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By Edward Zelinsky

Many important decisions are embedded in the federal budget proposed by President Obama. Among these are the President’s embrace of the defined contribution paradigm. That paradigm promotes retirement savings through individual accounts such as IRAs and 401(k) accounts.

The Internal Revenue Code currently provides a savers’ income tax credit for lower income individuals who contribute to IRAs and 401(k) accounts. The Obama budget proposes to expand this credit and make it refundable. In addition, the Obama budget proposes to establish administrative infrastructure in the Department of Labor as the first step toward requiring employers without pension or profit sharing plans to enroll their employees in workplace IRAs.

Together, these two proposals commit the Obama Administration to the existing system of individual accounts as the prime means of encouraging private retirement savings.

Some observers had predicted a retreat from individual accounts in light of the Crash of 2008 and the consequent decline of most participants’ 401(k) and IRA balances. However, the Obama budget indicates that such a retreat is, so far at least, not occurring. Indeed, the Obama budget, if adopted as proposed, commits the federal government even more deeply to the individual accounts of the defined contribution paradigm.

Something similar happened after the fall of Enron. Enron’s demise devastated the 401(k) accounts of many Enron employees who held large quantities of Enron stock in such accounts. Some observers predicted that this debacle would force reconsideration of the individual accounts of the defined contribution paradigm. But, like Holmes’s dog that did not bark in the night, no such reconsideration occurred.

Similarly, the Obama budget signals that, in the wake of the Crash of 2008, the federal government remains committed to individual accounts for retirement savings. President Obama proposes to double our bet on IRAs and 401(k) accounts, both by enriching the tax-subsidy for low income persons who contribute to such accounts and by making such accounts universal in the workplace.

This decision puts President Obama in potential conflict with his allies in the union movement. Today, the last bastions of the traditional defined benefit plan are the unionized work forces of state and local governments. Taxpayers thus find themselves paying taxes for lucrative defined benefit plans for unionized state and local employees. And now the Obama budget makes clear to these taxpayers that their retirement savings future is financing their own 401(k) accounts — even as these taxpayers fund often rich defined benefit pensions for government employees.

President Obama has not embraced President Bush’s rhetoric about an “ownership society.” However, there is in substance great continuity in the retirement savings policies embodied in President Obama’s budget and the prescriptions of the Bush Administration. The Obama budget, by expanding the savers’ income tax credit and moving toward universal IRAs in the workplace, embraces the defined contribution paradigm.

Marc Palatucci, Intern

David Bach is the best-selling author of the Finish Rich book series. In his latest work, The Finish Rich Dictionary, Bach provides definitions for over a thousand financial words and terms. Interspersed throughout the definitions are ten essays designed to help the reader navigate today’s financial environment, and avoid it’s many pitfalls and perils. In this excerpt, Bach gives seven rules to follow in planning for ones retirement.  To read other excerpts from this book click here.

Here are seven rules for planning for retirement:

1. Invest for growth. Even with the recent downturn in the stock market, it’s still critical that, when you invest in your retirement accounts, you invest for growth. Many people are now making the crucial mistake of thinking that the stock market will never go up again and, as a result, they are putting all of their money in guaranteed investments (like certificates of deposit). The problem with investing in something that is guaranteed is that the return may be less than inflation, which means you are actually losing money each year. The cost of living has been climbing steadily, at an average of slightly more than 3 percent a year. Playing it safe will not allow you to beat that rate. If your retirement account doesn’t grow faster than inflation, you’re not going to have enough money to live on when you retire, 20, 30, or 40 years from now.
While seeking growth requires you to invest some of your money in stocks (and that means more risk), over the long term, you should come out ahead and be able to build a bigger nest egg.

2. Take advantage of free money. One of the smartest things you can do when it comes to saving for the future is taking advantage of the free money your employer may give you. In many cases, employers will supplement your retirement plan contributions with contributions of their own. These matching contributions usually start at 20 percent of what you’ve put in and sometimes go as high as 100 percent. At the same time, you should still make the maximum allowable contribution, not just the percentage of your paycheck that your company will match. If your employer stops matching your contributions (as many companies have recently started doing), don’t make the critical mistake of stopping your contributions to your retirement account. With or without a match, you want to use your retirement account at work.

