News, Analysis, and Research for the Retirement Planning Industry

How About If I Pay You To Save?

In Uncategorized on 7 July 2011 at 4:35 pm

Poor plan sponsors, they just want to do the right thing by their employees. However, according to this article by Anne Tergesen in today’s WSJ, it appears as though, once again, the road to hell (perhaps not “hell”, exactly, but certainly a “Ramen Retirement”) is paved with good intentions.

The 2006 PPA allowed employers to automatically enroll workers in 401(k) plans. The problem, according to an Employee Benefit Research Institute analysis done for the WSJ, is that more than 2/3 of companies set the employee contribution rate to 3% or less. Since inertia is the 2nd most powerful force in the universe (behind only Matthew McConaughey’s ability to repel shirts), employees are locked into paltry savings rates that are below what EBRI analysis shows employees elect when required to opt-in to the plan. What to do?

There are lots of ideas on increasing employee contribution rates, and I have blogged about a couple. These generally require some kind of new strategy on the part of the plan sponsor. Let’s give employers a break from the cajoling and let Uncle Sam do it in the form of some tax relief for middle class savers:

If you save at least 10% of your salary in a traditional 401(k), 403(b) or 457 plan, your federal income tax rate goes down by 2 percentage points.

Five things I like about this idea:

  1. It forces people to make a real commitment; they don’t get a 1% break for saving 5%
  2. The 10% threshold means only those with incomes below $165k (2011) can take advantage of it. These are the people who need to be saving the most and the least likely to be saving at high rates already.
  3. You can get creative with the 2%. Perhaps it’s 1% if you want cash back, 2.5% if it is all in the form of a U.S. government matching contribution to your DC plan, or 1% of each.
  4. The loss of revenue* in the form of lower taxes (and likely lower consumption) will be offset with higher future revenues when participants take distributions from those plans (contributions and gains are 100% taxable at future ordinary rates) or upon conversation to a Roth
  5. The idea came to me in the shower this morning after reading Anne’s article. I am generally enamored with my own ideas.

Will this be enough incentive to make a meaningful improvement in retirement savings? Would pairing it with a back-loaded match make it more effective? We’ll have to try it and see. When you consider a recent Allianz study that suggests 56% of Americans will not be able to cover basic living expenses in retirement, it seems like it is worth a shot.

*I recognize I am glossing over the fact that given our current budgetary woes, we will have to pay for this today and cannot just rely on the higher deferred revenues.  I am open to suggestions, but thought we could start with the $175mm spent annually in upkeep on an unused monkey house and other unused VA buildings. Once we start adding in things like the $2.9 million spent on studying World of Warcraft, the $112 million in fraudulent tax refunds to prisoners, and the $216,684 study of why political candidates make vague statements (see them all here), I bet we can get there.

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