RSS FeedWhen ideas emerge out of fear instead of facts, consequences can be scary. Amid the tumultuous stock market and worries about the cost of the bailout, policymakers, politicians, and the presidential candidates are focusing now on the downfalls of 401(k) plans.
At a hearing before the House Committee on Labor and Education a few weeks ago, several experts testified about the effect of the financial crisis on these defined-contribution retirement plans, all but sounding the death knell for 401(k) plans. Certainly, 401(k) balance sheets have taken a hit of about $2 trillion since the beginning of the year – although these paper losses are not cast in stone unless they are cashed out or transferred to another type of investment. And most certainly, some who may have considered retiring in the next few years will want to work longer to recoup a portion of their nest eggs.
At the hearing, Teresa Ghilarducci of the New School for Social Research proposed a plan to let workers trade their current 401(k) plans in for a Guaranteed Retirement Account (GRA). This type of plan would pay a monthly amount at retirement, similar to an inflation-indexed annuity, at a guaranteed three percent real rate of return. Moreover, every worker would continue to contribute a mandatory five percent of his earnings into a GRA (the employer would contribute half), with the government depositing $600 a year, inflation-indexed, into the account of every worker. Ghilarducci notes that the plan has many advantages: First, for those who are worried about fairness, the GRA plan, says Ghilarducci, would be fair. Since the current tax-deferred set-up of 401(k) plans benefits higher-income workers (uh…of course it does, since they pay most of the taxes), the GRA would eliminate the 401(k) tax subsidy to the "rich" in place of a $600 tax credit given to every worker. Another advantage, noted Ghilarducci, is that the accounts are prefunded since workers are saving their own money.
But unlike some mandatory personal savings plans, GRAs are not personal, per se, as they do not allow individuals to pick from a limited array of funds like the federal Thrift Savings Plan does. The money would instead be pooled and invested by the government as it sees fit. (Think about what the government has done with the Social Security Trust Fund, and then think about what they could do with your money).
Moreover, a GRA is no less immune to problems than a 401(k) plan. Although a guaranteed three percent real rate of return sounds good on the surface, in the fine print the government would have the right to reduce the guaranteed rate of return during economic down times and allow workers to access their funds during those times.
In essence, instead of strengthening 401(k) plans which have served most workers quite well, the fear-based solution is to gut them to the point where they become unattractive to retirement savers and employers, leaving people even more unprepared for retirement and relying on government entitlements. That is certainly a Halloween "treat" we could do without.
Tags: 401(k), GRA, Guaranteed Retirement Account
3 Responses to “Guaranteed Retirement Accounts: Trick or Treat?”
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Helium
October 31st, 2008 at 5:02 pm
I agree. I think I’d rather be responsible for my own savings rather than entrust them to an organization that has shown time and again that saving money or even breaking even is a foreign concept.
Very informative. In these times of crazy confusion and speculation, it is comforting to find useful information that is thoughtful and well researched.
November 21st, 2008 at 12:03 pm
Teresa Ghilarducci isn’t the only one advocating “reforming,” that is, eliminating 401(k) plans. For example, Thursday, Nov. 20, 2008, on PBS’s Newshour, Jacob Hacker, professor of political science at the University of California, Berkeley, and author of “The Great Risk Shift,” said “I think that we should be taking this opportunity to start thinking about how we might want to restructure 401(k) plans so that they can provide a more secure source of retirement income for workers….such as providing people with a promise of a relatively guaranteed benefit…” [transcript available here http://www.pbs.org/newshour/bb/business/july-dec08/retirement_11-20.html
Furthermore, Hacker continued, 401(k) plans “…are highly unequal. So 70 percent of the $135 billion that we spend to subsidize 401(k)s and IRAs is going to the richest 20 percent of Americans. We need to make that more broadly distributed as part of a larger package of reforms that will put our retirement security system on a more secure foundation for the future.”
The subsidy Hacker is talking about the fact that employee deposits to 401(k)s, 403(b)s and IRAs are made with pretax dollars. I think that, like Teresa Ghilarducci, he would favor refundable tax credit — basically a government match — for low and middle income workers — “funded” by denying a tax advantage to anyone for savings beyond that basic amount.
This approach appears to be favored by advisers to president-elect Obama. It makes sense to replace tax deductibility with a refundable tax credit when you apply it to a consumption good that you want everyone to purchase a comparable amount, such as health care. But what this does for savings is raise the marginal tax rate on saving, discouraging those with higher incomes from saving at all. It would, instead, encourage them to change their pattern of saving and consumption so as to minimize their tax burden. This could result in a net reduction in saving , and therefore less capital investment. (Just the thing our economy needs right now!)