3. Don’t borrow from your retirement plan. Although your retirement plan may allow you to borrow money from your account without paying taxes or penalties, don’t do it. Why? For starters, imagine being laid off from work. At the worst possible time, your company tells you, “You have to pay back your 401 (k) loan.” Without a paycheck, you can’t pay back your loan, right? Your company then reports your loan as a distribution, and now you owe the IRS taxes on the loan, plus a 10 percent penalty fee. But wait, you’re not working. How will you pay the IRS? See the problem here? This is happening to thousands of Americans right now. Don’t let it happen to you. Leave your retirement money alone until you’re ready to retire.

4. Consolidate your accounts. Many people remember Grandma’s advice about not putting all your eggs in one basket, but they often misunderstand it. Not putting your eggs in one basket means diversifying your risk - putting your money into different kinds of assets, such as stocks, bonds, mutual funds, and other investment vehicles. It doesn’t mean opening an IRA at a different bank or brokerage firm every year.

There is simply no way you can do a good job managing your retirement accounts if they are spread all over the place. If that’s what you’ve done, consider consolidating them into one IRA custodial account. Not only can you completely diversify your investments withing a single IRA, but you’ll also find it much easier to keep track of everything.

5. Be careful who you list as the beneficiary of your retirement account. Many people follow their lawyer’s advice to create a living trust to protect their estate, put all their assets in their trust’s name. This is a big mistake. When you do this, your rollover, which allows, for example, a widow to take over her late husband’s IRA and put it in her name, without having to pay any taxes on it until she actually starts taking the money out. If the husband has transferred ownership of his IRA to a trust, the wife can’t take it over in the event of his death. Instead, the account goes to the trust, and the proceeds become taxable. For much the same reason, you shouldn’t make a trust the beneficiary of any of your IRAs or 401(k) plans. You should also make sure that, if you or your partner has been married before, your ex isn’t still listed as the beneficiary on any of your retirement accounts. Finally, if you’re newly married, make sure that your spouse has put you down as the beneficiary of his or her accounts. Many people when they marry have “Mom” down as a beneficiary. No offense to “Mom” or “Sis,” but you want your name on that beneficiary statement. Also, make sure you list your kids as contingent beneficiaries.

6. Always take your retirement money with you. When you leave a company where you’ve been contributing to a 401(k) plan, don’t leave your retirement money behind. Rather, immediately inform the benefits department that you want to do an IRA rollover. Your former employer will then transfer your retirement funds either to a new custodial IRA that you’ve set up for yourself at a bank or brokerage firm, or to the 401(k) plan at your new employer (assuming there is one and it accepts money from other plans). If you leave money in an old 401(k) plan, your beneficiary, upon your death, would have to go back to a company where you may not have worked in years to get your money. The process can take as long as a year, and the money could be subject to taxes before your beneficiary can collect it.

7. Don’t shortchange yourself. Whatever else you do in your financial life, take retirement planning seriously. There is nothing you can do that will have more impact on your future financial security than maximizing your contributions to a retirement account and making sure that money works really hard for you.

Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America.  In this article, Zelinsky discusses the federal government’s promotion of common stock investments for 401(k) participants. He suggests that, in light of the Crash of 2008, that promotion constitutes misguided paternalism.

Even as we contemplate the financial carnage of the Crash of 2008, the federal government sends a strong, paternalistic and, ultimately, misguided message to 401(k) participants: Invest your retirement savings in common stocks.

Congress, in the Pension Protection Act of 2006 (PPA), directed the Secretary of Labor to promulgate regulations specifying the “default investments” to which 401(k) funds will be directed if participants fail to make their own investment choices. Under the regulations issued by the Secretary of Labor, a plan fiduciary obtains immunity from liability for a participant’s investment decisions only if the plan’s default investment constitutes a “qualified default investment alternative.” Among other requirements, a qualified default investment alternative must satisfy one of three mandatory patterns: a “life-cycle” pattern under which “a mix of equity and fixed income” investments changes for the individual participant as the participant ages, a “balanced” portfolio under which each participant has the same “mix of equity and fixed income” investments “consistent with a target level of risk appropriate for participants of the plan as a whole,” or a “managed account” under which an investment manager allocates a particular participant’s account to “a mix of equity and fixed income” assets.

