On average, Americans are behind on their retirement savings, and many are not financially prepared to enter retirement. There are many reasons for this: people are living longer than a couple generations ago, pension plans, which were once commonplace, are now few and far between, it’s tough to balance current needs with future needs, many people mistakenly think Social Security benefits will take care of their retirement needs, and some people simply can’t afford to save much, if anything.
While it’s easy to identify the problem, finding a solution has been elusive. Not that people haven’t tried. A recent article from Money Magazine features an interview with economist Meir Statman, a finance professor at Santa Clara University who specializes in behavioral finance. He suggested the government make retirement saving compulsory. (Yes, Americans already contribute a portion of their paycheck to Social Security, but this proposal would be in addition to Social Security contributions. Also keep in mind that Social Security was never intended to be a retirement plan; Social Security benefits are designed to supplement retirement).
How Would it Work?
In the article, Mr. Statman proposes the government mandate workers save a portion of their income into a plan similar to a 401k plan, which would be administered by employers. Those who are self-employed would have access to a plan similar to the health insurance exchanges in the new health care laws (this idea wasn’t elaborated upon, but it could be as simple as creating a new retirement program classification and allowing qualified custodians to manage accounts on behalf of savers, much like companies can be custodians for 401ks, IRAs etc.).
Mr. Statman recommend starting at 8% of pay, which is a reasonable starting point, and higher than many Americans currently save. He also stated that a 15% savings rate would be more ideal.
Similar ideas have been discussed before, but have never been passed into law. The closest we have seen is the Pension Protection Act of 2006 which gives employers the option of automatically enrolling employees in an employer sponsored 401k plan, such as a 401k. However, employees have the option of opting out, or changing their automatic contribution level.
Benefits of Mandatory Retirement Plan Contributions
The benefits are obvious – most Americans don’t save enough, and many are woefully unprepared for retirement. Requiring Americans to save for retirement would help many people better prepare for retirement and be less of a burden on the state or family members if they are unprepared when they enter retirement. Many savers would also find that required contributions wouldn’t cause an undue strain on their finances, especially if the government offered tax benefits as they do with 401k contributions.
Problems with Mandatory Retirement Plan Contributions
On paper, I can see how this idea looks good. Unfortunately, the article was light on details. Given that this could be a game changer for virtually everyone in our nation, knowing the details would be essential before passing judgment. Here are a few question marks I see around this proposal:
- How would a forced savings plan affect 401ks or other employee sponsored retirement plans? Would they replace these plans, or be in addition to these plans?
- Would businesses be required to make contributions to these plans as part of the employee compensation?
- Would there be tax benefits on contributions? If so, would there be a traditional or Roth element?
- Would the plans be portable? Mr. Statman plan states the programs would be administered by employers. I’m sure the employees would still own their contributions, but would they be able to easily transfer them to new plan much like one can transfer a 401k to a new employer or rollover a 401k into an IRA? Or would there be a centralized management platform?
- Would the government leave Social Security alone? Social Security has come under fire over the last few years because the program is underfunded. Requiring people to save on their own could open the door to decreasing or eliminating Social Security for future generations.
- How would this affect small businesses? Mr. Statman offered the solution of having “retirement plan exchanges” for those who are self-employed. This may also be a good option for many small businesses who can’t afford the added bookkeeping expenses of creating retirement plans for their workers, especially for those who are part-time or contract.
- What about people who truly can’t afford to make retirement contributions? I can understand that many people would prefer not to have this mandated, but some people truly cannot afford to decrease their paycheck.
What Are Your Thoughts?
Overall, I understand where Mr. Statman is coming from. Many people don’t save for retirement, even though they know it is a good idea for them. Even companies automatically enrolling people in 401k programs isn’t always enough. Some people need more than a nudge to get started – they need to be shoved. I’m just not sure we can legislate our way out of this situation.
What do you think?
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