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					A Universal 401(k) Plan
Michael Calabrese

                   ith over $12 trillion in assets,   retirement saving plan—an Individual
                   traditional pension trusts and     Career Account (ICA). The plan would
                   401(k)-style saving plans ac-      supplement, not supplant, the existing
        count for the vast majority of finan-          private pension system. All workers not
        cial assets accumulated by households         participating in an employer plan, in-
        in recent years. For those with access,       cluding recent hires and part-time em-
        America’s employer-based private pen-         ployees, would be signed up to contrib-
        sion system provides powerful saving          ute automatically by payroll deduction,
        incentives—both tax breaks and em-            although an individual could choose not
        ployer contributions—as well as the           to save. The government would match
        convenience and discipline of automatic       voluntary contributions by workers and
        payroll deduction. Unfortunately, em-         their employers with refundable tax cred-
        ployer-sponsored plans cover less than        its deposited directly into the worker’s
        half of all workers. More than 70 million     account. Workers participating in their
        American workers do not participate in a      employer’s plan would receive stronger
        tax-subsidized, payroll deduction saving      tax incentives to save, but otherwise see
        plan—and therefore they tend to save          no difference. Contributions for work-
        very little for retirement. As a result,      ers not participating in an employer plan
        a projected 40 percent of today’s baby        would be forwarded to a federal clear-
        boomers are likely to depend almost en-       inghouse, which would manage small
        tirely on Social Security’s poverty-level     accounts at low cost and could even con-
        benefit after age 70.                          vert account balances into guaranteed
           As a nation, we are saving too little      income for life at retirement. Individu-
        and not doing enough to give lower-paid       als could maintain the account through-
        workers the combination of opportunity        out their careers, since it would remain
        and security they need to cope with ac-       open as they moved from job to job. This
        celerating technological and economic         supplemental system would make saving
        change. We need to facilitate pension         easier, automatic, and fair.
        portability while simultaneously shift-
        ing the burden of subsidizing basic ben-      Limitations of our Industrial-Era
        efits from American business to society        Pension System
        as a whole.                                   America’s postwar pension system has
           The solution is a Universal 401(k)         been a great success in many impor-
        plan that gives every worker access to an     tant respects. From 1945 to the late
        automatic, professionally administered        1970s, the percentage of private-sector

A Universal 401(k) Plan

       workers covered by pension plans grew rapidly from                    trusts subject to government oversight at relatively
       20 percent to just above 50 percent. The working                      low cost. Workers—at least those who clocked
       and middle classes became shareholders and, with                      more than 20 hours per week—were automatically
       Social Security, accumulated the foundation for a                     covered and received, at retirement, guaranteed
       secure retirement. Pension funds also steadily be-                    monthly income for life. The federal government
       came the world’s largest pool of “patient capital,”                   insured these traditional pension benefits against
       boosting U.S. growth and innovation by underpin-                      employer bankruptcy through the Pension Benefit
       ning the world’s most sophisticated, liquid, and dy-                  Guarantee Corporation. Combined with Social
       namic capital market.                                                 Security, these pensions allowed workers who re-
          When the landmark Employee Retirement Se-                          mained at a firm for 30 or more years to replace
       curity Act (ERISA) became law in 1974, its fidu-                       well over half of their pre-retirement income, with
       ciary, funding, vesting and other provisions were                     the primary risk being that inflation could reduce
       designed to perfect what was then a system of em-                     the purchasing power of their fi xed pension ben-
       ployer-sponsored defi ned-benefit (DB) pensions.                        efit over time (particularly as, in recent years, most
       Employers made all the contributions and shoul-                       firms have stopped giving regular cost-of-living
       dered all the investment risk, managing pooled                        adjustments).











                 1990            1995            2000           2001            2002              2003     2004          2005

                     Highest Earnings Quartile                   Second-highest Earnings Quartile
                     Third-highest Earnings Quartile             Lowest Earnings Quartile

       Source: Congressional Research Service Analysis of March 2005 Current Population Survey.

                                                                                                Ten Big Ideas for a New America



                2.40%                                                              5.25%             3.05%
                Other (incl. Public Assistance)                                    Pensions          Assets

13.10%                                                                                                        6.75% Other
                                                                                                              (incl. Public Assistance)

                                 33.20%                                    83.00%
                                 Social Security                           Social Security

Source: Social Security Administration, Income of Population 55 or Older, 2004, released May 2006.