When one cuts through the bureaucratic verbiage, a strong message emerges: 401(k) funds, particularly the funds of younger participants, should be invested in common stocks.

At one level, the PPA and the DOL regulations which implement it reflect a plausible investment theory, namely, that common stocks, for the long run, do better than do more conservative investments. The PPA and the DOL regulations also respond, in light of this theory, to two accurate perceptions about the 401(k) world: First, unless participants direct otherwise, 401(k) plans have historically placed participants’ resources into conservative, low-yield investments like money market funds. Second, 401(k) participants often fail to diversify their holdings out of these conservative default investments.

Hence, the PPA and the DOL regulations channel 401(k) funds toward common stocks by effectively requiring that at least part of passive participants’ accounts be invested in such stocks.

Surveying the wreckage of the Crash of 2008, this looks like misguided paternalism. Many investors who buy common stocks in the current bearish environment are likely do well in the long run. But, as they say, past performance is no guarantee of future success. And some, particularly smaller investors, may sincerely and (from today’s perspective) rationally prefer to avoid the volatility associated with common stocks.

There is, as we have just seen, a reason that the extra projected profit associated with common stocks is labeled a “risk premium.” The passive 401(k) participant who leaves his funds in conservative, low-yield investments looks more reasonable today than he did when Congress passed the PPA in the bull market of 2006.

A defender of the PPA and the DOL regulations could retort that they do not require participants to invest in common stocks, but merely send 401(k) funds to equity investments unless the participants direct otherwise. True. But the PPA and the DOL regulations nevertheless reflect a father-knows-best attitude, taking it as the federal government’s responsibility to privilege its preferred approach to investing and enshrining that stock-based approach in the law.

Before the Crash of 2008, such paternalism looked plausible. At an as yet unknown date in the future, such paternalism may look plausible again. Today, it looks misguided.

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Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. In this article, Zelinsky discusses the U.S. Supreme Court’s recent decision in MetLife v. Glenn. That decision, he concludes, unintentionally reinforces the trend from defined benefit to defined contribution plans. Under MetLife v. Glenn, employers which sponsor and administer defined benefit pensions operate under a conflict of interest which subjects their administrative decisions to greater legal scrutiny.

Wanda Glenn was an employee of Sears, Roebuck & Company (“Sears”) and, as such, was covered by the Sears long-term disability insurance plan. Metropolitan Life Insurance Company (“MetLife”) both administered and insured the Sears plan. Ms. Glenn applied for continuing disability benefits. MetLife, as plan administrator, denied Ms. Glenn’s application for benefits which, if granted, MetLife, as the plan’s insurer, would itself have paid.

Ms. Glenn sued. Her lawsuit made its way to the U.S. Supreme Court which held in MetLife v. Glenn that, in light of the discretion confided to MetLife by the Sears plan, MetLife’s denial of Ms. Glenn’s disability benefit was to be reviewed judicially under a deferential “abuse of discretion” standard. However, the Court further stated, MetLife, as plan administrator, operated under a conflict of interest since any benefits MetLife granted as such administrator MetLife itself also paid as the plan’s insurer. Hence, in assessing whether MetLife, as plan administrator, abused its discretion, the courts must, among other factors, “take account of the conflict” MetLife faced as a plan administrator which was also the plan insurer. Such conflict of interest might “act as a tie-breaker when the other factors are closely balanced.”

MetLife v. Glenn has engendered extensive discussion. However, so far, one aspect of this decision has gone unremarked: MetLife v. Glenn is one more unintended push from our legal system, nudging employers away from traditional defined benefit plans towards 401(k) plans and other similar defined contribution retirement arrangements. After MetLife v. Glenn, the administrative decisions of employers sponsoring and administering defined benefit pensions will typically be subject to greater legal scrutiny than will be the administrative decisions of employers sponsoring and administering most 401(k) and similar individual account arrangements. This greater scrutiny incents employers to shift from their defined benefit pensions to defined contribution plans.

