Get the Facts Straight Before Dissing the Current Retirement System

We hear a lot these days about the supposed inadequacy of 401(k)s and other defined contribution plans for providing income for American workers in retirement.  Those who are most critical sometimes reveal a soft spot for the defined benefit (DB) pension plan, the “no worries” retirement plan designed to provide long-tenured workers with a guaranteed income after leaving the workforce.  Many overlook the fact that, even in the DB heyday, workforce mobility resulted in many, many workers never qualifying for that “large” pension check.   

The truth is, neither the 401(k) nor the DB plan was created to be only leg upon which a retiree would stand during retirement.  The classic model as many are aware is actually a “three-legged stool.”  In addition to an employer-sponsored retirement plan, the other two legs of this stool – by tradition – are Social Security, and additional personal savings and assets of the worker.  Together this three-legged stool would support a reasonably secure retirement. 

As much as we may be frustrated by some academics, think-tank specialists and lawmakers who feel we need a paternalistic, mandated government-run program that guarantees benefits to retirees, we don’t doubt they are sincere in their goal of helping people achieve a secure retirement.   But with the budget woes in which our country is mired, and the extremely divided political climate, a European-style universal defined benefit pension system is not realistic.  Even if that would be desirable.

But before wringing our hands and running for cover, accompanied by shouts of “the sky is falling,” let’s consider some data that suggests that things may not be as bleak as some profess.  The data is presented in an article recently appearing in the Wall Street Journal.  It was jointly written by Sylvester Scheiber, a former Chairman of the Social Security Advisory Board and now an independent pension consultant, and Andrew Biggs, former Deputy Commissioner of the Social Security Administration and currently Resident Scholar at the American Enterprise Institute. 

Scheiber and Biggs point out that the data most often cited to measure the magnitude of qualified plan and IRA payments to U.S. retirees is greatly understated.  How so?  Proposals to revamp the retirement saving system that originate in Congress, or in the halls of academia, routinely cite retirement income figures from the U.S. Census Bureau’s Current Population Survey, or CPS.  But Scheiber and Biggs note that CPS data counts only Social Security benefits and scheduled periodic payouts from retirement accounts – typically annuitized balances in IRAs and defined contribution plans – and DB plan payouts. 

The” as-needed” or irregular withdrawals are not counted, say Scheiber and Biggs, and are huge.  They should know, because they compared CPS retirement payment figures to Internal Revenue Service data on IRA and employer plan distributions, which are required to be reported annually – on pain of penalty – on IRS Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc.   

Examples of their findings include the following.  CPS data for 2008 reported $222 billion in “pension or annuity income.”  IRS retirement plan and IRA reporting forms showed $457 billion.  Given the fact that most large balances in employer-sponsored plans are destined to eventually be rolled over to IRAs, where they will probably not be annuitized, accurate IRA estimates are extremely important.  But CPS data is even more suspect here.  In 2008 the CPS reported $5.6 billion in IRA-derived income.  But, according to Scheiber and Biggs, retirees themselves reported $111 billion in IRA distribution income on their tax returns. 

The two former Social Security officials contend that the CPS not only misses at least 60 percent of the IRA and employer plan income being delivered to retirees, but greatly underestimates the share of the U.S. workforce that has an opportunity to participate in an employer plan.  CPS reports that roughly one-half of all U.S. workers have this opportunity, yet Scheiber and Biggs note that the Social security Administration’s analysis of Form W-2 data places the figure at over 70 percent.

Can the U.S. retirement system be made better?  Certainly.  We can retain and enhance incentives for employers to establish plans and encourage early participation, embrace automatic employee enrollment and automatic escalation of employee contributions.  Perhaps create an automatic IRA program for employers not yet ready for the deep end of the pool.  These are things that can make a good system even better.  Let’s consider these, while at the same time recognizing the true magnitude of benefits being delivered now, before we throw the baby out with the bath water. 

Some Good, Much Questionable in Camp’s Tax Reform Proposal

Much of the country may be oblivious to the tax reform proposal that House Ways and Means Committee Chairman David Camp released on February 27^th.  But for some in the financial, tax and retirement sectors, reading this legislative draft was like making contact with a cattle prod.  Despite advance warning of what Camp’s tax reform might look like, it was still a jolt to actually see in print the proposed dismantling of key elements of the retirement saving infrastructure as we know it.

