As Congress discusses a massive, expensive and complex $3.5 trillion “human infrastructure” budget reconciliation plan, included are two proposed major expansions of employer retirement plans, which are extremely flawed. One would require all private-sector employers, except the smallest, to offer most workers an automatic contribution plan or access to an approved IRA, with a required default worker contribution rate from six to 10 percent of pay. The other would add a government match to any retirement contributions from low-paid workers.
There are at least three major problems with this Democratic Ways and Means Committee proposal: 1) many workers, especially those just gaining access to retirement plans, do not need that much extra savings. It would actually harm their current standard of living to save such an amount; 2) instead, this should be the time to use the resources at hand to modernize and fund Social Security, the national retirement program serving all workers, which is rapidly approaching insolvency. This is especially important for those with low wages; 3) the administrative structure of so many small accounts will likely not be implemented in the current provider environment, certainly not by the law’s 2023 deadline.
In the proposal, a hefty tax is imposed on employers with six or more employees who fail to maintain or facilitate highly delineated contribution plans or arrangements for all workers, excluding only those who are younger than 21, have not worked full-time for at least a year, or part-time for at least two years with the employer, are union members, or whose employer is a church or governmental entity. The plan or arrangement must start with a six percent contribution rate from the employee, increasing by one percent each year of the worker’s participation until 10 percent is reached, unless the employee opts out of the contribution.
Workers would choose from a limited list of investments, but the default would be a target date investment, subject to market risk; all funds would have “low-cost” or “not unreasonable” fees determined by an IRS-convened working group. Also by default, the contribution plan or arrangement would be taxed as a Roth IRA, that is, contributions would not be excluded from current taxable income. If the employer chooses to offer its own plan it must include life annuities as a distribution option, while if it chooses an IRA arrangement for its employees instead, it must pick from a list of IRS-approved private-sector providers, or from one sponsored by a state government. Employees, however, can choose their own IRA provider. The law comes into effect on December 31, 2022.
Furthermore, the federal government will match half of all retirement plan contributions up to $1,000 for households earning below $50,000. The match phases-out as income increases to $70,000 when it becomes zero. The same system applies to individuals earning below $25,000. The match phases-out when individual income increases to $35,000. The match will somehow go from the government to the worker’s Roth plan or IRA, provided, according to the proposal, the worker did not take distributions during that year or the prior two years. Presumably, the investment earnings on the employee contributions and government matches would be subject to the current 10 percent tax penalty and any income tax if distributed before age 59-1/2.
Social Security replaces 54 percent of pre-retirement earnings of low-wage workers so the need for additional retirement savings for them is modest. Saving 10 percent of earnings every year when young, with children, paying off educational and housing debt, in a temporary low-wage job, and so on, is not a rational strategy and will cause immediate hardship to many households. The government strongly encouraging such savings on a wholesale basis is not good policy. Eventually, most poorer households will realize this mistake, stop contributing, and/or withdraw past contributions, causing the imposition of the tax penalty, loss of the government match, and in general cause a churn in the retirement accounts, while also obviating the policy’s original intentions. In particular, when low-wage workers move from job to job, or experience sudden and unfamiliar investment losses, they are more likely to withdraw the small balances from their retirement accounts, move between different IRA providers, or lose track of their accounts.
The Social Security retirement program is projected to become insolvent in 2033. Even prior to then, its draining finances are a large and growing burden on the federal budget. As has been stated repeatedly by the Trustees over the years, some combination of reductions in scheduled benefits and increases in taxes for Social Security will be needed before or at the point of insolvency. Moreover, the program needs modernizing because its benefit structure discourages work and savings, and does not reflect the wholesale entry of women into the workforce. But if the fiscal capacity of the federal government is used for new and growing social welfare programs, including these new retirement plans, and through substantially higher taxes on the well-to-do, what will be left for Social Security? Moreover, it makes better policy sense to increase or replace any reduced Social Security benefits for all moderate-wage workers (including itinerate, part-time, young, employed by small employers, etc.) with government-matched modest contribution accounts managed efficiently by Social Security and held until retirement, as I proposed in 2016, rather than the proposal’s complex add-on IRA system.
Finally, the proposal is administratively infeasible. It is highly unlikely that private sector IRA providers subject to the need to make a profit or at least break even will be found by 2023 (if ever) to administer so many small retirement accounts from so many small employers, with so many legal requirements under the oversight of an IRS working group. Based on data from the March 2020 Current Population Survey, I estimate the proposal would create almost 56 million new retirement accounts by 2023, an astounding number compared to the current 61 million current IRA holders. Those with new access to retirement accounts would be younger, lower-wage earners, less educated, and more likely to work part-time than those with current access to employer retirement plans. A tenth would-be new account holders earning $12,000 or less annually, and a quarter would earn $23,000 or less. Even with a 10 percent contribution rate, many of these accounts would be small. Instead, many employers will need to use state plans. But even here the current environment is inadequate. Only 14 states have enacted legislation to sponsor such plans, and only five states are currently operating plans, with only $310 million in assets.
The frenzied rush to enact such massive social welfare legislation on a partisan basis is evidenced by the half-baked nature of this retirement proposal. As Senator Manchin recently stated, it is better to take a pause, consider better policy developed on a bipartisan basis, and to save Social Security in the process