Embedded in the traditional defined benefit pension administered by the sponsoring employer is the conflict of interest stemming from the employer’s obligation, as plan sponsor, to pay the costs of the plan — just as MetLife, as insurer, paid from its premium revenues the costs of the Sears disability plan. In the defined benefit setting, greater plan distributions to participants and beneficiaries require greater employer contributions to the plan. Consequently, any distribution denial by the employer sponsoring a traditional defined benefit pension implicates the conflict of interest in which MetLife found itself: If the employer as plan administrator denies plan benefits, it thereby reduces its costs as plan sponsor.

In contrast, an employer sponsoring and administering a typical defined contribution plan usually has no such conflict of interest since the individual accounts of such a plan belong to the participants. If, for example, an employer, as administrator of a 401(k) plan, denies a participant a hardship distribution from the plan, that denial does not decrease the employer’s costs; it merely delays the distribution to the participant of his 401(k) account until later. Since there is no conflict of interest in that setting, under MetLife v. Glenn, the employer’s decision will receive greater deference if challenged in the courts.

An important factor causing the decline of traditional defined benefit pensions and the concomitant rise of individual account arrangements like 401(k) plans has been the heavy regulatory cost imposed on defined benefit plans. MetLife v. Glenn represents the latest such cost, an unintentional cost, perhaps a small cost, but a cost nonetheless. Employers who sponsor and administer defined benefit plans are now on notice that, because of their conflicts of interest, their administrative decisions will generally receive less deference from the courts than will the comparable decisions of their competitors sponsoring and administering 401(k) plans who do not operate under such conflicts of interest. By itself, this will rarely cause an employer to terminate its defined benefit pension and shift to an individual account arrangement. But, to paraphrase the Supreme Court, this is the kind of cost which can act as a tie-breaker when the decision is close.

Consequently, Metlife v. Glenn, by reducing the deference ultimately granted to employers which sponsor and maintain defined benefit pensions, represents one more small, but unintended, push away from such pensions.

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Today we are proud to bring you Teresa Ghilarducci (who just published When I’m Sixty-Four) in conversation with Jacob Hacker (author of The Great Risk Shift). These two experts will be debating how to ensure retirement for future generations. This is part two of the which will we be publishing all week, so be sure to come back and check our exchange.

Teresa Ghilarducci taught economics for twenty-five years at the University of Notre Dame and now holds the Irene and Bernard L. Schwartz Chair of Economic Policy Analysis at the New School for Social Research. She is also the 2006-2008 Wurf Fellow at Harvard Law School. Her most recent book is When I’m Sixty-Four: The Plot against Pensions and the Plan to Save Them.

Jacob Hacker is a Professor of Political Science at Yale University and a Fellow at the New American Foundation. His most recent book is The Great Risk Shift: The Assault on American Jobs, Families, Health Care, and Retirement And How You Can Fight Back.

Dear Teresa,

I see these multiple perspectives on retirement every day, in my research and my own life. I visit my dear colleague Bob Dahl, who in his mid-90s continues to publish path breaking books on democracy and political equality. How can I talk with someone so intellectually vibrant and not want to be contributing in that way in my own old age?

And then I remember Elinor Sheridan, whom I wrote about in my book. In her seventies, she was trying to find a job because her 401(k), crushed by the stock-market decline of 2000, had already been depleted. Even with Social Security, the pension she receives from 17 years at a hospital provided a meager standard of living. Elinor had worked her whole life — as a mom and wife (divorced) and then, ironically, as a “risk manager” at the hospital — and now she was not because she wanted to but because she had to. So much for the golden years.

It is good to have someone celebrating retirement as a benefit to our society, rather than a burden on us and future generations. The labor movement may be the “folks who brought you the weekend,” but it was FDR and countless fellow campaigners for a guaranteed retirement income who who brought us retirement as we now know it. And the campaign is not over.

