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Brookings Fellow Argues for Fewer Hurdles for Lower-Income Savers

More than 20 years after the creation of the first 401(k) retirement savings plan, American workers would seem well on their way toward building a secure retirement. Assets in 401(k)s and similar defined contribution plans reached $2.9 trillion by year-end 2003, according to the Investment Company Institute, a mutual fund industry trade group. Assets in Individual Retirement Accounts (IRAs) totaled another $3 trillion, while government and private pension plans and annuities accounted for another $6.2 trillion, bringing the retirement market total to $12.1 trillion. That's about $41,000 for every man, woman and child in the nation, not including any Social Security benefits to which they might be entitled.

But it's not enough, and not nearly as evenly distributed as it needs to be, says Peter Orszag, a Senior Fellow in Economic Studies at The Brookings Institution, Co-Director of the Tax Policy Center sponsored by the Urban Institute and The Brookings Institution, and Director of The Brookings Institution's Retirement Security Project.

The reasons for these troubling statistics, Orszag said, go beyond the problem many workers have of trying to set money aside while simultaneously paying their current living expenses. They include, he said, a retirement savings system riddled with obstacles that discourage rather than promote savings. And he argued that government policy changes enacted in recent years have moved that system further in the wrong direction.

High atop the list of misguided government policies, said Orszag, is a tax code that, because it is graduated, gives the strongest savings incentives to higher-income households least likely to need to save more for retirement, and the smallest incentives to lower-income households who most need to save more. Further, he said, tax legislation that in 2001 raised the maximum amounts that can be contributed to IRAs and employer-sponsored plans will have little impact on the vast majority of workers who could not meet the previous maximums.

At the employer level, Orszag said, too many companies make it easy for workers not to participate in retirement plans by forcing them to take action to join the plan, decide how much to save, and determine how those savings should be invested. A preferable system, he said, would be one in which automatic enrollment is the norm (workers would have to take action to opt out of the plan), coupled with a so-called SMART (Save More Tomorrow) feature in which workers' contribution levels automatically increase at set intervals, such as when they receive an annual pay raise. The federal government, he added, should adopt legislation making it clear that such features would not violate any state labor laws.

Orszag also suggested the federal government make it easier for people to save by allowing their federal income tax refunds to be deposited in whole or part into retirement savings accounts. Low-income workers, he added, also could benefit from a law that would allow employers to match their contributions to retirement savings plans at a higher rate than they do for high-income workers. Also, he said, the federal government could improve the "saver's credit" provided for by the 2001 tax legislation by making the credit refundable (payable to low-income workers who have no tax liability that can be offset by the credit), by extending the credit further up the income scale, by phasing the credit rate down more smoothly than is done now, and by extending the credit beyond 2006, when it is set to expire. Finally, Orszag said, the government should consider eliminating asset tests for social programs such as Food Stamps, Medicaid and college Pell Grants, in which savings held in a retirement account can disqualify applicants from receiving those benefits. Such tests actually discourage lower-income workers from saving for retirement, he argued.

Orszag dislikes the idea, pushed by the Bush Administration, of creating self-directed individual accounts within the Social Security system. He argued that this would create a huge cash deficit during the implementation to the new setup, which would be difficult to fill at a time when the federal government is already running record deficits. He also worried that too many workers facing a cash crunch-whether to care for a sick family member or buy a new car-might be tempted to take their money out of their individual accounts long before they reached retirement. Congress, he warned, would be under intense political pressure to allow such early withdrawals.

Although the obstacles built into the current retirement system are onerous, Orszag said many of them would be relatively easy to correct. Doing so, he said, "would move public policy in a much more promising direction than the path we have been on."

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