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Some Big Ideas on Retirement Security

President Obama, in his address to a joint session of Congress last night, called for big ideas to address the problems we are facing today.  Fortunately for us we don’t have to reinvent the wheel when it comes to big ideas.  Many “think tanks” in the U.S. have been conducting research and making policy proposals for decades.  In many instances, including health care reform and retirement security, the research has been performed and policies have been proposed.  Now it is a matter of identifying the best proposals, debating the pros and cons of those proposals and implementing the best policies.

President Obama did not mention it last night in his address.  He already has a lot on his plate.  But, the next crisis we face will be the lack of retirement security.  People were not saving enough for retirement before our economic crisis and now for many people the retirement savings that was in 401ks or IRAs has been decimated by the drop in the financial markets.  It is estimated that people’s 401ks and IRAs have lost $2 trillion in value since this economic crisis began and an AARP survey indicates that a growing number of baby boomers have stopped contributing to retirement plans in order to cover other more important living expenses.

There are three main problems with our current retirement savings system:

1)  Workers assume too much investment/market risk.  The defined benefit pension system of old has been replaced by a defined contribution system of 401k and IRAs.  Employee contributions and, if workers are lucky, employer contributions are typically invested in a choice of mutual funds or individual securities that are subject to market volatility.

2)  Tax incentives have been backwards and regressive. 

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Qualified retirement saving today reduces taxable income, a deduction that is worth 35 cents on the dollar to high-bracket taxpayers who need little incentive to save. In contrast, a tax deduction for
saving is worth zero to the 35 million low-earning households who pay 15.2 percent in payroll taxes but don’t have income tax liability to offset. Indeed, even median-income families in the 10 and 15 percent income tax brackets receive a weak subsidy compared to the 35 percent subsidy rate that applies to those earning over $200,000 a year.

3)  Not everyone has access to retirement plans. Employer-sponsored plans cover less than half of all workers.

There is hope.  Many “think tanks” and people have been thinking about retirement security for quite some time and there are many good proposals out there.  Below is a brief introduction to two proposals.  These proposals are submitted in the interest of sparking a discussion about the issue of retirement security.

1)  The Universal 401k Plan - The New American Foundation: NAF’s proposal calls for Individual Career Accounts.  The key part to this proposal is a new refundable tax credit.  The government would match voluntary savings with a refundable tax credit that would be deposited into the worker’s account.  Every working American would have access to the tax incentive and the portable savings account whether or not his/her employer sponsors a retirement plan.  These accounts would take advantage of existing payroll infrastructure.  It would allow for an automatic payroll deduction.  The amount of such deduction would be determined by the worker on his/her IRS Form W-4. 

Participation would be the default option.  Workers would automatically be enrolled in program unless they opt out by indicating as such on his/her IRS Form W-4.  A new entity, similar to the Federal Thrift Saving Plan, would be the administrator of the Individual Career Accounts.  Workers would get to choose from several broad and low-cost index funds and there would be an age-based allocation default if the worker does not specify allocations.  These Individual Career Accounts would supplement the existing private pension system.

2)  Super Simple Savings Plan - The Aspen Institute: The principle behind Aspen Institute’s proposal is that the current defined contribution plan is too complex and burdensome for many employers.  Their proposal would cover all workers except short-term workers and it would be available to all employers.  The idea is that the Super Simple Savings Plan would be a low-cost and simple system for the employer.  It would replace all other defined contribution plans except for the standard 401k.  The proposal does contemplate making these retirement accounts mandatory for all employers.  There would be automatic enrollment which would require the worker to opt out of the plan.  There would be better tax incentives than currently available for low and middle income individuals to save through a government matching contribution.

Both proposals are very interesting but take somewhat different approaches to the problems.  The New America Foundation proposal is one that focuses on the individual while the Aspen Institute proposal focuses on improving upon existing retirement plans.  These plans have two very important things in common: 1) new tax incentives to encourage retirement savings; and 2) automatic enrollment.

However, these plans do not address the investment/market risk that workers assume with defined contribution plans.  If we are going adopt something other than a national pension system then there has to be some insurance or guaranteed rate of return on investments.  There has to be some preservation of a retirement nest egg - some portion of the savings should earn a return but not be subject to investment/market risk.