Posted on Tuesday, December 14, 2010
In yet another example of "innumeracy" when it comes to retirement adequacy, the Bipartisan Policy Center has proposed tackling the deficit by halving the amount that employers and employees can contribute to 401(k) accounts because they insist that affluent people will retire rich and we should stop giving them tax breaks. The total combined contribution would be limited to 20% of an employee's annual earnings or $20,000, whichever is smaller.
In doing so, "qualified plans no longer will be a vehicle for wealthy individuals to convert a substantial share of their assets into tax-free retirement assets."
Would that this rich-person tax flim-flam were true. The fact is, even upper middle income individuals are currently not allowed to contribute enough in order to retire, given that you can't sock away more than $16,500 to your account if you're under 50, and people need to contribute a minimum of 10% of their paychecks to their accounts.
My household is currently one of the millions of victims of this counterintuitive policy, which would be made worse by these reforms, forcing us to put most of our household savings in non-qualified investments because of the puny $5,000 ceiling on annual IRA contributions.
The BPC insists that removing tax breaks would let "most individuals retain the ability to contribute enough to... replace a substantial share of their earnings in retirement."
But why should any American be forced to bankroll their own retirement -- as opposed to their employers?
The "inconvenient truth" is that very few, if any Americans can retire on their 401(k) savings, whether they are pulling down a five-figure or seven-figure income. It's got nothing to do with tax breaks and everything to do with the measly employer contribution rate equal to 3% of pay, the second lowest in the world. Australia's contribution rate to their version of a 401(k) account is equal to 9% of pay, Denmark's is 11.8%, Hungary's is 8%, Mexico's is 6.5%, Poland's is 7.3% and the Slovak Republic's is 9%.
The actuarial "rule of thumb" for retirement adequacy is that you need retirement savings equal to a minimum of 10 times "final pay," or your salary right before retirement, to be able to retire. So a $610,000 next egg in your 60s isn't a windfall, it's the goal if you're earning the median income of $61,000.
If there are 1,000 people in the U.S. who've accumulated "10 times final" in their accounts in their 60s I'd be amazed -- especially affluent Americans. Fidelity's latest report on its clients showed that the median 401(k) account balance for those between the ages of 60 and 64 earning more than $100,000 was $273,000, or less than three times the salary of someone earning $100,000. Vanguard's figures are even gloomier: only three percent of its participants have accumulated more than $250,000 and the median account balance for those over 65 is a paltry $52,000.
If you think that most of Vanguard's and Fidelity's customers are likely covered by a regular pension, also know as defined benefit plan, think again. Only 11% of the private sector population is covered by one and even employees of large companies are probably out of luck. While at the end of 1998, 90 of the Fortune 100 companies offered some sort of pension benefit, according to Towers Watson, today only 17 of them offer them to new hires.
Incredibly, another committee that is advising Obama on fiscal issues, the White House National Commission on Fiscal Responsibility and Reform, is considering tackling the deficit by cutting tax breaks to corporate pension plans as well. Thanks guys! Now pension coverage will shrink from 11% of the population to zero percent of it!
And while there has been much debate about making Social Security solvent, there's been none that I know of about making it adequate. The U.S. has one of the least generous Social Security systems in the advanced world -- replacing one third less income than other countries -- so that it only replaces the incomes of lowest earners.
Unfortunately, President Obama's so-called 401(k) experts simply support "automatic enrollment," in which employees contribute 3% of their pay -- one third of what is needed -- without requiring a minimum employer contribution. As for the 50% of the Americans with no plan at all? They get an "automatic IRA," in which employees can contribute but employers don't have to.
The only trend more frightening than this lack of knowledge about retirement adequacy is that insurers are pitching annuities to Boomers in their 60s, sticking them with a high-fee product that can't make an empty nest egg full.
Ironically enough, if we can't require employers to contribute enough to their employees' accounts to ensure retirement adequacy, the only solution is to do the opposite of what the think tanks call for, which is to increase tax breaks for the majority of us who have to bankroll most of our own retirement. Financial planners should consider teaming up with the mutual fund industry to lobby to raise the ceiling on deductible IRAs from the measly ceiling of $5,500 to $50,000 for any American who isn't covered by a pension. Only in that way will some of us be able to save outside of our 401(k) accounts, given that otherwise retirement is currently not an option for most Americans.
This post originally appeared as an op-ed in Investment News.