Retirement security is under attack. Corporations are jettisoning traditional guaranteed pensions, Congress is pouring money into tax breaks for individual benefit plans that exclude millions and mostly benefit the affluent, virtue in proposals for partial privatization of Social Security that will put the promise of secure retirement= further at risk.

But this exchange would be pretty uninteresting if all I said was “Amen,” and so let me continue in the vein of disagreement for at least a little while. I have two concerns about the Guaranteed Retirement Account (GRA) vision — the first more philosophical, the second more practical. (And I should note, as a fellow policy wonk, that GRA is a nice acronym, especially when compared with John McCain’s chosen shorthand for his health plan of last resort, GAP, or “Guaranteed Access Plan.” Note to the McCain candidacy: A plan that’s billed as filling gaps should probably have another moniker, though perhaps the McCain folks believe in truth in advertising.)

First, the more or less philosophical concern: Are GRAs the best immediate use of federal resources and the scarcely unlimited running room for new federal taxes — excuse me, “mandatory contributions”? I am not one to go in for the clash-of-generations view so common in official Washington and the news media. (After all, we all get old, and young and old alike support Social Security and say they want a secure retirement.) But I am not sure I am ready to man the barricades for a major new commitment to provide enhanced retirement income when so many needs go unmet for working age Americans and kids. For one, and I say this only half in jest, I would rather have the 5 percent of payroll proposed to fund GARs for my universal health plan
= (http://www.sharedprosperity.org/topics-health care.html). For another, Social Security provides a tattered but still crucial safety net that is sorely lacking in other areas of American economic life—most notably, health care (again, I really want that 5 percent!). My point is not that we don’t need a new campaign for retirement security — we do. It’s just that I”m not sure it should be the first priority of those seeking economic security. The aged look out for themselves pretty well in American politics. Not so the young, the disadvantaged, the cash-strapped working family — though, yes, they will all be old some day and, yes, our pension system fails them above all.

Now, the practical worry. We have a huge 401(k) complex on which millions of Americans rely. In my 2002 book, The Divided Welfare State, I described the slapdash way in which this system came into being (trust me; almost no one knew what they were getting into, though once the floodgates were opened, corporations figured it out pretty quick). But I also made the point that existing systems of social protection, however haphazardly created or inadequate in practice, are fiendishly difficult to supplant with new, more rational arrangements. I called this “path dependence.” But we could just as well call it “political reality.” And it seems to me that the political reality today is that it will be very, very hard to completely redirect existing tax breaks for 401(k) plans and create an entirely new supplementary pension system managed by the federal government.

If that judgment is correct (dispute away), then where does it leave those of us living in the reality-based policy community who recognize that the 401(k) defined contribution model is incapable of providing retirement security for all but those at the top? I argued in The Great Risk Shift thSocial Security, and (2) transform 401(k)s into something that looks like a guaranteed retirement benefit. Without going into the details, I called for making 401(k)-type accounts available to everyone, even if their employer failed to provide them; requiring automatic enrollment through the workplace; and offering progressive “matches” to supplement lower-income workers’ contributions, even if employers do not offer a standard match. And I said that all account balances should be automatically converted into annuities (a guaranteed income for the remainder of one’s life) at retirement unless someone could show they had sufficient wealth to protect themselves against outliving their assets. (providing such annuities through the post office back in the 1930s).

By the way, this would surely cost serious money – which puts it somewhat in tension with my first point about priorities. But it has the virtue that it could be done in stages, with the lowest-cost aspects (automatic enrollment; annuitization, which should be self-financing) coming \ first. Its more important virtue is that it might be possible to do at all.

Fire Away,

Jacob

Thanks for reminding me of Robert Dahl and what was unspoken, our hope we are as incisive in our nineties and in control of our time.

Please know it was both — FDR’s Social Security and union pensions (e.g. those for the Ladies Garment Workers, bricklayers, coal miners, steel, auto workers etc.) that created the middle class and middle class retirement. But, as you point out, the campaign for “decent retirement for all” is not over. Except for the wealthiest men and women, people, now in their 40s and 50s, will likely be the first U.S. history to be more at risk than their parents of experiencing a sharp drop in living standards in old age.

