Nice quick piece today in the Wall Street Journal about the proposed “Obama IRA”:
WSJ: Breaking Down the Obama IRA
It’s been a while since I’ve written a personal finance-related post, but this move towards fixing our retirement savings policies in the United States is the most promising since 2005.
Here are the basics of the Obama IRA, at least, based on current information:
- Companies with 10+ employees will have to start offering payroll deduction service to contribute to a “Universal IRA” account.
- Employees would be automatically enrolled at 3%
- Employees can set the rates higher or lower
- Employees would get a few specific options: Series I Savings Bonds, Money Market, Stable Value.
- At approximately $3000 – $5000, the amount would migrate to a Target Date Maturity Fund
That’s it on details. There are a few things I like about this plan:
- Broadly available. Most people would be covered under this plan.
- Opt-out. The libertarian side of me loves the fact that people can choose their own contribution limits. The behavioral economist in me loves the fact that the default state is set to opt-out, so that inaction leads to some savings for everyone.
- Low cost. The structure of the plan ensures low cost options for both employers and employees. Today, far too much hard earned money is literally wasted through hidden and exorbitant fees charges by retirement plans and mutual funds.
- Simple investment options. Most people do not need a wide variety of options to provide a good, default retirement vehicle. This one keeps it simple.
Things that I don’t like:
- 3% is too low. There is absolutely no possible way that a 3% contribution is going to help provide for retirement in a meaningful way, at any income level. Most “opt-out” advocates currently recommend starting at 3%, but automatically increasing at a rate of 1% per year until they hit 10%.
- Why tie this to employment at all? These plans should be available to anyone, particularly self-employed who don’t have the sophistication to set up more advanced vehicles. In fact, imagine the option at tax-time to direct your refund towards your retirement account.
- Create an open market for running these accounts. Define the “plain vanilla” investment types. Cap the expense ratios that can be charged. Allow any private firm to offer these plans. USAA, Vanguard, etc will compete for this large pot of assets ($100B+ per year at current estimates).
- Add an Immediate Annuity option at retirement. One of the biggest problems people have with 401k & IRA plans today is a lack of sophistication on how to turn a lump-sump into income that will last the rest of their lives. It’s a version of the lottery-winner problem. Offer a standard conversion for these accounts into a combination of a partial sum, an immediate annuity, and longevity income insurance to guarantee that you will have a certain amount of income until you die. That’s what people really like about traditional pensions & social security.
- Exempt these accounts from Social Security Means Testing. By means testing Social Security, we’ve already created a perverse incentive where incremental income in retirement can be taxed, at some levels, at more than 100%. Give these accounts a boost by exempting income from these accounts from income tax calculations in retirement. Otherwise, we’ll continue to penalize the ants who save for the winter vs. the grasshoppers who spend through their spring & summer months.
The plan isn’t perfect, and there is ample opportunity for the current Congress to complete mess it up. But conceptually, the Obama IRA is starting to move in the right direction. Ironically, it shares some of the goals of the privitization of Social Security – shift the nation towards providing for retirement through individual savings & investment rather than through transfer payments.
I’m working on a follow up post that outlines what I believe would be a better direction for retirement savings, since it’s clear that the previous concepts of pensions, social security, and the 401(k) all have significant weaknesses.