It’s election time, so a lot of ideas are being thrown around. Retirement policy might not seem like the most gripping topic of the moment, but there are a few proposals out there. Two in particular deserve comment. One is a good idea—the other is a clunker.
The good idea is a national automatic individual retirement account (IRA). The clunker is reducing tax incentives for 401(k)s and similar retirement savings vehicles.
The auto-IRA is long overdue. Forty-two percent of private sector workers in America have no workplace retirement plan. According to The Pew Charitable Trusts, “more than 30 million full-time, full-year private-sector workers ages 18 to 64 lack access to an employer-based retirement plan.” This does not even include part-time workers or those informally employed.
Washington is often dysfunctional. So, in recent years, numerous states have gone ahead and adopted so-called “Secure Choice” legislation, designed to create auto-IRAs or similar programs that increase access to workplace retirement savings programs. This is positive movement, but it creates a potential checkerboard or hodgepodge of systems that could be more easily administered in one national program.
One might expect that the more conservative or libertarian view would be that people should take care of themselves; it’s not the government’s role to babysit them. But that view should also recognize that much more government and social welfare spending will be needed to care for people who have not prepared for retirement. One recent study concluded that Pennsylvania would have to spend $700 million more per year on social welfare programs due to the fact that elderly citizens did not save enough (and that $700 million was only on state-funded programs). The same study also concluded that undersaving would contribute to less spending, thus costing the Pennsylvania economy the equivalent of 20,000 jobs.
The UK had the same problem and addressed it simply and effectively by creating the National Employment Savings Trust (NEST). Through this system, every employer is required to offer a workplace retirement vehicle with automatic enrollment or, if they don’t, they must simply enroll employees in NEST. Of course, employees are free to opt out. But this approach simply reframed the question. Rather than saying, “Hello. You are hired. Would you like to enroll in the 401(k)?” The employer says, “Welcome to our payroll, health care and retirement plans. Let us know if you want to opt out.”
Last year, the Setting Every Community Up for Retirement Enhancement (SECURE) Act made significant improvements in the U.S. retirement system. U.S. Representative Richard Neal, D-Massachusetts and chairman of the House Ways and Means Committee, was the primary sponsor of the SECURE Act, and he has promoted new legislation, currently known as SECURE Act 2.0. That proposal includes a national auto-IRA—an idea whose time has come.
The idea whose time should never come is the reduction or elimination of tax incentives for retirement saving.
Various proposals have been floated for years to reduce the deductibility of 401(k) and similar plans. The reasoning behind these proposals appears to be twofold.
First, the fact that some income is not taxed by the federal government is viewed as a tax “expenditure.” It’s as though the money belonged to the government in the first place, and the deductibility was the equivalent of the government “spending” money. Thus, if you want to raise funds in Washington to pay for other programs, this “tax expenditure” can be targeted.
The second argument is that the deductibility is unequal. A person in the 12% tax bracket who puts $1,000 into a 401(k) avoids $120 in taxes, while a person in the 30% tax bracket avoids $300. Now, if we want to increase the incentive for a lower wage earner to save for retirement, that makes a lot of sense. But why in the world would we want to decrease the incentive for higher or middle class wage earners?
Let’s try to get a handle on how well middle class earners are doing in their savings for retirement. In 2018, the St. Louis Fed noted that the 70th percentile of retirement account balances for people aged 56-61 was $148,000. That is not the median for all the age group from 56 to 61. That is the 70th percentile! $148,000 may sound like a lot of money, but a 65 year-old retiring with $148,000 in retirement savings needs to plan to make that money work for 30 years or longer in retirement. Even with Social Security, this does not add up to much.
The problem with this proposed change in retirement policy is that it has nothing to do with retirement policy and everything to do with politics. It is obvious that we should be encouraging both low-income earners and the middle class to save for retirement.
The auto-IRA is sound retirement policy. Decreasing incentives to save for retirement is not. Let’s not allow politics to get in the way of sound retirement policy.
Charles E.F. Millard is a senior adviser for Amundi Asset Management and the former director of the U.S. Pension Benefit Guaranty Corporation (PBGC).
The views expressed are those of the author and not necessarily Amundi Pioneer Asset Management.
« Views of Financial Resiliency Differ by Generation