Solving the Retirement Crisis: A Tax Proposal

by JT McGee

I think most everyone is aware of the very real and present danger that lies in wait for America’s baby boomer generation: they’re not financially ready for retirement. That’s an understatement…

The Employee Benefit Research Institute is the go-to authority in data mining for information about future retirees. Each year, the Institute surveys hundreds of people to determine the status of the retirement landscape, so to speak. This survey is conducted in March of each year, so I expect a new release soon, though I will continue on with data from its 2010 study.

We have no idea where to end, and thus we have no idea where we should start:

how much people think they'll need for retirement

A full 29% of people think they need less than $250,000 to retire, and 13% don’t even want to take a guess. This study was conducted in the United States, so I’m just going to come to the conclusion that everyone will need more than $250,000 for any reasonably comfortable retirement. We shouldn’t be surprised at the results, even Wharton MBAs don’t understand retirement planning!

Goals vs. Progress: How Savings Stack Up


Another excellent study was released by Wells Fargo in December 2010. I’m going to highlight the juicy parts, with emphasis mostly on baby boomers, the generation closest to retirement age.
 

As of December 2010, the median retirement savings for those 50 to 59 was only $29,000. However, having reported their figures to the company, some 56% of future retirees in this age group said they were “confident” or “very confident” about having enough to support the retirement lifestyle they desire.

 
Step back for just one moment. If median savings are $29,000, and 56% of people responding said they felt confident in their retirement plan, then that means, in the best case scenario, at least 6% of respondents 50-59 years had saved less than $29,000 for retirement but felt good about it! That’s just stupid.

But it gets even better:
 

All told, the average middle class saver predicts a need for $300,000 in retirement savings, but has saved only $20,000 to reach that goal. This same group expects to have a retirement 19 years in length, with a 10% annual withdrawal rate.

Facepalm. Let’s fix this.

retirement savings facepalm

There is only one solution on which we ALL agree

The only public policy improvement supported by all five “generations” surveyed was legislation intended to increase awareness and provide for better access to 401k-related financial advice. Hell yes! This is where we begin.

We don’t need to debate social security, we don’t need to take on Medicaid; let’s see what we can do just by making opportunities available where we agree.

Bringing in two more studies:

  • Charles Schwab found that after speaking to a representative, more than 70% of people who sought 401k advice increased deferral rates, nearly doubling their annual savings rate to almost 10% of total pay.
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  • Fidelity reports that after using an online tool designed to help investors plan for retirement, fifty percent of all users increased savings to 7% of pay from 4%.

My Modest Proposal

It appears that savers only need to think about their retirement in order to save for it–Fidelity saw a 75% increase in savings due to an online tool, for crying out loud! I think it’s time for a new tax incentive of epic proportions.

Let’s halve the 7.65% FICA tax rate that an employer has to pay for hiring employees. In exchange, the company has to allow employees, twice per year, to sit with their 401k plan sponsoring agent to discuss their retirement goals, savings goals, and financial planning goals, whatever.

So, the employee gets two days off per year to receive competent retirement advice, and the company saves 3.825% of the employee’s wages per year just for allowing them to plan for retirement. The total cost to government would be $250 billion per year based on a very reasonable revenue numbers from 2007.

Nitty Gritty

Okay, so the government gives up $250 billion in revenue, how does that help the retirement situation? We’ve seen already that just by looking at their finances with another person, seventy-percent of people nearly double their annual savings, often up to 10% of their income.

Extrapolating that out, we take .7*10% of income/2 (because it doubled) = 3.5% increase in private retirement savings in exchange for a 3.825% reduction in tax revenue. Oh, well, looks like we hit a roadblock…Psych! We didn’t include the 30% who may have increased, but not doubled, their savings. Also…

Remember, we’re giving companies a 3.825% reduction in their cost of hiring, essentially 10 days of pay (260 workdays * 3.825% reduction in wages), in exchange for one day off, twice per year, for that employee to plan for retirement.

  • What do companies have to do to get the deal? Offer a 401k.
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  • How many workers have access to one right now? Roughly 50%.
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  • How many would have access to one if employers got an effective 8 free days of work for sponsoring a 401k? Probably all of them.

Protecting the Lower and Middle Classes

Take into consideration the benefit of savings in a 401k; assets invested through a 401k program are shielded from bankruptcy.

Don’t give me that nonsense about how I’m robbing social security and taking from the poor. Let’s be real. This solution will bring bankruptcy-protected asset shelters to more people, and provide more security to the lower and middle classes than ANY policy passed in history. And it does so not by promoting welfare, nor poverty, but by promoting independence, savings, and generational wealth building.

I say give up the $250 billion in annual revenue because the benefits are far larger than the costs. We’ll see many, many hundreds of billions of dollars in new savings among part-time or full-time workers who had never previously considered life after work. Additionally, every person will now be paid a full day’s wage to go sit down and talk finances with a planner twice per year.

No bullshit, no nonsense, just solutions. Congress, are you listening?

Besides, doesn’t anyone see the benefit in reducing the cost of employment by 3.825% per year, residually? Talk about a jobs program! Don’t even get me started on jobs… When Bernanke starts sounding like a supply-sider it might just be time to get this show on the road.