   This industrial-era system was based on assump-                     tionately benefit high-wage earners and are subject
tions of career-long job tenure, stable corporate                      to regulatory sticks—antidiscrimination, fiduciary,
structures, pressure from strong unions, and large                     and reporting requirements—that, however rea-
doses of employer paternalism—conditions, like                         sonable, discourage small employers in particular
traditional DB plans themselves, that have been                        from helping their employees save.
rapidly disappearing over the past two decades.
Since the first 401(k) plan emerged out of an un-                       What Is Needed
intended tax loophole in 1981, the number of U.S.                      A renewed and updated effort to facilitate saving
firms with DB plans has plunged from 100,000 to                         and retirement security for all Americans should be
fewer than 30,000 now. Today, we are a 401(k) na-                      designed to address the following unmet needs:
tion. More than 60 percent of private-sector work-
ers lucky enough to have any pension benefit work                       Improve individual retirement security. America’s
at firms that sponsor only a 401(k)-type contribu-                      real retirement security crisis is not about Social
tion plan.                                                             Security or the many big companies freezing their
   Even as 401(k)s and other defi ned-contribution                      traditional pension plans and switching to 401(k)s.
accounts emerged as the dominant plan type, the                        The larger problem is that a minority of American
nation’s fundamental approach to encouraging                           adults are participating in any retirement plan—
pension coverage and retirement saving has not                         whether DB or 401(k) plans or Individual Retire-
changed. It continues to rely entirely on voluntary                    ment Accounts (IRAs). Participation in employer
plan sponsorship by employers who are offered tax                      plans peaked during the 1970s and has remained on
carrots in the form of deductions that dispropor-                      a plateau since. Only 45 percent of all private-sector

A Universal 401(k) Plan

       workers participated in a retirement plan in 2005,        the Great Depression. If we truly want to promote
       according to the Congressional Research Ser-              national saving, reduce dependency on social insur-
       vice. While participation is slightly higher among        ance, and create an inclusive “ownership society,” we
       full-time workers (52 percent), it is also strikingly     will need new mechanisms that extend the advan-
       low among workers who are low-income, young,              tages of private pensions to everyone. After all, re-
       work part-time, or work at small firms. A General          tirement plans are how America saves: tax-deferred
       Accounting Office study found that 85 percent              pension plans (of all kinds) have accounted for more
                                 of Americans without a          than 80 percent of personal saving in recent years.
        A projected 40           pension benefit at work             Not surprisingly, pension participation is low-
                                 shared one or more of these     est among workers whose savings would truly add
    percent of today’s           four characteristics. Thus,     to net national saving: workers who earn less than
                                 whereas 65 percent of full-     the median wage. While the affluent can respond
    baby boomers are             time workers at firms with       to tax incentives for saving by shifting rather than
                                 more than 100 employees         actually increasing their net saving effort, house-
      likely to depend           participate in retirement       holds that would not otherwise save generate net
                                 plans, that rate sinks to 45    new national saving. Indeed, a majority of middle-
    almost completely            percent at firms with fewer      to-low-income households are not responding to
                                 than 100 employees, and         current incentives. Among the bottom 60 percent
   on Social Security’s          it plunges to 25 percent        of all workers by income—those earning less than
                                 for firms employing fewer        $40,000—only about a third (36 percent) partici-
  poverty-level benefit           than 25.                        pate in employer plans, according to the Congres-
                                    Fewer than 60 percent        sional Budget Office.
          after age 70.          of today’s older workers,          We might at least expect the workers lucky
                                 those aged 47 to 64, are        enough to participate in 401(k)-type plans to be ac-
                                 on track to maintain even       cumulating significant savings. Among the subset
       half of their pre-retirement standard of living dur-      of high-tax-bracket earners with steady access to a
       ing retirement. Too many individuals and families         401(k), this is the case. But participation rates in
       are headed toward retirement age with little more         the bottom two quintiles of the earning distribu-
       than Social Security’s safety net. A great deal of        tion are far lower, and the average amount accumu-
       the opposition to partial privatization of Social Se-     lated is barely above $10,000. Even among 401(k)
       curity undoubtedly related to the average citizen’s       participants in the middle-earning quintile, the
       keen awareness of how many elderly desperately            average account balance was only about $30,000
       depend on the program’s meager but guaranteed             in 2001. One reason for the low participation rates
       (and inflation-adjusted) monthly payment. Among            and accumulations is that even if a worker has cov-
       the elderly, 40 percent rely on Social Security for       erage today, he or she may not have access to a plan
       90 percent or more of their income—a dependency           next year in a new job. Even if the new employer
       ratio that is even higher for widows and unlikely to      sponsors a plan, new hires are not eligible to par-
       improve for the baby boomer generation, accord-           ticipate for at least one year. The result is gaps in
       ing to government projections.                            coverage. What is needed is a seamless, lifelong
                                                                 saving system.
        Boost national saving and investment. Despite the           Even when lower-wage workers have consistent
        fact that baby boomers—the largest segment of the        access to an employer plan, the tax incentives for
        adult population—are in their prime saving years,        saving are upside-down. The tax break for retire-
        the personal saving rate in 2005 was actually negative   ment saving is one of Washington’s most expensive
        (-0.4 percent) for the first time since 1933, during      programs, costing a projected $134 billion in uncol-

