Industry Voices

IMHO: Savings “Bonds”

By Nevin E. Adams | July 27, 2011
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July 27, 2011 (PLANSPONSOR.com) - In my experience, there are three major reasons that people save for retirement.

There’s the lure of the “free money” represented by the employer match, the benefit in deferring the payment of taxes, and there’s the hopefully obvious benefit of helping make sure you have enough money set aside to provide a financially satisfying retirement.  While one might hope that the last represents the dominant motivation for most, I suspect it’s almost incidental.

Anecdotal evidence would suggest that the match exerts a powerful influence on savings behaviors.  Sure, any number of participant surveys emphasize its importance as a factor, but to my eyes, the most compelling evidence is the clustering of participant deferral rates—in plan after plan—at the level at which the employer has deigned to provide that financial incentive.

As for the tax advantages, outside of Warren Buffett, I can count on one hand the number of individuals of my acquaintance who feel they are “under-taxed.”  More importantly, I can still remember the first time I had someone explain to me how not forking over a chunk of my hard-earned pay to Uncle Sam now made it possible for me to save more without actually reducing my take home pay.  Moreover, how that “extra” savings, through accumulated earnings and the “magic of compounding,” could help my savings grow even more, and even faster.1  It was then—and remains, IMHO—a powerful incentive for individuals to save.

That said, of late, the taxation of these contributions—or perhaps, more accurately, the TIMING of the taxation of these contributions—has been much on the minds of those looking to solve the nation’s debt situation by raising revenue, most notably in the so-called “Gang of Six” proposal’s reported adoption of the National Commission on Fiscal Responsibility and Reform’s notion to cap annual “tax-preferred contributions to [the] lower of $20,000 or 20% of income” for 401(k)-type retirement plans.” This stands in sharp contrast to the current structure, where the limit on the combination of employee and employer contributions is the lesser of a dollar limit of at least $49,000 per year and 100% of an employee’s compensation. 

Simplistically, it’s hard to imagine that many workers today are setting aside 20% of pay for retirement.  Even someone who is deferring 6% and receiving a very generous dollar-for-dollar match would presumably still be well within the comfort zone of those new limits.  The $20,000 cap is, of course, more problematic.  Still, I’m sure that those who proposed that cap of $20,000—particularly when the current limit on pre-tax deferrals is $16,500, and the median deferral less than half that sum—think it won’t matter much to “regular” folks.  At least they might have thought so, had they not paid mind to a recent analysis by the nonpartisan Employee Benefit Research Institute (EBRI), not just for the highly compensated, but for those who today may not be, but who would hit those limits during their later working years (see Capping Tax-Preferred 401(k) Contributions Would Hurt Workers).