Disappointing, too, that while billed as pursuing the noble aim of putting the nation’s budget house in order, at the same time making taxation simpler for us all, this tax reform proposal takes advantage of a too frequent congressional practice that offers “solutions” that look good in the short term but often come at the expense of budgetary solvency in the long run.

First, I might point out that the tax reform proposal offers a few positive things.  The SIMPLE 401(k) plan, which the tax reform proposes ending, has seen very little adoption from its beginning in 1997, offering greater complexity and less generous benefits than the  more popular SIMPLE  IRA plan.  Medical Savings Accounts, or MSAs, really serve no purpose now that we have Health Savings Accounts, and most would not mourn their disappearance, either.   Some simplification of options is a good thing.

Allowing an extended time period to roll over an outstanding plan loan that is offset when a participant retires would help preserve retirement assets; a win-win, from my perspective.  Permitting a plan participant to continue making elective deferrals after they have taken a hardship distribution is another positive.  The current law’s requirement to suspend deferrals for six months penalizes the participant who wants to save and eliminating this requirement is a step in the right direction. 

There are some reasonable arguments, pro and con, about limiting the length of retirement plan and IRA payouts to nonspouse beneficiaries, or whether to retain the early distribution penalty exceptions for first-time home buyers and for higher education expenses.  Retirement assets are, after all, for retirement, some might say, while others would say that the ability to access funds for these purposes encourages savings and that providing beneficiaries with extended payout options is a useful planning tool.  Reasonable minds may differ.

Other elements of Rep. Camp’s proposal are, I believe, neither positive  nor open to conjecture.  Eliminating Traditional IRA contributions, and forcing IRA, 401(k), 403(b) and 457(b) savers to make more Roth contributions, is a gimmick intended to capture more tax revenue in the short term, in order to pay for Rep. Camp’s other reforms within the 10-year period in which this proposal will be measured.  I’m not saying that Roth contributions are not a good thing, as they clearly are in the right circumstances.  Rather, I contend that eliminating tax deferrals and Traditional IRA contributions is not. 

Understandably omitted from this committee’s summary is the fact that guiding so many contributions into Roth IRAs and Roth accounts in employer plans will result in less tax revenue in the future.  For when these accounts later disgorge qualified distributions, all earnings will be tax-free.  The Roth features in IRAs and employer plans are valuable, but I doubt that the previous Congresses that created them contemplated that tax-free earnings would ever become the rule rather than the exception.  Pre-tax contributions do not result in lost revenue, but simply federal tax revenue collected at a later time, something that too many congressmen and senators either do not understand, or refuse to admit.  Chairman Camp’s tax reform proposal is leading us toward the possibility of revenue shortfalls in the future, leaving it to a later Congress to raise taxes, or cut other expenditures, to correct such shortfalls.

Apart from this Roth-centric proposal’s negative effects on future federal tax revenues, eliminating pre-tax IRA contributions and restricting employer plan pre-tax saving would be detrimental to many taxpayers, who would no longer be able to make reasonable tax planning decisions with the options available to them today.  Contrary to what Rep. Camp may believe, many people would save less, if at all, if they did not receive a current-year tax deduction or exclusion for those savings. 

Though there are numerous other questionable provisions I might cite, I will limit myself to one more.  Perhaps the most indefensible of Rep. Camp’s tax reform elements would lock down IRA and employer plan contribution and testing limits, without cost-of-living adjustments, for a full decade.  How, at a time when Americans are being told they are not saving enough for retirement, when we are seeing presidential orders issued to broaden retirement saving options even further, can we propose to hold contribution limits to present levels for 10 years?  How many workers would be willing to agree to no wage or salary increases for 10 years?  How many senators and congressmen?  Can we count on a 10-year period with no inflation?  It is another example of sleight-of-hand to make the federal budget appear balanced for that period of time.

I admire Rep. Camp for taking on the daunting task of tax reform and balancing the federal budget.  I also know that many Americans will have to make some sacrifices toward that end.  But I’m confident that there are special interests and more dubious tax expenditures – actual tax expenditures – that are more worthy of targeting than American workers trying to accumulate a nest egg for a reasonably secure retirement.