Back in 2008, I wrote about the misguided proposal to undermine 401(k) plans by taking away their tax benefits and replacing the whole system with a national retirement plan -- a plan with a government-guaranteed return equal to 3 percent above the rate of inflation. Moreover, the payout would never be in a lump sum but in an annuity that would guarantee a lifetime income also indexed to inflation.
The current tax deductibility and tax-deferred compounding enjoyed by qualified retirement plan participants would be offset by a flat $600 per year tax credit per employee. Everyone would contribute 2.5 percent of their income. The money for all these guarantees would come from the taxes the government would henceforth be collecting on virtually all investment efforts conducted by U.S. citizens. While I expected this proposal to die quickly on the vine, I now learn that it is gaining traction back in Washington. Like Oofty Goofty, it keeps flipping back up.
To get anywhere, the proponents of this new program have to make the case that the current collection of defined benefit pensions, 401(k)s and other retirement plans have failed miserably. This attempt lacks credibility in the face of the $6 trillion we have all managed to accumulate in a combination of our voluntary 401(k)/403(b) plans and their resulting rollover IRAs.
Bemoaning the fact that old-fashioned defined benefit plans have largely gone away, critics of our current system fail to mention that those original plans only benefited employees who rarely changed jobs and who worked for governments or large companies. The vast majority of American workers work for companies with less than 100 people and change jobs once every seven years on average. The old system never did anything for these workers. President Ronald Reagan championed the cause of "portable retirement plans" and the rest is history -- creating today's $6 trillion, which is growing exponentially.
As I grind through the math supporting variations of this proposed sea change in retirement plan legislation, I'm left just shaking my head. Where are these numbers coming from? For example, the current average tax saving generated by a head of household's 401(k) contribution, who makes between $100,000 and $200,000, is listed as $1,985. This looks like the researcher failed to notice that the marginal tax bracket for someone making that amount of money is over 30 percent, and that they contributed, on average, about $10,000. I know these numbers because I actually operate these plans. I'm not sitting in a Washington think tank bending over backward to make a case for a flawed theory.
It's true that 401(k)/403(b) voluntary retirement plans have failed a portion of our workforce, but 78 million have benefited, so the glass is more than half full. The group the plans have failed to benefit are those who elected not to contribute -- the latter because of a lack of discretionary income or lack of discipline. Under this new proposal, they will be forced to contribute, but for those with very low incomes, the $600 government credit will essentially be their 2.5 percent contribution.
Waiting at the end of the forced march accumulation period will be a mandatory annuity purchase, which pays a specific amount for the rest of a retiree's life. Annuities are a good deal if you live to 105, but if you get hit by a bus on the way out of the government's annuity sales office, you would get nothing. Your sacrifice compensates for those who live a long time. But it gets worse. The proposed annuity payment would be an inflation-indexed payment guaranteed by the government should insurance companies offering the guarantee happen to fail -- a foregone conclusion if we have 1980's level inflation at 18 percent again.
Jumping through all these hoops is designed to end Washington's hand-wringing over what in the industry today is known as the "Big Red Truck" syndrome. The latter refers to how a lump sum payment at retirement often gets spent.
Not that there's anything wrong with that. Who are we to pass judgment on how priorities get arranged? Someone who realizes that they are already contributing 12.4 percent to Social Security may prefer to live a little with other money they have saved. To be forced to contribute an additional 2.5 percent of income to a retirement program that then becomes an annuity would strike most as a forced-fed bad deal benefiting insurance companies to be bailed out by taxpayers.
The champion of this disaster-in-the-making is U.S. Sen. Tom Harkin. You might drop him an email to let him know what you think of this proposal.
Stephen J. Butler is CEO of Pension Dynamics. Contact him at 925-956-0506 or email@example.com.