Research

What Can the United States Learn from the Rest of the World’s Retirement Systems?

June 25, 2024

Issue Brief | Why does the United States’ pension system perform poorly compared with systems in other countries? The United States can significantly improve its comparative performance by mandating retirement savings, plugging leakages, professionalizing investments, and expanding annuities. 

By: Karthik Manickam and Teresa Ghilarducci

 

Key Findings:

  • The United States consistently underperforms compared to its wealthy peer nations in the Organization for Economic Cooperation and Development (OECD). The U.S. earned a low C+ in the 2022 and 2023 Melbourne Mercer Index, notably falling behind Australia, Denmark, and the Netherlands which are graded B+ and above. 
  • Australia, Denmark, and the Netherlands all have higher pension floors and retirement mandates, resulting in both a higher net replacement rate and net pension wealth relative to the United States.
  • Mandating coverage, plugging leakages, professionalizing investments, and adding annuities would vastly improve the United States’ retirement system. 

The United States’ pension system consistently ranks lower than other comparable countries on internationally recognized indices such as the Melbourne Mercer Index, which assesses the adequacy of countries’ retirement system coverage; financial sustainability; and integrity regarding regulation and governance. Other countries have better retirement outcomes in the form of higher replacement rates and net pension wealth because they have mandatory retirement accounts, cover more workers, and have simplified retirement savings instruments. Moreover, most nations prevent leakage from accounts before retirement and pay out benefits in the form of lifetime income. Mandating coverage, plugging leakages, professionalizing investments, and adding annuities would improve the United States’ comparative performance.

 

The United States’ pension system consistently ranks below other comparable countries (Table 1), getting a barely passing grade of C+ in both the 2022 and 2023 Melbourne Mercer1 Pension Index rankings. One main reason for this is that the U.S. pension system departs from those of other OECD countries: it is voluntary, complex, do-it-yourself, and heavily financialized;2 as a result, many workers experience retirement insecurity.

 

Table 1 - USA’s 2023 Rank in Comparison to Reference Countries  

System

Rank

Overall Grade

Total

Adequacy

Sustainability

Integrity

Netherlands

1

A

85.0

85.6

82.4

87.7

Denmark

3

A

81.3

82.5

82.5

77.8

Australia

5

B+

77.3

70.7

78.4

86.1

USA

22

C+

63.0

66.7

61.1

59.5


Source: 2023 Melbourne Mercer Index 

 

The United States underperforms in comparison to the Netherlands, Denmark, and Australia due to insufficient retirement incomes, low retirement account access, and a lack of universal coverage. American workers, as amateur portfolio managers, pay high fees and earn lower fee-adjusted, risk adjusted investment returns compared to a professional portfolio. Despite generous tax benefits (which go largely to upper-income earners) and extensive regulations, the U.S. employer-based and private retirement savings system does not deliver secure income for most retirees. These weaknesses make the U.S. pension system an underachieving international outlier, especially among wealthier peer nations.

 

Why Does the United States Rank So Poorly?

Pension systems consist of tiers, or pillars3, that correspond to policies or programs that run in parallel to ensure that retirees have retirement income and savings. The first tier is the pension floor, aimed at ensuring all retirees some form of income. The second tier typically consists of mandatory social insurance, which is usually the main pension source for most workers. Tier three typically includes complementary schemes, usually voluntary, meant to encourage additional savings on top of existing mandated retirement savings amounts. In the U.S. system, tier 1 is Supplemental Security Income; tier 2 is Social Security benefits; and tier 3 includes 401(k)s, individual retirement accounts (IRAs), traditional pensions, and additional savings mechanisms.

A well-designed pension system4 ensures that workers’ standards of living are maintained after they leave the workforce and throughout their retirement. In a functioning system, a middle-class worker becomes a middle-class retiree. Maintaining this living standard over one’s life course requires workers to save sufficiently during their working life and have access to additional supports like healthcare and welfare support to cover any shortfall in savings from being sicker or living longer than expected. 

The U.S. system fails at even that first vital step. The American system does not help people save, even if they are motivated to take personal responsibility for themselves. The U.S. system relies heavily on voluntary participation in employer-based retirement plans (tier 3). Despite this (or perhaps because of it), only about half of the U.S. workforce participates in a workplace retirement plan.5 Stopping and starting contributions significantly weakens retirement plans, typically making the accumulation anemic and insufficient. Because younger people are the least likely to save in a voluntary system, they are robbed of the very thing the young have in abundance — time to save. These insufficient contributions and low participation rates mean that workers are unable to save enough to maintain their post-retirement standard of living.

Workers also face a complex, confusing array of retirement options and are expected to be financial experts, leading to a problem where workers either refuse to exercise their plans or choose suboptimal ones. The complexity of how such plans operate also adds to administrative overhead costs.

A core problem with the current U.S. system is that it is not aligned with the capabilities of most human beings. The system works if everyone starts investing at an early age. Waiting to save requires a substantially higher sacrifice of current consumption. Take an example of someone who starts saving $300 a month at age 25. They earn an average of 5% annually, compounded monthly across 40 years. At the end, they have $450K saved, and the markets have provided most of that amount ($302K) through compounded interest. But their twin doesn’t begin investing until ten years later at age 35. They invest almost twice as much, $550 a month for 30 years, also averaging a monthly compounded 5% return. By age 65, the twin has only earned $252K.

