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Wednesday, October 08, 2008

A Bad Idea - Al Franken's 401(U) Proposal

From his campaign website:

The 401(U)
Saving for retirement is an investment in economic security – it should be part of every family's budget, not a luxury for the wealthy. Unfortunately, our struggling economy puts this goal out of reach for too many Minnesotans. Meanwhile, our government's system for encouraging long-term savings simply doesn't work effectively. Al Franken proposes a bold new system to help families put something away for retirement – at almost no cost to the taxpayer.

There are three fundamental flaws in our current system for encouraging retirement savings.

First, it doesn't work effectively for nearly half of American workers who have no employer-sponsored retirement plan – 1.2 million workers in Minnesota.

Second, saving for retirement is far too complicated. Even when workers are given the option of joining employer-based plans, many do not take it because it is incredibly difficult to enroll, let alone to research the details of various plans and investment portfolios. And when they leave a job, they cannot take their retirement account with them.

Third, the system is upside-down and backwards. Because our current savings incentives are based on tax deductibility, a wealthy employee in the 35% tax bracket gets 35 cents for every dollar he or she saves, while an employee in the 10% bracket receives only 10 cents (and an employee who pays no taxes gets nothing). It is therefore no surprise that of the nearly $200 billion a year we spend to encourage retirement savings, about half goes to the top 10% of earners, while 10% goes to the bottom 60%.

Al Franken will propose a new account, called a 401(U), to address each of these flaws.

The 401(U):

Universal. Every firm with more than 10 workers that does not provide a qualified pension plan would be called upon to offer universal automatic payroll-deduction retirement accounts (modeled on current IRAs) as a default for their workers. Employers would not have to sponsor any retirement plan; they would not make matching contributions; and they would not have to comply with traditional retirement plan rules. They would not manage the plan at all. They would merely deposit a portion of their employees' paychecks into standard, easy-to-open retirement accounts that would be managed and maintained by participating financial institutions. And to cover whatever administrative costs accompany these 401(U)s, employers would be given tax incentives similar to those now offered to firms that open qualified pension plans. This new savings vehicle would provide a no-hassle option to millions of workers who have no employer-sponsored retirement account. It is designed not to replace existing employer-sponsored plans, which Al Franken would seek to promote as the savings vehicles of choice, but rather to encourage more employers to move toward sponsoring an employer retirement plan.

Automatic, portable, easy – and workers keep control. Workers would automatically have a portion of their paychecks directly deposited into their 401(U), unless they explicitly opt out. Account funds would be invested responsibly in low-cost, diverse portfolios. And 401(U)s would be fully portable. Families would be free to withdraw funds from their URA after age 65, or at any time for education expenses or the purchase of a first home. 401(U)s would also preserve autonomy and choice. Workers could opt out of the program, or any of its specifics, at any time. They could also shape their account to fit their unique needs.

Generous. Current tax deductions for retirement savings would be replaced with a generous 30% government matching contribution that would be the same for all households. For each dollar that a worker puts into a 401(U), the government would add 30 cents, up to a contribution limit similar to IRAs. The same 30% match would apply to existing retirement savings vehicles such as 401(k)s. This matching contribution would be deposited directly into workers' retirement accounts. The result for a great number of middle class workers would be a tripling of the incentive to save. Many more workers who currently get no incentive to save – because they pay no taxes – would receive a generous incentive. (The system would be designed to ensure that workers making less than $250,000 are held harmless.)

What would it cost?
The shift from tax deductions to matching contributions is close to revenue-neutral.

I wonder where Mr. Franken gets his input on the existing system....

'Incredibly difficult to enroll'

Says who? I've changed jobs a few times, and have never found enrollment to be 'incredibly difficult'. Yes, sometimes there is a waiting period before you're eligible, but the enrollment form is not complicated.

'And when they leave a job, they cannot take their retirement account with them'

That just isn't true. Every plan has vesting rules, but employee contributions are usually fully vested right away. The portion that may take time to vest would be the employer contribution.

This 401(u) proposal says that employers would not make any contribution to the plan. Employer contributions to retirement plans are often considered part of an employee's compensation, and also provide an added incentive by matching a portion of the employee's contribution. Why take away that feature?

Nor does the Coleman campaign press release on this topic make any mention of the 30%government match.

Even if a worker doesn't currently have access to an employer-sponsored retirement plan, they have the option of a self-directed IRA, for which the tax deferral is provided.

The details of how and where these accounts would be invested needs some more fleshing out.

I don't buy the argument about the unfairness of the incentive, based on progressive taxation. If somebody is paying an effective tax rate of 35%, even after deductions for retirement savings, the US Treasury should be saying 'Thank you' to that taxpayer. A worker can actually lower their effective tax by virtue of taking advantage of the incentive. The underlying math makes no sense.

The proposal makes no mention of whether or not the withdrawals from the would be taxable. Withdrawals from 401(k) or traditional IRA's are taxed as ordinary income, so any incentive provided for the original contributions are recaptured when the retiree pays taxes on the withdrawals. Are withdrawals from the 401(U) taxable? If not, this is far from a revenue neutral idea. Franken is only looking at one part of the cycle.

It's an incomplete and ill-advised idea.


Aaron said...

The Coleman press release was basically all made up. No press or even bloggers used it -- you start doing the math and you realize it is bogus. The 401(k) carry over question is that you need to switch to your next employers 401(k) plan in order to "take it with you." Yeah, you can keep it, but you can't contribute to it easily in many cases if your employer uses a different 401(k) plan, especially if there is 401(k) matching.

The 401(U) has nothing to do with IRAs either.

Say, by the way, what happened to that post where you 100% confirmed a day early that Clinton was Obama's running mate? You heard from a family friend that's friends with the campaign or something.

Aaron said...

Excuse me, perhaps that was "DavidD," not "MarkH."

Markh said...

Minnesota Democrats Exposed used the Coleman press release.

I've rolled over 401(k) plans from past employers into a new employer's plan. It is not a big deal.

What would Franken's plan do for self-employed people? They'd have to keep using IRA's, right?

This is an ill-advised idea.

I never posted anything about who might be Obama's running mate.

Aaron said...

MDE isn't really a "blog" -- it's a republican operative's website with messaging.

lloydletta said...

Aaron, the press release was substantive, and I hope the debate on Saturday gets into this. Most of Coleman's press releases are not. I have some money in a Roth IRA. Under Franken's plan, will I now pay taxes on the gain (if there is a gain) when I take the money out?

If Franken gets elected, I imagine this plan would be dead on arrival for the reasons Mark states. The part of McCain's health plan which is paid for by taxing employer based health plans and replace it with a $2500 per person (if single) refundable tax credit would also be dead on arrival in the unlikely event McCain gets elected.