I bristle a bit when accused of not being a reality-based policy wonk. There is not a pension economist on the planet that will defend our system of tax breaks for savings that only help the affluent move money from taxed accounts to tax-favored accounts, costing the Treasury over $80 billion per year. Thus, it is no surprise that the tax breaks - called tax expenditures - have soared while overall savings rates keep on going down. A full 50% of the tax expenditures for 401(k)-type accounts go to only 6% of workers; those at the top earning over $100,000 per year.
70% of the tax breaks go to the top 20%. The most head banging reality of it all is that these people would have saved without the help. The current system has no basis in logic.

Who did this? Who brought old age income security under attack? I used to think it was mostly corporations spending less on pensions because they could get away with it. The shift in market power to employers and away from workers is partly the reason, but a big part of the attack comes from Congress indulging the 401(k) industry. And a dedicated, ideologically-based campaign to transform Social Security into individual accounts (my Chapter 5 covers that intricate history and, as you rightly point out, continuing saga) is the other source of the plot against pensions.

My proposal for guaranteed supplements to Social Security is based in this reality. GRAs obtains pensions for all with no additional risk or federal spending. And, they restore savings rates to the higher rates before the “debt boom” that started in the 1980s.

Philosophically we are on the same page. You didn’t say it right out, but I guess you are just as terrified as I am that high payroll taxes would cause terrible things like widespread tax evasion and an underground economy. I’ve come to appreciate how lucky we are in America that we have almost 100% employer compliance (the stray restaurant and construction sites notwithstanding) in paying social security tax.

Keeping payroll taxes low is philosophical and practical. Nonetheless, I support your plan for an additional payroll tax to pay for health care and for a mandatory 5% contribution to a GRA. First, the government will offset the 5% GRA contribution with an indexed $600 annual contribution.

Second, the “mandatory contribution” is unlike a tax, it will go into an individual’s account under that individual’s name. Third, money for the old doesn’t take away money from the young. One of my best articles has the best title - Do the Old eat the Young? (I also teach a class on social policy with the same name). The ugly fear that supporters of Social Security and pensions compete with government support for working-age Americans and kids is not well founded. You know what? Nations that pay for the old also pay for kids. It is also a pattern in American history. When American families funded their pensions and paid ever increasing Social Security taxes, they voted for increases in property taxes to pay for schools.

Thus, we can plausibly argue for a bread and roses social policy. Your great book, The Great Risk Shift, put working class families’ insecurity front and center. The kids! The kids! Only African American kids have higher poverty rates than older single women. And, you are right, over the last 4 decades, we have drastically cut old age poverty rates while more kids face poverty risks. But did bread leave the mouths of babes to feed the grandmas? No. Tax expenditures - taxes not collected for special reasons, like for oil depletion and for profits of banks operating abroad — between 1974 - 2004 tripled. And the growth in tax breaks, mostly for businesses and the wealthy, far exceeds the growth in social spending. That is where much of the money for cash-strapped working families have gone.

I agree, thought the practical reality of checking the runaway 401(k) industrial complex might be difficult, it is not impossible don’t annihilate Wall Street firms, the government will contract with for-profit professional money managers just as we do for for investing pensions for Federal Reserve employees, Texas teachers, etc. Even Chuck (in the “Talk to Chuck” campaign for Charles Schwab brokerage accounts) and other broker dealers will have something to do. Employers can still keep their 401(k) plans, but their merits have to be r al, not based on the tax breaks going to the bosses. So, though it is difficult to implement policy as if we are “starting from scratch” because of “path dependence” this 401(k) path is fairly new - the tax breaks have soared only recently. And, if we can keep tax breaks for 401(k) contributions up to $5,000 per year - not up to, in some cases, $46,000 — we only spend $25 billion per year for GRAs for all, funded with $600 federal contributions for everyone.