The U.S. system allows many cases like this because it places all the responsibility, pressure, and risk on the individual. In an economy filled with precarity and volatility, people make rational decisions with their money that later prove damaging because the system hasn’t helped them save for the future. This harms some people more than others. The system’s failure to provide the means to invest as soon as a worker starts paying Social Security disproportionately impacts working women and nonwhite workers who start work earlier and die sooner.6 

Insufficient contributions and low participation rates mean that workers cannot maintain their standard of living once they retire.

American workers face a complicated gauntlet of legal and financial regulations. Workers are expected to be financial experts facing a confusing array of retirement options. American employers know that the highest-paid and most sophisticated workers are getting the most out of their voluntary retirement plans. But for most workers, the DIY system deepens inequalities instead. In two-thirds of plans, employer contributions make earnings inequality worse. Nearly half (44%) of employer contributions to voluntary retirement plans go to the top 20% of earners.7 Employers know that complexity is such a problem that workers either refuse to participate in their plans or choose suboptimal plans. That complexity also adds to administrative overhead costs.

Another confounding factor is the heavy emphasis on financialization that has left the pension system subject to market risks. Workers are not fully in control of their age of retirement8, and tend to underestimate how long their retirement will be. Consequently, they save less money than they need.

 

What Do Other Countries Do that the United States Doesn’t?

Comparing the U.S. system with three OECD reference countries — Australia, the Netherlands, and Denmark — we find that these peer nations ensure that pension coverage is universal; that retirement contributions are mandatory and regular for almost all workers; that pension floors are elevated enough to avoid high levels of elderly poverty; and that people only draw on their retirement accounts when they are retired. As a result, America’s peer nations feature pension systems that allow workers to retire with incomes and pension wealth that can sustain their standard of living after they leave the workforce. 

 

Universal Pension Coverage and High Pension Floors

The portion of citizens aged 65 and over who are covered by each country’s tier 1 pension floors varied widely in 2022 data (see Figure 2 based on data from OECD’s 2023 Pensions at a Glance). Australia9 and the U.S. have means-tested pension floors, while The Netherlands10 has a residence-based pension floor, meaning that all residents who have lived and worked in the country for a sufficient amount of time are entitled to a basic pension. Denmark has both a means-tested and a residence-based component to its pension floor.11

All three of these peer countries achieve much higher coverage rates through pension floors that cover a much broader population than the U.S. system does. Australia’s targeted pension floor is more inclusive than the U.S. system and covers 58% of the 65+ population, compared to just 13% coverage in the United States. Denmark’s targeted and residence-based pension floor components cover 72% and 87% of the population respectively. The Netherlands’ AOW pension floor is residence-based and thus covers both citizens and non-citizen residents, allowing for a coverage of 101%.12

 

Figure 2 - Percentage of Population 65+ Covered by Tier 1 Pension Floors in 2022

Source: Data from OECD Pension at a Glance 2023

In addition to wide coverage, all three reference countries have a high benefit value, meaning that retirees receive much higher pension support compared with their peers in the United States, regardless of how much they’ve worked in their lives. The benefit value a worker receives through the pension floor is expressed as a percentage of the average worker’s earnings at retirement for that country. The United States’ pension floor provides the lowest benefit value at 15.6% of the average worker’s earnings at retirement, while the Netherlands’ residence-based pension floor provides the highest at 29.1% of their average worker’s earnings at retirement (see Figure 3).

 

Figure 3 – Benefit Value Received as a Percentage of Average Earnings at Retirement

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Source: Data from OECD Pension at a Glance 2023

 

Mandated Coverage

All three reference countries have robust pension programs that require both employers and employees to contribute to pensions. These mandated contributions — which make up the second tier of their pension systems — are more effective than the U.S. system at ensuring that workers have high retirement incomes and pension wealth relative to their earnings at retirement. 

Denmark and the Netherlands both have de facto legal requirements that workers must be covered by some form of pension. Coverage is achieved through collective bargaining with employees. Unions and workers’ bargaining rights are well-protected, and the agreements cover each sector. Australia has a “Superannuation system” that mandates all employees to have a Superannuation account into which both employees and employers are required to contribute some portion of their salary. In comparison, the United States’ only mandatory pension contribution is Social Security. 