{ 12 comments… read them below or add one }

Robert @ The College Investor March 2, 2011 at 22:49

I think that is a great incentive. However, some may call it privatizing retirement, which while it seems smart, many people were in uproar about it a few years ago.

Another simple solution is to automatically sign-up new employees to 401(K)s at the maximum employer match. This opt-out method increases retirement savings tremendously!

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Moneycone March 3, 2011 at 07:04

I think that is an excellent idea AND opt in to 401K by default rather than opt out!

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JT McGee March 2, 2011 at 23:15

Yeah, I had been thinking about the potential hurdles in getting over the “privatized social security” brand. There is a very distinct difference in this proposal and all other privatization proposals: my proposal is focused on getting people to think about their investment plans whereas previous proposals were focused on allowing people to invest their social security taxes how they see fit.

I’m not changing social security in any way, instead using the already existing taxes as leverage for tax cuts provided employers give employees 1) a 401k account and 2) time to seek advice (with pay) on how to plan for retirement.

Whether or not that can be explained to the voting public, I’m not sure. This was a major oversight with privatized plans of the past: they never offered up solutions to educate or guide people in making good financial decisions. I think this does that.

As for opt-out, I’m okay with it. It does increase savings, but it doesn’t increase anyone’s perspective on their financial future. I’d prefer someone have $300,000 saved at the end of retirement and know what to do with it than have the same person have $500,000 and have no clue what to do with it.

Thanks for commenting, I appreciate it. Getting over the calls for privatization was a pitfall I hadn’t completely thought through. My politicking self was more interested in selling the tax reduction as a retirement-fixing job creation program, and not in appeasing the largely incompetent collective known as “the voting public.” Forgot about them. :P

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JT McGee March 3, 2011 at 08:32

@Moneycone – Good deal!

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Bogey March 3, 2011 at 10:04

JT,

The decrease in tax revenues would be much greater than $250 billion. It is not only the 3.825% in FICA revnue that is lost today. If people are suddenly contributing twice as much money to their 401k’s, all of this money will avoid taxation today, causing further loss of revenue for the government. While all those savings will eventually get taxed, it does cause a decrease in revenues in the near term.

I actually just blogged about how unknowns with regard to the tax code make saving for retirement difficult.

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Mark March 4, 2011 at 19:12

I like the idea but I think that the cost would be greater than $250 billion as well.

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LaTisha @FSYAonline March 3, 2011 at 11:01

This sounds like a really good idea. It’s interesting that most people really don’t think about retirement until they get closer and they have no idea how much they need to save in order to meet their goals. The automatic opt-in to employer matching would prob be the best way to bump up savings.

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JT McGee March 3, 2011 at 11:08

@Bogey – I thought about that, but any contributions made to a pre-tax 401k are not pre-FICA. Since less than half of all people actually pay Federal Income Taxes, I’m confident there would be very little net change in current tax receipts. If anything, a reduction in tax receipts now might not be such a bad thing, given the currently low interest rate environment. I’m not willing to start doing FV and NPV calculations, but I bet there is also case to be made that more 401k participation means more matching which means more long-term tax revenue. Again, you’re right, the tax code is so complicated it would take tens of thousands of dollars and probably hundreds of man hours to study this in such a way to predict any outcome with reasonable certainty. We need a university. :)

I’m actually not one for new tax changes, and I think a simplified code would help. You know the retirement landscape is becoming difficult when people use the term “tax diversification.” :P

Actually, seeing as this would reduce the cost of employment by 4% on the lower end, I think you’d have a growth in new domestic hires that would make up for any lost revenues. Now, I can’t be certain of this, but the reduction/elimination of FICA taxation on the employer side is about as “pro-growth” as it gets.

@LaTisha – I like automated opt-in, but we need education as much as we need savings. An uneducated saver is probably just as bad as the educated poor. Making people save means you make them have money, but having money doesn’t mean you’ll use it wisely. There’s definitely middle ground to be found.

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Buck Inspire March 3, 2011 at 17:51

Terrific article. Shocking numbers from those reports you found. I like the idea of automatic 401k setup. Going through paper work and the selection process is a big enough hurdle for many people not to set it up. Great point about education, too. Perhaps a middle ground is auto 401k setup, in an index fund, but shock the employee with stats like “Your 401k will earn you 8%, but if you got more savings and retirement education, you could get 15%!” Hopefully the “deal” will spark more workers to learn how to get pretty prepared for retirement. :)

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Chris March 3, 2011 at 21:38

Love the expression ‘facepalm.’ Nice article but tragic statistics…. amazing how little people have saved and how the math is totally irrational. No wonder people have so much anxiety about retirement!

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JT McGee March 4, 2011 at 10:26

@Buck It’s scary isn’t it! That’s a good idea too, an all or nothing incentive. “Hit this number or no-go on matching!” Hmm…

My biggest concern is that it is mostly the middle class that is falling behind on savings. The averages look excellent, mostly because a small number of wealthy people skew those numbers higher, but the median statistics are awful!

@Chris – It’s unreal. I think it’s funny how some have so little money, but so much confidence about the future.

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Amanda L Grossman March 4, 2011 at 11:11

Good idea. I retweeted!

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