I regularly read John Rekenthaler’s Morningstar column, largely because he is very good writer and often has interesting insights into investing and the financial industry (mainly mutual funds). He and other Morningstar commentators occasionally lapse into writing about public policy – mainly retirement, financial regulation, and taxation of mutual funds. I find that their policy prescriptions miss the mark (in my view) as often as they hit, mainly I think because they come at it from a different frame of reference than I do.
Rekenthaler’s last two columns address a public policy issue he has been visiting over the years – problems with America’s retirement system reliance on 401(k) and similar plans (e.g., 403(b)s) as its core source of retirement income (beyond Social Security, of course) – but now he actually is proposing a number of fixes or solutions, rather than just pointing out problems and flaws. I have generally agreed with his criticisms and now find his proposed solutions to be sensible, as far as they go (not very). Unfortunately, the hyper-partisan gridlock that defines Congress is likely to prevent any measured consideration and discussion of his or similar improvements. So, we are likely to continue to muddle along with accidental policy (401(k)’s, as Rek points out were a policy accident that employers hopped onto) that is a mess, at best.
The two columns are here: “401(k)s Have Reached Their Expiration Date” and “The New American Retirement Plan” and are both worth reading.
In my view, using voluntary defined contribution plans, like 401(k)s and 403(b)s, as a basic building block of a national retirement system has two huge flaws:
- They depend upon voluntary, regular saving for the distant future – consistently setting aside a portion of earnings to be used often decades later. Many/most humans are not psychologically set up to do that; deferred gratification is not easy even if the payoff is in the near term.
- They require individuals themselves to do the investing in a way that realizes a reasonable rate of return. That is an immensely complex task that the vast majority of people do not want to undertake, even if they were intellectually capable of doing so (and many/most are not). Of course, a vast pool of people/entities is out there and more than happy to do that for a fee. Unfortunately many of them are either incompetent or charge high fees or both, making it much more difficult to earn the necessary reasonable rate of return on those savings.
Thus, in my view, a voluntary, defined contribution system faces the basic problem that it must swim against strong currents of human psychology and behavior that make it difficult to save consistently and invest intelligently. The expected result is what we have for the generation that is dependent on these plans – many people have saved little or nothing and those that have saved often realize below market returns, either because they were lured into high-fee plans or bought high and sold low.
These are only the big problems; there are plethora of smaller ones with the current system. However, the mobility of employees more or less dictates a defined contribution structure. Even if employers wanted to provide defined benefit plans and they obviously don’t, that model only works for long-term employees. The practice of working for one employer for your whole career is now the exception, not the rule. And as a society, we should encourage or make it easy for people to change employers and careers. Multi-employer plans have been an abject failure – witness the problems with the plans covering miners and truckers. (Watching The Irishman gives you one idea of the problem, but not the real one.) So, we should to fix the 401(k) system.
Rek’s proposed improvements all make sense to me. They are largely based on systems in other countries, so he concludes (correctly, I think) that they are workable. His proposed changes include (read the column for the full view):
- Delinking access from your employer’s choice to offer a plan – currently many employers (mostly smaller ones) do not offer 401(k) plans forcing their employees to use IRAs. Rek would take employers out of the picture altogether and create one national plan that everyone would have access to. That makes sense to me for many of the reasons he outlines.
- Basic participation would be involuntary – you would be auto enrolled but could opt out of increases in contributions. He allows as how he’s not stuck on the involuntary element. Making participation mandatory would ensure that all workers accrue some retirement savings beyond social security; makes sense to me but I don’t see any Congress I can imagine going for it.
- Stop leakage – do not allow assets to be withdrawn for anything other than retirement or disability. There is evidence of a lot of leakage – when people change jobs, to finance home purchases, etc. It is worth noting that preventing leakage seems to run counter to the thinking of some Republicans in Congress who are proposing to allow people to tap their social security benefits to pay for child care! I really don’t get that.
- Mandating some sort of default, diversified investment options (undefined) that would insure a basic market return at low fee levels. Other countries apparently manage to do this.
You can debate whether America has a retirement crisis or not. I think it does, but it’s a slow decay, not a rapid burn. As a result, Congress is unlikely to address it. Congress should at least have the discussion Rek’s columns suggest but it likely won’t because it will inflame opposition from many quarters, I’m sure. It always does and that apparently freezes any meaningful congressional action. I expect that members of Congress will content themselves with doing more meaningless stuff like the SECURE Act. They won’t even discuss small bore issues like:
- Why do we have both Roth and traditional IRAs, 401(k)s, etc.? The amount of needless time and energy spent by savers trying to divine which flavor IRA to use is staggering. Just Google “Should I contribute to a traditional or Roth IRA?” I may write a separate post that explains why I think Roths are the version that should go.
- Along similar lines, why don’t we have one plan for the self-employed? Why should they need to figure out whether a SEP IRA, Simple IRA, a Keogh, etc. is better for them?
- Are the tax benefits more generous than necessary to encourage funding a basic retirement? Does Mitt Romney really need to be allowed to have a $50+ million IRA? (How did he ever accumulate that much? He never released the relevant tax returns to allow determining that; a fact that now pales in the light of the current occupant of the office refusal to release any returns at all.) Or should there be a cap on contributions or IRA assets, just as there are limits on the benefits that can be paid under defined benefit plans? Obama proposed a $3.5 million cap, I think. That might be too low, but the concept sure seems reasonable.
- There is a long litany of similar and even smaller-bore issue that should be addressed or at least debated.
After I initially posted this, Rekenthaler followed up with a third column/post that responds to criticisms or other feedback that he received about his proposal. This followup contains a useful summary of what he is proposing and made me think about another implication of his proposal, because he obliquely addresses it:
- By going to one national plan (i.e., employers no longer would voluntarily decide whether or not offer 401(k)s to their employees), that opens up the possibility – indeed, it seems like a certain implication – that employers would no longer be constrained by nondiscrimination rules. Nondiscrimination rules likely drive many employers who do participate (particularly smaller one) to provide employee matches, because doing so is necessary to satisfy the nondiscrimination rules that allow participation and contributions by highly compensated employees and owners.
- If that occurs and I’m sure it would, the system could tilt a little bit even more to favoring high income individuals. At least, I’m guessing that employer matches drive a lot of contributions. This offsets a bit the benefits of making access easier for employees of firms that don’t offer 401(k)s.
- It’s unclear to me how to fix that in a sensible way, unless you mandate matches if owners and highly compensated employees participated at some level in the previous tax year. This could be done similar to the current nondiscrimination rules, I would suppose. The linkage would be less clear and harder for elected officials to justify I would think.
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