A key part of the proposal is the creation of broadly diversified Trusteed Retirement Funds (TRFs), whose sponsors are trustees, with fiduciary responsibilities.
Payroll deduction of every employee’s salary would automatically go into a broadly diversified TRF unless the employee either opts out or selects a preferred TRF, or if the employer already sponsors a defined benefit (DB) pension plan. TRFs will relieve employers from fiduciary responsibility for all future DC contributions.
To protect retirees from the risks of inflation, longevity, and the unpredictability of the stock and bond markets, retirees will be encouraged to use their TRF savings to buy either an immediate or deferred indexed annuity. A Federal Longevity Insurance Administration would be established to enable private insurance companies to provide cost-effective annuities.
All TRFs and annuities will be without marketing costs.
The paper’s authors, Russell L. Olson and Douglas W. Phillips from the University of Rochester, looked at other countries’ retirement systems when developing their proposal, giving special consideration to Australia based on the success of its superannuation program. This program mandates high pension contributions for every employee by his employer, but the contributions go to managed funds that each employee may select. The researchers note, “Australia now has the fifth highest ratio of pension assets to GDP (92%), and it has accomplished most of this in the last 20 years. Australians now have more money invested in managed funds per capita than any other economy.”
According to the paper, Australia has accomplished this through a wide range of private defined contribution funds called “superannuation funds,” which must meet specific requirements. To be tax-qualified, each fund must have a trustee, a trust deed defining members’ rights and obligations, a written investment strategy with broad diversification, and the most widely used funds must meet certain standards for fees and reporting.
The researchers said they do not believe Americans would agree to the mandating of large pension contributions in addition to what they already contribute to Social Security (through FICA taxes). But they believe the challenge of adequate retirement savings for Americans can be met by establishing high levels of retirement contributions by employees to Trusteed Retirement Funds, from which employees have the right to opt out, and by adapting the best of Australia’s superannuation concepts.
In the paper, the authors lay out the blueprint for TRFs, including fiduciary, governance and investment requirements. Those who believe they can invest their money better than any available TRF may set up their own TRF. In addition, sponsors of regular TRFs may offer options that allow participants to implement their own investment strategy and to invest in their own portfolio of mutual funds and other investments. The opportunity would offer many of the benefits of a self-managed TRF at a fraction of the cost, provided the portfolio met the sponsor’s fiduciary requirements.
The authors note that retirement plan participants do not often purchase annuities with their lump-sum distributions at retirement, and contend that retirees would benefit from an alternative that is not now widely available—a deferred annuity, which an individual would purchase when he retires and from which he would begin receiving payments if he lives to a much older age, say 90. The premium for a deferred annuity 25 years into the future would require only a small portion of the retiree’s retirement assets (perhaps as little as 3%), and then he could safely spend all of his remaining assets by the time he turns 90.
Unless the purchase of an annuity was mandated, however, why would most retirees be motivated to buy one? The authors suggest their motivation would be spurred by two provisions of their proposal:
- A central accounting agency would get workers thinking in terms of annuities throughout their working career by including in each worker’s annual report: the annual amount of an indexed annuity that the worker’s current TRF balance could currently buy at age 67; the cost at age 67 of a deferred indexed annuity for that amount, effective at age 90; and the same information for a joint and survivor annuity. This information would be intended to show a worker how much more he needs to save in order to ensure an adequate income in retirement, and to get him thinking in terms of buying an annuity whenever he retires.
- When a retiree requests his first withdrawal from a TRF (or any other remaining DC fund) the fund would purchase a deferred indexed annuity for him unless the retiree elected in writing any of the following options: buy an immediate indexed annuity; buy a deferred annuity starting at a different age, say 85 or 95 (based on an alternative pricing list); or buy no annuity. The premium for annuities would have to take into consideration the negative selection that would result from the fact that retirees who do not expect to live long would choose not to buy an annuity.
Regarding tax incentives for retirement savings, the authors said the government should redirect its retirement tax subsidies to best accomplish its purpose. They suggested starting with tax relief for workers earning, for example, $30,000 or less. To encourage them to make TRF contributions, their contributions should be treated as tax reductions instead of tax deductions.
In order to limit total tax subsidies for retirement funding to the current level of tax subsidies, current year eligibility for a person to make further TRF contributions would be denied to any participant whose market value of assets in his combined defined contribution accounts exceeds a maximum balance. The maximum balance should be whatever figure would maintain the nation’s total tax subsidies for retirement funding at the present level of its tax subsidies. The maximum balance would vary by the contributor’s age, allowing for the number of years that remain for investments to continue earning returns. “This approach would use our federal tax spending for retirement in a way that would encourage retirement savings by the maximum number of American workers,” the authors concluded.
More details about the proposal are in the paper “Let’s Save Retirement,” which may be downloaded from here.