The 401(k) structure has three clear and obvious flaws. First, it is not universal. Thirty-three percent of American workers lack access to 401(k) plans, or their equivalent. Second, the accounts are not portable. That’s a severe flaw, given that from ages 18 to 54, American workers on average have 12 different employers. Third, many 401(k) plans require participant action. That does not sound like much of an impediment, but people often freeze when asked to make investment decisions.
In addition, there is a fourth, less-discussed problem: inefficiency. With the exception of businesses that participate in multiple employer plans, each 401(k) sponsor must construct its own plan rather than use another’s. Given that the United States contains 600,000 401(k) plans, this makes for a great deal of duplicated effort—requests for proposals, hearings, and documentation.
Any truly ambitious proposition to improve the 401(k) structure must address at least the initial three issues, and ideally also the fourth. In 2020, I offered such a recommendation, in an article titled “The New American Retirement Plan.” That column advocated that the nation possess a single 401(k) plan run by the federal government. Rather than be the plans’ primary sponsors, as they are today, employers would have no role save to connect workers with the system.
The proposal, I acknowledged, was unrealistic. “Congress will almost certainly not” advance bold retirement-planning legislation, I wrote, given its “current inability to craft broad bipartisan legislation.” As a result, anything resembling a national plan is “politically unfeasible.”
The New Bill
Wrong again! So much for my political prognostications. To my surprise and delight, Congress earlier this month introduced the Retirement Savings for Americans Act of 2022, which advances the idea of a national 401(k) plan. What’s more, the bill carries both bipartisan and bicameral support, as it is backed in the Senate by Democrat John Hickenlooper and Republican Thom Tillis, and in the House by Democrat Terri Sewell and Republican Lloyd Smucker.
To be sure, the act is less sweeping than my suggestion. Rather than replace the existing system, it would supplement it, by installing the “American Worker Retirement Plan” in all companies that lack acceptable 401(k) plans. The AWRP also lacks the full power of the 401(k) structure. Its contribution limit is a modest $6,000; it cannot be used by higher-income employees; and it does not provide an immediate tax benefit, as it is structured like a Roth IRA.
That said, some aspects of the act go even further than I had proposed. The legislation is not shy. Here are its key characteristics.
1) A single plan. AWRP’s investment options would resemble those of the federal government’s Thrift Savings Plan. It would contain 1) a government bond fund, 2) a stable-value fund, 3) a large-company U.S. stock fund, 4) a small-company U.S. stock fund, 5) an international-stock fund, and 6) target-date funds. The assets would be indexed.
AWRP accounts would be portable among companies within the system. They also could be rolled into either an existing Roth IRA or a Roth 401(k) plan.
2) Automatic enrollment. Eligible participants would be automatically enrolled in AWRP at a 3% contribution rate. As with most 401(k) automatic-enrollment programs, employees who do not select their own investment options would be slotted into an age-appropriate target-date fund. AWRP also echoes existing automatic-enrollment programs by permitting unwilling workers to opt out at any time.
3) Tax credit. So far, the AWRP resembles my New American Retirement Plan proposal. But it also contains several features that I had not considered.
One is the AWRP’s version of a company match. Mandating that companies put their own money into AWRP is a political nonstarter. So, too, would be directly using government funds to bankroll a match. But AWRP’s creators found a method that might appeal to both parties: tax credits! Participants could receive up to a 5% refundable government match tax credit designed to mimic a 401(k) employer match. This would include an automatic 1% contribution as long as participants remained employed, and a matching contribution equal to 100% on the first 3% of their contribution rate and 50% on the next 2%. The bill also specifies that only low- and moderate-income workers would be eligible for the credit.
Whether this arrangement will survive after the Congressional Budget Office calculates its estimate of forgone tax revenue is another matter. But it scores points for ambition.
4) Income and contribution limits. AWRP is intended for lower- to middle-income workers, not corporate executives. Consequently, it excludes highly compensated workers, as defined by the IRS. The program’s annual contribution limit, as previously mentioned, is the Roth IRA maximum of $6,000. However, AWRP does permit higher contributions for employees over the age of 50, per the IRS’ catch-up provisions.
5) Payout options. The bill’s proponents also got creative with AWRP’s distribution options. Besides requesting 1) a lump sum, as with 401(k) plans, retirees can also use their assets to 2) buy an immediate annuity or 3) establish a fixed annual withdrawal schedule. They may also blend those three choices, in any combination.
Having flopped almost entirely with my last effort, I will avoid making a political forecast this time around, other than to note that while marshaling bipartisan and bicameral support is encouraging, the bill does carry the drawback of costing the federal government money. Even if the matching tax credit is excised, the legislation would forfeit substantial future IRS receipts by generating much higher Roth IRA participation. That prospect will not please fiscal conservatives.
Should the proposal advance, hard questions will also be asked about its practical effects. As my Morningstar colleague Aron Szapiro points out, AWRP’s existence would in some cases discourage companies from starting their own retirement plans, since they could painlessly use the government’s version. Such decisions would squeeze employees who hope to contribute more than AWRP’s $6,000 annual limit. They would also prevent such workers from enjoying a 401(k) plan’s immediate tax benefit. (In response, the bill’s authors state that they believe that the crowd-out problem would be modest because of how they have designed their plan.)
But those, so to speak, are problems of prosperity. May the discussion for the Retirement Savings for Americans Act reach that level. That alone would be a victory.
Here and Now
More modestly, but still meaningfully, Congress has recently updated the Secure Act, which was initially passed in 2019. Unlike the Retirement Savings for America Act, which stakes out new ground, the Secure Act enhances existing programs. Among other items, the new version of the Secure Act would further raise the mandatory starting age for required minimum distributions, halve the penalty for missing an RMD, and standardize the 401(k) rollover process.
All useful items, if less exciting for a columnist than a ground-up proposal. Further details may be found here.
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