Figure 4 shows the net pension replacement rate13 for each country’s pension system for low- income14 and middle-income workers15 as well as the OECD’s average. Once again, we find the U.S. is behind. Australia, the Netherlands and Denmark only have data for their mandatory public and private pension schemes, while the United States has data for its mandatory scheme — i.e., Social Security and Supplemental Security Income — as well as for voluntary schemes such as 401(k)s and IRAs. The United States’ mandatory pension replacement rate for both low-income (60.6%) and middle income (50.5%) workers is significantly lower than all other countries and the OECD average (except for Australia’s middle-income worker (33.7%) due to Australia’s progressive taxation system).16  The United States’ replacement rate is improved when voluntary pension provisions are included (101.5%17 for middle-income workers and 87.7% for low-income); however, over half of US households do not have such voluntary savings accounts.18

 

 Figure 4 - Net Replacement Rates as a Percentage by Country

Source: Data from OECD Pension at a Glance 2023

The savings mandates translate into the accumulation of pension wealth over time as well. Figure 5 shows the net male pension wealth19 accumulated as a multiple of average earnings at retirement for low- and middle-income earners. The United States’ mandatory pension systems results in only 11.5 and 9.5 times the average earnings at retirement, which is well below the OECD average of 14.6 and 12.3 as well as the Dutch levels of 17.6 and 16.8.

  

Figure 5 – Net Pension Wealth as a Multiple of Average Earnings at Retirement by Country


Source: Data from OECD Pension at a Glance 2023

 

Policy Solutions to Boost the U.S. Pension System and Grade 

The superior performance of Australia, Denmark, and the Netherlands provides a path forward for the U.S. to improve its pension system. Key policy interventions include: the implementation of Guaranteed Retirement Accounts (GRAs)20 that would require contributions of 3% by both employers and employees from the start of their careers, with pooled investments and payouts in the form of annuities; state- and city-led automatic enrollment into individual retirement plans;21 and expansion of the Thrift Savings Plan for low- and middle-income workers.22  

 

 


Endnotes

1 Melbourne Mercer. Global Pension Index 2019. Melbourne: Mercer Institute and Monash University. https://www.mercer.com/insights/investments/market-outlook-and-trends/mercer-cfa-global-pension-index/

2 Ghilarducci, T. (2024). Work, Retire, Repeat: The Uncertainty of Retirement in the New Economy. Chicago, IL: The University of Chicago Press.

3 International Labor Organization. ILO (n.d.). The ILO Multi-Pillar pension model: Building equitable and sustainable pension systems. https://www.social-protection.org/gimi/Media.action?id=16573 

4 Barr, N., & Diamond, P. (2006). The Economics of Pensions. Oxford Review of Economic Policy, 22(1), 15-39. Retrieved from http://www.jstor.org/stable/23607164

5 Radpour, S., Papadopolous, M., & Ghilarducci, T. (2021). Trends in Employer-Sponsored Retirement Plan Access and Participation Rates: Reconciling Different Data Sources. New York, NY: Schwartz Center for Economic Policy Analysis and Department of Economics, The New School for Social Research.

6 Ghilarducci, T. (2024), pp. 87-105.

7 Greig, Fiona. Anna Madamba, Guillermo Carranza, Cormac O’Dea, Taha Choukhmane and Lawrence D.W. Schmidt. (2024). Are employers optimizing their 401(k) match? Vanguard Research. https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/considering-more-equitable-efficient-401k-match.html

8 Farmand, A., & Ghilarducci, T. (2021). Involuntary Unemployed by Class. New York, NY: Schwartz Center for Economic Policy Analysis and Department of Economics. The New School for Social Research.

Australia’s Age Pension is a means-tested tax-funded pension for Australian residents indexed to a Consumer Price Index and a Pensioner and Beneficiary Living Cost Index. 

10 The Netherlands’ AOW pension is a tax-funded pension that workers are entitled to, based on the number of years spent working in the Netherlands. It provides 70% of the minimum wage for a single person and 50% per person in a couple (totaling 100%).

11 OECD. (2023). Pensions at a Glance 2023. Paris: OECD Publishing.

12 The 2023 OECD Pension at a Glance reports coverage as the share of total pensioners covered (i.e., including both citizens and non-citizen residents) to the population above 65; thus, a share of greater than 100% means that the total number of recipients including both citizens and non-citizen residents is greater than the total population older than 65. Other countries with coverage rates greater than 100% include Czechia, Estonia, Lithuania, New Zealand, and Norway.

13 The net pension replacement rate is the net pension entitlement that a worker receives divided by their net final earnings just before retirement. The net replacement rate is used to measure the degree to which a pension sytem provides a retirement income that replaces their pre-retirement income. The net replacement rate is based on disposable income to indicate how much a worker would actually receive. 

14 Defined as earning 0.5 times the average worker’s earnings at retirement in that country.

15 Defined as earning 1 times the average worker’s earnings.

16 OECD, 2023. 

17 A net pension replacement rate greater than 100% means that the projected net benefit that an average retiree from a given country is projected to receive is greater than the average net final earnings just before retirement.

18 Morrissey, M., Radpour, S., and Schuster, B. (2022, November 16). The Older Workers and Retirement Chartbook, Chapter 2: Retirement. Economic Policy Institute. https://www.epi.org/publication/chapter-2-retirement/

19 Net pension wealth measures the total net discounted value (excluding taxes) of the lifetime flow of all retirement incomes into mandatory pension schemes at retirement age as a ratio of annual earnings before retirement. A value of 11.5 means that upon retirement the average worker is expected to have been able to save 11.7 times the value of their income at retirement. 

20 Ghilarducci, T. (2024), p. 179.
21 Ghilarducci, T. (2024), p. 179.
22 Ghilarducci, T. (2024), p. 180.