1980s, people thought they preferred to have control over their retirement accounts and their investments, said Ghilarducci. But it turns out that if they actually have a choice between a pension and a 401(k), they prefer the pension.

A pension is a “defined-benefit” account, giving an employee a lifetime payout based on a formula taking into account factors such as how long he or she has been with a company and not necessarily based on how well the investments do. A “defined-contribution” plan, such as a 401(k), on the other hand, offers no guarantee on how much money will eventually be paid out.

“When people have a choice—and they have a choice in the public sector—they actually choose, when they’re asked, a defined-benefit plan. So it’s clearly employers who prefer the 401(k), and that’s because they’re cheaper,” Ghilarducci said. (Companies that offer pensions have to tap their own earnings if the pension’s investments fall short.)
Why Defined-Benefit Plans Are Better For Workers

According to Ghilarducci, there are four reasons that, for workers, defined-benefit plans such as pensions are superior to 401(k)s and similar accounts:

1) A defined-benefit plan requires the employee to enroll, unlike defined-contribution plans, which are often voluntary.

2) With such a plan, neither the employee nor his or her relatives can get access to their retirement savings. (This is a big drain on assets in defined-contribution plans such as 401(k) accounts.)

3) Defined-benefit plans offer a higher rate of return. “Professionals invest the defined-benefit plan,” Ghilarducci said, “not the individuals choosing various mutual funds. And defined-benefit plans always outperform defined-contribution plans.”

In fact, last week, a study by Towers Watson showed that, in 2011, investment returns on pension plans outperformed those of defined-contribution plans by the largest margin since the 1990s. Out of 2,000 plan sponsors analyzed, defined-benefit plans had median investment returns of 2.74 percent, while defined-contribution plans had median returns of ?0.22 percent

4) Finally, a defined-benefit plan pays out an annuity for the rest of the employee’s life, so the employee doesn’t bear the risk of outliving his or her money—a frightening possibility for holders of 401(k)s and similar accounts.

Ghilarducci discounts some other factors that are frequently cited: “There’s a lot of noise that you’ll hear—that it’s lack of financial literacy, that it’s student debt,” she said. “None of those matter. Having an $8,000 or a $20,000 to $30,000 debt does not affect accumulating the more than $600,000 that most people need for retirement. Those are fly-speck reasons. There are lots more reasons to think that people are more financially literate now than they were 30 years ago. So no other reason holds a candle to the collapse of the employer-employee retirement system.”
Financial Literacy, The Cost Of Education And Other Factors

Annamaria Lusardi, professor of economics at the George Washington University School of Business, says that lack of financial literacy and a broader web of money challenges are hindering people’s ability to save.

She agrees with Ghilarducci that the shift away from pensions toward 401(k)s has given people more responsibility—such as deciding how much to contribute every month or year and how to allocate that money, once retired—but that financial literacy has not increased accordingly, so people are not equipped to make good decisions. “People always had a low level of financial literacy,” she said, “but in the past it didn’t matter because they didn’t have to make those decisions.”

On top of that, Lusardi said that two new factors are exacerbating this lack of financial literacy: the cost of education and access to credit. “People enter the labor market now, with respect to previous generations, always with a higher amount of debt. And by the way, it’s not just their own education, but the education of their children,” she said. She also noted how easy it is to borrow now in a multitude of ways, from our credit cards to home equity lines of credit. So, while the cost of education has drastically increased and acquiring debt has become easier, people have made saving for retirement a lower priority against taking on and paying down debt, both for their own and their children’s education.

The fact that people are borrowing in riskier, more costly ways shows that their whole financial picture is shaky. For instance, a recent study by the Federal Reserve Board estimated that 45 cents of every dollar contributed to retirement accounts “leaks out,” or is withdrawn early—meaning it is taken out before 59-and-a-half, and taxed and levied with penalties. Lusardi also recently published a paper with the National Bureau of Economic Research showing that in 2009, 24 percent of Americans had used a high-cost method of borrowing within the previous five years. These included using a pawnshop and taking out a payday loan.
So What Can Be Done?

Lusardi doesn’t necessarily believe the return to a pension system will work: “Defined contributions are here to stay, because they are defined by the different demographics and labor markets we have today—people change jobs, and [their retirement accounts] need to be portable. We need to have financial education in the schools, so people are prepared for the new economic environment they will face,” she said.

She also noted that many experts advocate for automatic enrollment into 401(k)s, but added, “because people borrow against their accounts, I think automatic enrollment is not enough.”

She supports financial education at school and in the workplace, and policies that make it easier for people to save and harder for them to borrow. “When we talk about retirement savings, we think too narrowly,” she says. “In fact, all of the financial decisions are interrelated, and we need to find ways people can get help and advice on how to deal well with their financial wellbeing.”

Ghilarducci, on the other hand, advocates for a new type of retirement plan that is better for employees than their current 401(k)s. These are the features she believes it needs:
• Universal coverage, so everyone would be saving for retirement
• Pooled assets, to reduce individual risk
• Payouts only at retirement, so people would not deplete or borrow against their accounts before retirement
• A steady lifetime income stream (a.k.a an annuity), so people don’t outlive their savings
• Portable benefits, so people can take the savings with them from job to job
• Low-cost and transparent administration to address the problem of fees charged by some retirement plans that keep retirement savings from growing.

While the retirement system isn’t about to be transformed tomorrow, you can take concrete steps to bolster your nest egg, as certified financial planner Lauren Lyons Cole recommends, from securing a raise to refining your priorities so you’re only spending on what truly matters to you.

But most importantly, shift your mindset. Make retirement one of your top priorities. Save with every single paycheck, whether you’re 22 or 62. Don’t assume you’ll be able to work past retirement age to make up for any shortfall in your savings, as many older workers are laid off. And remember that your expenses in retirement may increase due to health costs. With every big money decision you make, ask yourself how you can help take care of the 70-, 80- or 90-year-old you.•