                                                                               Ten Big Ideas for a New America

lected federal tax revenue this fiscal year alone. Yet    foreign and domestic, creates enormous volatil-
about 70 percent of that subsidy goes to the most        ity for companies and workers alike. Median job
affluent 20 percent of taxpayers—and virtually            tenure has declined significantly over the past two
none (2 percent) goes to encourage saving by the         decades. Even at firms with retirement plans, an
lowest-earning 40 percent. The reason is simple but      increasing number of workers cycle through jobs
too often overlooked even by liberal policymakers:       without earning employer-paid benefits, since it
a program subsidized by tax deductions, as opposed       typically takes one year to be eligible to participate
to refundable tax credits, is highly regressive.         and five years to vest. A combination of two-in-
   Qualified retirement saving today reduces tax-         come families and just-in-time labor strategies by
able income, a deduction that is worth 35 cents on       firms has increased the share of nonstandard work
the dollar to high-bracket taxpayers who need little     arrangements. Nearly 30 percent of U.S. workers
incentive to save. In contrast, a tax deduction for      are working in part-time, temporary, or contract
saving is worth zero to the 35 million low-earning       arrangements that rarely include pension coverage.
households who pay 15.2 percent in payroll taxes         While this emerging “free agent” workforce may
but don’t have income tax liability to offset. Indeed,   be good for flexibility and productivity, it makes
even median-income families in the 10 and 15 per-        the current employer-based pension system in-
cent income tax brackets receive a weak subsidy          creasingly inadequate.
compared to the 35 percent subsidy rate that ap-
plies to those earning over $200,000 a year.             Lighten the social benefit burden on business. It’s
   Another way to deliver a subsidy through the tax      clear that most small and start-up companies either
code is through a credit, which directly reduces         cannot or prefer not to shoulder the administrative
taxes due. In fact, the Saver’s Credit, enacted in       burden and financial risk of sponsoring a pension
2001, creates this incentive, although it is limited     plan. Indeed, despite the “carrot” of tax subsidies
to very low-income taxpayers with income tax li-         for pension plans, a majority of firms with fewer
abilities to offset. The most powerful way to en-        than 500 employees do not offer one. In addition,
sure that low-income workers receive an incentive        even very large companies with a predominantly
at least as generous as an affluent worker is to make     low-income workforce—the Wal-Marts and Mc-
the Saver’s Credit refundable, as the Earned Income      Donalds among employers—have little incentive
Tax Credit (EITC) is, so that the low-wage worker        to sponsor a plan for workers who (a) receive little
receives it even if she has only payroll tax and not     or no financial benefit from a tax deduction and (b)
income tax liability.                                    without a strong incentive would prefer a higher
                                                         wage now to an employer contribution for retire-
Increase benefit portability and workforce flexibility.    ment. In contrast, big, high-wage employers—the
In yesterday’s more stable, goods-producing econ-        Microsofts and Intels—use retirement plans to
omy, traditional pensions were designed to reward        steer tens of millions of dollars in pension tax sub-
seniority and to retain older, long-tenured work-        sidies to their employees every year.
ers with firm-specific skills. Domestic firms were             This creates the anomalous situation whereby
more insulated from foreign competition, unions          the federal government provides more than $100
were stronger, job tenures were longer, and a much       billion in compensation subsidies to the employ-
higher share of the (predominantly male) work-           ees of a minority of companies—most of which
force occupied standard full-time jobs.                  are large firms with workers paid above-average
  The 21st-century workforce is very different.          wages. Meanwhile, companies with a substantial
The service and information technology economy           percentage of low-wage workers that do offer good
puts a premium on younger, more educated work-           benefits (employers like Starbucks) are paternalis-
ers with transferable skills. Competition, both          tically shouldering a cost that should be borne by

