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Sunday, May 26, 2013

Modernizing retirement plans and savings

The congressional tax committees have a website for people to submit tax reform ideas and comments -

Here is one I submitted on May 26:

Rethink Retirement Plans and Savings Incentives for the Modern Era

Several changes have occurred which make retirement savings more important to workers, but which also make it more difficult to build such savings. 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 thus, must figure out on their own how to establish one. They have a choice of tax vehicles for an IRA (such as regular or Roth) and they have many options as to where to set up their IRA (stock brokerage firm, bank, etc.).

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 because people are living longer.

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

  • A simple system to enable all workers (employees and self-employed individuals) to have a retirement savings account. This should occur for both part-time and full-time workers and even if an employer does not help with administration or contributions.
  • Retirement savings contributions should be coordinated with payroll tax deductions. A system to enable self-employed individuals to also make contributions along with self-employment tax payments should also be considered.
  • Find ways to help individuals improve their financial literacy.
  • Portability. Be sure the system allows for contributions to be made to the one account even if a worker changes employers or also has income from self-employment.
  • Strive for simplicity.

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

Example of 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 would constitute the start of their retirement account that would be used for all future contributions; there would be only one account. When the individual works for an employer who also wants to contribute to employee retirement accounts, such funds are placed in the individual's existing account. Also, for each paycheck or quarterly estimated tax payment of a self-employed individual, an amount would be contributed to their retirement account. Individuals could be allowed to transfer their retirement account to a commercial broker for management or let it stay with the federal government. The federal government could be allowed to transfer management to third parties for a fee.

Annual reporting would be required to let individuals know their account balance and other details. 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 may begin, hardship withdrawals, etc.

Benefits of this type of approach:

  • All individuals who work have a retirement account. This single account would be used whether they are an employee or sole proprietor or both.
  • 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 earned income tax credit (EITC) the worker receives.

What do you think? 
Have you submitted any proposals?


Christopher Harrington said...

Great post! My coworker and I were discussing this yesterday. Thanks for the useful information.

Grant said...

After auditing many 401(k) plans, and having participated in many myself, I have come to the conclusion that they are not very effective in their goal in getting the average American to save/invest for retirement, especially when considering the amount of people who are eligible to participate. I hold the same belief for IRAs. Most 401(k)s and IRAs have restrictions, or make it very difficult to invest outside of stock and bond based securities/mutual funds.
I like the idea of the government effectively consolidating retirement accounts by having one account setup for each individual. It will help people manage their retirement account better as they only have to manage one account and don't have to deal with rolling over accounts, multiple statements, etc. This account however should allow individuals to invest in more than just stocks, bonds, and mutual funds. Many people don't have the financial literacy/savy to manage these types of investment to properly address the risk involved and meet their retirement goals. Real estate, investing in a new business of their own, or some other investment may be a better return on investment. Unfortunately the one investment that people understand pretty well is interest income from Savings accounts, CDs etc. Unfortunately, interest rates have been driven down so much that people are being driven to riskier investments.

Unknown said...

I'm looking into retiring soon and the planning process has been very difficult. The first thing I did was look into an ira account and my investment portfolio. I've also heard seeking a professional self directed ira custodian may be very beneficial to your retirement plans. Do you have any advice or tips for my planning process?

Professor Nellen said...

I encourage you to read some financial planning books (such as from Kiplinger) before talking to a planner or someone who tells you they have a good retirement deal for you. Be cautious of people who really just want to make commissions off of arrangements they get you into. Also be sure you understand the plan or arrangement.

Venetta said...

This is cool!