Why planning for retirement is hard, and what to do about it

Lately my dad has been ending our calls by asking after my IRA (my Individual Retirement Account). I’m not sure why.

Saving for retirement can feel like burning money. It's not like I've met Future Chitra; I can't tell you what her preferences are, what the world she lives in looks like, or, in my most depressing moments, whether the world she lives in is one she looks forward to. Add to that the fact that saving for retirement is, in the U.S., a lot of work, and the whole thing seems like a futile exercise. 

I don’t know why he asks.  Maybe it’s because he doesn’t have any grandkids he can ask about, and asking about my IRA is the closest substitute he can think of. Maybe he’s just being a boomer dad, and it’s easier for him to ask about my finances than my feelings.

Or maybe when my dad asks about my IRA, what he’s really asking is: Are you still looking forward to the future? And if you are, are you putting your money where your hopes are?

Are you controlling the piece of the future that you actually, directly, can?

Why do we do it this way?

Before we get into the practices of how my dad says I should save for retirement, let's talk about why it can feel so overwhelming for those of us who are working and saving in the U.S.

Many other developed countries with state-sponsored retirement plans do it through defined benefit systems (a.k.a. pensions): you work, you contribute (sometimes automatically) and you get a defined amount of money each month when you retire.

That’s also, broadly, how Social Security payments work in the United States: you pay about six percent of your salary into Social Security now, and when you retire — subject to conditions like having worked long enough — you expect to receive somewhere around 30 to 50 percent of your previous income.

The problem is that defined pensions are a bit of a pyramid scheme: New workers need to constantly enter and contribute to support current retirees. Fewer new workers or too many older workers (due to lower fertility and/or low immigration) threaten the viability of the pension system, as we saw French pension protests last year. The result is that the government is (or should be) heavily invested in getting people to make babies or come to their countries to work, both of which have their own political and demographic challenges.

Hence the rise of the defined contribution, popularized by the first Reagan tax cut bill in 1981. Instead of defining the benefits you’ll receive later, i.e. the money you receive in retirement, defined contribution plans define the amount you and your employer contribute to a retirement account today. They save employers a lot of uncertainty and require less forward-planning by institutions.

Today, about 15% of private-sector workers have access to defined benefit plans, but about 70% have access to defined contribution plans (BLS). The only pension plans around seem to be those for state and local government employees (BLS), which are often underfunded. The majority of Americans, according to the National Institute on Retirement Security, report high anxiety about retirements, with another majority believing pensions would restore security.

What were the consequences?

The technical details of the defined contribution — allowing all workers to contribute to their own retirement accounts, with employers contributing extra — belie the bigger rhetorical shift that took place: the employee is responsible for supporting herself in retirement.

That shift in responsibility means we each have to become mini-financial experts just to keep up. But doctors are trained in medicine; firefighters know how to fight fires; teachers teach — why do we all have to learn about index funds and diversification too? After years of contributing labor to the economy, does past ignorance mean we deserve poverty later?

Today, financial literacy often functions as yet another wedge separating haves and have-nots, only worsening retirement prospects for the worst off Americans.

Research by Olivia S. Mitchell, a professor of economics at The Wharton School in the University of Pennsylvania, and co-authors has found that since low-income workers tend to rely and benefit more from fixed-income retirement sources, like Social Security payments, they aren’t incentivized to learn about — or even able to, if they can’t access them — vehicles like IRAs and 401(k)s that would supplement their retirement income. In that way, Mitchell said, “Financial literacy can be ‘crowded out’ by redistributive social security programs such as in the U.S.”

That extra literacy matters: It helps higher income workers with “a variety of financial decisions, including planning and saving more for retirement, better diversifying their investments and better protecting themselves against outliving their assets in later life, resulting in generally greater financial resilience. That means, for better or for worse, there really isn't any getting around having to learn a few personal finance concepts.

What can you do about it?

Here in the U.S., there are a variety of defined-contribution plans, all constructed around tax incentives, to help workers defer compensation and invest it, usually into the stock market.

Investing your retirement funds into the stock market has two benefits, macro and micro. First, more money injected into the stock market helps businesses and the overall economy grow (“the pie is growing”). Second, every investor’s wealth can grow with the stock market, which usually outpaces inflation by a lot (“you’ve got a slice of the pie”).

The downside, of course, was illustrated almost perfectly by the 2008 Financial Crisis and the 2020 COVID downturn: Every worker who wants to retire is intimately exposed to fluctuations in the stock market.

In 2008, when the stock market crashed, retirees who suffered the most. Furthermore, it was middle or upper-middle class households who relied on those deferred contribution plans who lost about 30 percent of the value in those plans (AARP).

The only way to mitigate risk is to do what economists call the “only free lunch in finance” — to diversify your retirement portfolio. Within the stock market, make sure your retirement savings are invested in broad index funds (a good explainer on that here). And as you age — and your risk tolerance decreases — move your money.

All of that requires so much more thinking than the automated Social Security payroll taxes I pay and the payments I expect to receive (barring a politically unpopular policy of gutting Social Security). 

So here’s the advice I’ll leave you with today: Take one step. Try any of the following steps, whichever feels easiest and most doable right now. It’s just one step, but it’ll keep you moving forward towards the thing I think we all hope for: a future where we retire prepared and happy.

1. Look up whether your employer gives you a 401(k). Find out how to contribute to it.
2. Contribute up to the employer match in your 401(k), if you can.
3. If your 2024 income is (expected to be) less than about $141,000, open a Roth IRA. Otherwise, open a Traditional IRA. Contribute at least one dollar today, and up to $7,000.
4. Contribute up to the 2024 maximum in your 401(k), $23,000. The IRS is increasing that to $23,500 in 2025.
5. Make sure your contributions are all actually invested into some kind of index fund offered either by your employer’s 401(k) plan or the administrator of your IRA.

Next time, we’ll talk about what each of the steps above actually lead to, why I put them in that order and how you can move yourself toward feeling like you have just a smidgen of a say — and maybe even some hope — in your future.