A Universal 401(k) Plan

       society as a whole—and which will need to be if we      Basic Program Elements: Incentives, Infra-
       want to achieve universal retirement security. If,      structure, Inertia
       instead, contributions by both workers and firms         A Universal 401(k) system can accomplish the vari-
       were matched by a refundable federal tax credit,        ous national policy objectives described above by
       then—as with the EITC—the after-tax value of            combining the following basic elements:
       benefits paid to low-wage workers would be less ex-
       pensive, rather than more so.                           1. Incentives: matching, refundable, and deposited
                                                               credits for new saving. Just as most employers match
       Individual Career Accounts: A Universal 401(k)          contributions to 401(k) accounts, the government
       Today’s private pension system works well for those     would match voluntary saving by providing a re-
       workers who have consistent access to a plan and        fundable tax credit that would be deposited directly
       choose to save. One big reason retirement plans are     into the worker’s account. This would create a far
       effective in generating saving is the powerful in-      more powerful saving incentive for middle- and low-
       centives provided by immediate tax deductions and       wage workers than current law. As noted above, a
       employer matching contributions. Another reason         tax deduction is neither an effective nor an equitable
       is infrastructure: employer-sponsored plans create      means to encourage pension saving among lower-
       the positive inertia of automatic payroll deductions    income and younger workers, whether or not they
       while also managing the complexities of investment      participate in an employer plan. And although the
       management at relatively low cost. These two key        current Savers Credit provides (most commonly) a
       attributes—incentives and an infrastructure for         10 percent tax credit for retirement saving by low-
       automatic saving—is what needs to be replicated         income taxpayers, the lack of refundability means
       for all Americans.                                      that millions of working-poor families—who have
          An essential step is to give every working Ameri-    payroll tax but no current income tax liability to
       can access to a tax incentive and portable savings      offset—receive no credit at all.
       account whether or not his current employer spon-          Instead, a refundable credit would operate just
       sors a retirement plan. The fact that so few workers    like an employer match in a company 401(k) plan.
       (less than 10 percent) save regularly in IRAs rein-     Studies show that workers are far more likely to
       forces what demonstration projects in asset-build-      save if given generous matching credits—and once
       ing have found: it is not primarily access to a sav-    they develop the habit of saving by payroll deduc-
       ings account that spurs participation, but the three    tion, most continue even when the match rate is
       “I’s”—Incentives, Infrastructure, and Inertia. The      reduced. A sliding-scale credit could give a greater
       proposed Individual Career Account would recast         incentive to low-income workers who are least like-
       federal pension policy by adding:                       ly to save. For example, workers in families earn-
          A tax incentive for saving that is more inclusive—   ing below $40,000 could receive a $1 per $1 (1:1)
          and potent—by expanding the Saver’s Credit,          matching credit on their first $2,000 in savings;
          making it refundable and directly deposited into     whereas workers in families earning above that
          an ICA.                                              level could receive a $0.50 per $1 (1:2) matching
          An account-based infrastructure that is citizen-     credit on their first $4,000 in savings. This would
          based, rather than strictly employer-based, yet      give all workers the opportunity to receive as much
          enables every worker to opt for regular contribu-    as $2,000 each year in matching deposits to their
          tions by automatic payroll deduction.                accounts, but the higher-wage earners would need
          Default options that convert myopia into posi-       to make twice the saving effort.
          tive inertia, through automatic enrollment, auto-       Like the current Saver’s Credit, the refund-
          matic payroll deduction, automatic asset alloca-     able credit should apply equally to contributions
          tion, and automatic annuitization.                   to 401(k)s and other employer-sponsored plans.