So, don’t throw me out of the reality-based policy community. Guaranteed Retirement Accounts, with all due respect, is a more effective, straightforward plan than your plan that relies on clever psychological jujitsu with automatic this and thats. You aim to raise pension coverage rates by taking advantage of human laziness through auto enrolling, auto annuitizing and - you should add — auto investing. Fundamentally, relying on voluntary, commercial accounts does not address huge leakages from high retail fees, leakages from churning and scams, and leakages from early withdrawals and, the biggest leak of all, the fact most employers do not bother to sponsor a pension plan at all.

The best part about the GRAs is that it addresses the two Americas. The GRAs gives every American worker with a Social Security number what only some lucky workers have. Workers with government, corporate and union defined benefit plans, and college professors in TIAA -CREF have low cost, not-for-profit financial institutions handling our pensions. The other Americans have nothing, or pay retail fees for leaky 401(k) accounts. The GRAs close that access gap - everyone has access to a low fee, professional, quasi-governmental, financial institution that guarantees an inflation-protected competitive market return.

Jacob, we can get health and pension security. No?

Teresa

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Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. In this article, he criticizes proposals for the states to administer private sector retirement savings plans. Read his past OUPblog posts here.

Legislators throughout the country are proposing that states start to administer private sector retirement savings plans. While the details of these proposals vary from state to state, they all provide that the states should embark upon the business of managing private sector individual account arrangements.

In Connecticut, for example, the state senate, before recently adjourning, passed S.B. 652 which would have created a state-sponsored “universal 401(k).” This legislation would have mandated the state’s comptroller to establish and administer a state-run “tax-qualified defined contribution retirement program” for the self-employed, the tax-exempt institutions, and the “small employers” of the Nutmeg State.

On the other side of the country, currently pending in the California legislature is AB 2940. If enacted, this legislation would authorize CalPERS, the Golden State’s public pension plan, to accept from California residents payroll deposits for state-administered individual retirement accounts. Similar legislation has been introduced in a variety of other states.

The concern animating all these proposals is well-founded. The defined contribution paradigm has worked well for many American households, in particular, middle- and upper-middle families who save and invest through 401(k) plans and IRAs as well as the employees of large employers which sponsor and typically match such employees’ 401(k) contributions. Despite this success, it is troubling that lower-income workers and smaller employers are severely underrepresented in the individual account system.

This problem, however, has deeper roots than is acknowledged by the advocates of state-administered private sector retirement plans. The current retirement savings system relies heavily on the income tax benefits of contributing to tax-qualified arrangements such as 401(k) accounts and IRAs. Those tax benefits are substantial for middle class and more affluent workers who defer significant federal income taxation through their tax deductible contributions to such accounts.

However, low income workers today do not pay significant federal income taxes. They thus have little, if any, tax motivation to make 401(k) or IRA contributions. A deductible contribution is not a meaningful incentive for someone in a low or zero tax bracket. This would remain the case even if states compete with the private sector suppliers of retirement plans. A low-income worker who derives no tax benefit from a deductible IRA contribution at his neighborhood bank will similarly derive no tax benefit from contributing to an IRA administered by his state’s comptroller.

Moreover, even if they want to make such retirement savings contributions, most low-income workers lack the discretionary income to do so.

The private market for retirement savings products is broad and deep. Today, every reader of a major newspaper or of the internet is bombarded by the advertising of the financial services industry, selling 401(k) plans and IRAs. There is no market failure requiring state-provided retirement savings for the private sector.

There is, furthermore, an unintended irony in the idea that the states should ride to the rescue of the private retirement system. The states can’t keep in order in their own pension systems. The states’ underfunding of their own pension plans is today a serious problem. There is something untoward about states which cannot solve their own pension difficulties purporting to act as the saviors of the private sector retirement system.

There is an important step the states can take if they are serious about encouraging 401(k) and IRA participation among low-income individuals. In particular, the states could, in their own income taxes, match part or all of the federal savers’ tax credit which subsidizes the retirement saving of low-income persons by providing a tax credit if a low-income worker contributes to an IRA or 401(k) account.

However, there is no compelling case for the states to enter the private retirement savings business. Let them put their own pensions on solid financial footings first.

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