Broadening Participation in Retirement Plans

The world has changed yet tax systems have not caught up. For example, years ago, many employees could expect to have a defined benefit type retirement vehicle provided by their employer. This required little action by employees. They did not have to understand investment options, contribution requirements, and tax rules. Today, many employees are offered no retirement plan and so must figure out on their own how to set up an Individual Retirement Plan (IRA). They have a choice of tax vehicles for the IRA (such as regular or Roth) and they have many options as to where to set up their IRA (stock brokerage firm, bank, etc.). Some employees have an employer-sponsored IRA, but that is still more complicated than a defined benefit plan provided by an employer. Some employees have retirement options through their work, but do not participate.

Many workers do not expect to stay, and in fact do not stay, at one employer for many years. Thus, even if an employer sponsors an IRA or 401(k) plan, the employee will need to be involved in the management and movement of the funds when they change jobs. Employees who changes jobs several times could end up with multiple accounts if they do not or cannot consolidate the funds saved at each place of employment into a single retirement plan.

There is a greater need for workers to have retirement savings today than was true decades ago - people are living longer. Also, they may not get their entire expected amount of Social Security benefits.

Tax and labor law changes to increase the number of workers participating in retirement plans should consider the following:

• All workers should have a retirement savings account – even if part-time and even if their employer does not help with administration or contributions.
• Retirement savings contributions should go hand-in-hand with payroll tax deductions. They should be automatic with the worker having to take action to either stop it or modify the percentage amount. A system to enable self-employed individuals to also make contributions along with SE tax payments should also be considered.
• Helping individuals improve their financial literacy.
• Portability.
• Simplicity.

The government can play a role in establishing accounts, simplification, and educating individuals.

[For some background data on retirement plan participation and issues to be addressed, see “Rethinking IRAs” by Nellen, AICPA Tax Insider,7 /24/08 at   and  11/20/08 on 401(k)s.]

Suggestion for a New Approach

The first time an individual receives a W-2 or pays self-employment tax (whichever happens first), the government could set aside a set dollar amount in a retirement account for that person. This is the start of their retirement account. When the individual works for an employer who also wants to contribute to employee retirement accounts, the individual has an account to make that happen. Also, for each paycheck or quarterly estimated tax payment of a self-employed individual, a percentage is contributed to their retirement account. Individuals may transfer their retirement account to a commercial broker for management or let it stay with the federal government. The federal government would be allowed to transfer management to third parties for a fee.

Annual reporting would be required to let individuals know how much is in their account. Rules would continue to exist, but in more simplified form, governing how much could be contributed annually, how much employers could also contribute, the age when distributions must begin, hardship withdrawals, etc.

Benefits of this approach:

• All individuals who work will have a retirement account.
• The initial contribution from the government ensures that all workers start a retirement account.
• The initial contribution from the government may also encourage individuals to be tax compliant from the start of the time they begin earning money.
• The system ties to payroll tax withholding and so should not be burdensome to any size employer since they already are required to comply with payroll tax rules.
• For low-income workers, the annual contribution could be made via part of the EITC the worker receives.

Some parts of this approach look like the Social Security system (paycheck withholding, some government assistance in tracking contributions). Consideration should be made to how these systems can work together in terms of annual reporting. The retirement savings though would be separate from Social Security funds and individuals would be able to manage their retirement funds by having them at a commercial brokerage account where they would likely be offered various investment options.

What do you think?