                                                                               Ten Big Ideas for a New America

Eligibility for the credit would be reconciled annu-        A new entity—a clearinghouse akin to the Feder-
ally through the income tax return process, which        al Thrift Savings Plan (TSP), which manages very
would also be used to encourage taxpayers to save        low-cost 401(k)-style saving accounts for 3 million
all or a portion of their tax refunds.                   federal military and civilian personnel—would re-
   Matching credits should be available for both in-     ceive all deposits and be the default administrator
dividual and employer contributions. This would          for small accounts. Record
give employers a greater incentive to make deposits      keeping would be central-          Individual Career
on behalf of their low-wage workers. Yet, by ex-         ized, but the investment
tending pension saving incentives to all workers         management would be                Accounts would
as individuals, employers would have the option          contracted out to private
to provide a pension benefit without the need to          investment firms, as with           supplement,
administer a pension plan. Employers could decide        TSP. The clearinghouse
from year to year whether to contribute to their         would strive to keep costs         not supplant, the
workers’ accounts—although in doing so, they             and complexity to a mini-
should be required to contribute either a flat per-       mum. As with TSP, partic-          existing private
centage or a flat dollar amount for all their pay-        ipants should have at most a
roll employees (otherwise ICAs could undermine           choice among a small num-          pension system.
ERISA antidiscrimination rules to ensure that em-        ber of very low-cost index
ployers are not using the tax subsidies to favor only    funds. Although payroll-
their higher-wage employees).                            deducted savings and matching tax credits would
                                                         flow through the clearinghouse, the assets should
2. Infrastructure: automatic payroll deduction and ac-   be fully portable and transferable at any time at the
count administration. Equally important is replicat-     worker’s request to another qualified financial insti-
ing the retirement plan infrastructure that is key       tution, or to a future employer’s pension plan.
to the success of employer-sponsored 401(k) plans.
As with 401(k) plans, every worker should have ac-       3. Inertia: default options for enrollment, investment
cess to the convenience, discipline, and protections     and annuitization. The W-4 form required of every
provided by automatic payroll deduction and pro-         worker would provide a simple means of indicat-
fessional asset management. When a worker fills           ing how much an individual wanted withheld and
out the required IRS Form W-4 (used to calculate         saved each pay period. Even better, the Universal
tax withholding), he or she can simply specify a         401(k) system could convert myopia into positive
monthly saving deduction. That’s the only decision       inertia by making participation the default option.
a worker needs to make—a choice to save.                 (Studies have shown that automatic enrollment has
   The sole burden on employers would be to              boosted 401(k) participation rates among low-in-
forward this automatic payroll deduction to the          come workers from 13 to 80 percent.) Unless the
employer’s own retirement saving plan (if there is       worker decided to opt out, the W-4 would give no-
one and the employee participates) or to a govern-       tice of the amount to be deducted and saved each
ment clearinghouse. Since most employers today           pay period. The initial default contribution could
use automated payroll processing services, there         be modest—3 or 4 percent of each paycheck—in-
would be virtually no cost to forward the deduc-         creasing by 1 percent a year thereafter, as pay in-
tion to a central clearinghouse. Even employers          creased, until it reached a level likely to achieve an
who do not automate payroll must forward in-             adequate accumulation over time.
come and payroll tax withholding to the IRS, so             If a worker did not wish to participate in his
including withholding amounts for saving would           employer’s plan, the payroll deduction would flow
be a minor burden.                                       automatically to the federal clearinghouse and into

A Universal 401(k) Plan

       his Individual Career Account. Although the work-      nuity benefit could be contracted to one or several
       er should be able to switch, periodically, between a   private insurers, or taken on by the Pension Ben-
       very limited number of broad and low-cost index        efit Guarantee Corporation, the federal pension
       funds, there would be a default asset allocation for   insurer that currently manages guaranteed annu-
       workers who made no choice at all—most likely a        ity payments each month for millions of private-
       life-cycle fund that would automatically adjust the    sector retirees who were participants in a defaulted
       mix of stocks and bonds to match the worker’s age      employer plan.
       and years until retirement age.                           While Americans clearly support retaining So-
          Finally, at retirement age, the default option      cial Security’s defined-benefit safety net, neither
       should be monthly payments rather than lump-           Social Security nor the inadequate coverage of
       sum withdrawals to ensure that retirees do not         today’s private pension system is providing enough
       outlive their benefits, replicating the great advan-    income in retirement. Thus, a citizen-based, por-
       tage of a defi ned-benefit plan. Although individu-      table, and automatic system—providing those who
       als could choose to withdraw (or roll over) all or     find it most difficult to save with powerful right-
       part of their nest egg, there should be incentives     side-up tax incentives—may be exactly the retire-
       to encourage and facilitate annuitization. This an-                         need.
                                                              ment revolution we need.❖