Retirement Do-Over

Richard Quinn

IT’S TIME TO THROW out our broken retirement system and start over. My first article for HumbleDollar, published more than five years ago, was titled Choosing Badly. It was about the inability of most employees to make good use of their 401(k) plan.

Guess what? Nothing’s changed.

Today, some 401(k) plans still have too few investment choices, while others have too many. There are multiple options that people don’t understand, such as target-date funds compared with index funds, or whether they should take advantage of the “brokerage window.” Plans will become even more complex as annuity options are added. This choice overload is partly to help the plan sponsors do their duty as fiduciaries—at the expense of their confused workers.

I recently spoke with an employer who will offer new hires a unique choice. They’ll be able to choose the existing cash-balance pension plan with employer contributions based on years of service and age, and they’ll get a guaranteed annual 6% interest credit and immediate vesting. In addition to this pension, the employer allows workers to participate in a 401(k) with an employer match of 50% on up to 7% of pay.

The new alternative, however, is to forgo the pension and instead enroll in a new 401(k) plan with a 4% guaranteed employer contribution, plus a dollar-for-dollar match on up to 4% of an employee’s pay. The possibility exists for an 8% employer contribution, which is roughly the cost to fund the typical pension plan.

Favoring the pension should be obvious because the employer guarantees lifelong payments to those who stick around long enough to qualify. How great is that? Still, I’d bet most workers will take the new 401(k) because of the easily grasped 8% payment. That’s the employer’s preferred option, too, because—unlike the pension plan—the employer has no long-term liabilities or interest-rate risk with the new 401(k).

The goal for this employer—and many others—is to work its way out of retirement plans that cause fluctuations in corporate earnings. That means it wants out of any defined benefit pension obligation.

This points up how accounting rules, federal laws and regulations create a conflict between the interests of the shareholders and that of workers—and the workers are losing. With the decline of pensions, the risk of paying for retirement has shifted to employees.

Why do we make saving and investing so complicated, especially when the average worker’s financial acumen is not great? Why do we need 401(k)s, 457s, 403(b)s, IRAs, Roths, SEPs and so on? Why the different rules for government, corporate, small business and non-profit plans? Why are rules and limits different for IRAs and 401(k)s, and even for married individuals?

For example, beginning in 2026, high earners making $145,000 a year or more will be required to make any 401(k) catch-up contributions to a Roth 401(k) account—meaning after-tax dollars must be invested, but can be withdrawn tax-free. Why?

I suspect the government will capture a slight short-term revenue gain—but with potentially much greater losses of tax income in the long term. It’s about short-term federal budgeting. On the other hand, this requirement likely does high earners a favor—at the cost of more confusion for workers.

All these variables present Americans with unnecessary decisions. The typical worker simply cannot or will not make such decisions. The system isn’t working.

A look at retirement savings makes that clear. The average 401(k) balance for those age 65 and older is only $232,700, while the median (or typical) balance is just $70,600. That $232,700 might generate income of $800 a month or so—not enough to retire on.

We need to start over. We must recognize the limits of the great majority of Americans to implement a 40-year plan to save and invest for retirement. They’re too intimidated by the thousands of pages of rules and regulations.

Here are my ideas: First, we should significantly increase the percentage of income replaced by Social Security so that, at retirement, middle-class Americans would have a basic livable income. This change would be funded by increasing payroll taxes, but more so on employers than workers. Payroll taxes would be levied on benefits provided through employer cafeteria plans, such as health spending accounts and dependent care, which are currently exempt. I would also add all state and local workers to the Social Security system.

The exact nature of these taxes is not important. It’s the concept that’s important—that, for most Americans, voluntarily saving for retirement, coupled with relatively modest Social Security benefits, won’t get the job done.

The tax percentage would automatically be adjusted annually to ensure the system’s ongoing sustainability. You get what you pay for. No more periodic funding crises.

I can already hear the outcry. No, this is not socialism, though it may be a wealth transfer. It’s also an honest recognition of the shortcomings of human behavior when it comes to retirement planning. Adequate income for a growing older population will have to be paid for one way or another.

My second idea: All current regulated retirement vehicles are eliminated and replaced with a single plan, whether employer-sponsored or not. One set of rules, regulations and limits, and the same tax treatment for all contributions. If you want to save specifically for retirement on a tax-advantaged basis, you’ll use this one vehicle as you see fit.

Congress—along with some states—have spent decades tinkering with schemes to encourage retirement savings, either by making plans a requirement or by rewarding retirement savings with tax advantages. But the result is a a multi-headed monster and a bureaucracy to go with it. It’s time to recognize our collective shortfalls and get back to basics.

Richard Quinn blogs at Before retiring in 2010, Dick was a compensation and benefits executive. Follow him on Twitter @QuinnsComments and check out his earlier articles.

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