How do we make sure savings become wealth?

Rising wealth inequality in the United States has several causes, one of which is the rise in savings inequality among Americans. Research by Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley shows that the large increase in U.S. income inequality starting in the late 1970s corresponded with a widening gap between the savings rates of those at the top of the income distribution and those at the bottom. In fact, in the run-up to the Great Recession of 2007-2009, the bottom 90 percent of the U.S. population had a negative savings rate.

Policymakers have a number of options to help reduce wealth inequality. In light of this research, they should consider focusing on policies that would help improve the savings rates of most Americans.

First, it must be said that faster income growth would likely increase the amount of money most Americans could save. But for now, we will focus on policies that might be able to help Americans save a higher percentage of each additional dollar they earn.

Let’s start by looking at the U.S. retirement savings system. The system was once said to be a three-legged stool, resting upon the three “legs” of Social Security, traditional defined-benefit pensions provided by workplaces, and private savings. Traditional defined-benefit pensions, however, have all but disappeared now that employers have increasingly shifted toward defined-contribution plans such as 401(k)s. And while strengthening Social Security will be vital, we should improve upon private savings as well.

This new reliance on private savings has been troubling for a number of reasons. One is that take-up isn’t very high, primarily because access isn’t universal. Employers aren’t required to offer access to 401(k) plans, and even then actual participation in plans seems to be on the decline among younger workers.

With those problems in mind, researchers have pointed out the advantages of auto-enrolling workers into savings plans, which is quite effective at getting workers to actually save. The positive results are part of the reason why several state governments are setting up state-sponsored savings plans that would have workers automatically contribute 3 percent of their earnings.

While these programs are wisely focused on increasing contributions, state governments should also be aware of the potential problems with turning contributions into actual wealth for workers. In short, they should be aware of investment fees. When you contribute to a retirement plan, there are going to be fees that are charged as a percentage of the funds you have invested. And the amount of fees you pay can vary quite a bit. The average fee is about 1 percent but can be as low 0.25 percent. In the New York Times article cited above, the new program from the Illinois state government will have fees of 0.75 percent.

A fraction of a percentage point might not seem like that much, but it can make a huge difference over time. According to calculations by Jennifer Erickson and David Madland of the Center for American Progress, a 0.75-percentage-point difference can make a $100,000 difference over the course of a career.

Policymakers that are invested in helping workers save more for retirement should be aware that contributions don’t just need to be increased—the contributions that are made need to also not be wasted.