federal solutions needed now
The Growth Act is one solution to the personal savings crisis. But many others are just as important to help ensure personal financial security for all. Some solutions focus on building savings by extending or expanding incentives for working Americans, others focus on managing assets more effectively in retirement, and still others focus on improving access to savings education and advice. What concrete, practical action can lawmakers take to make a real difference in our nation’s savings outlook?
On August 17, 2006, President Bush signed into law the Pension Protection Act, which implements several of the proposed reforms described below (marked “enacted”). Specifically, this legislation makes permanent updated contribution levels for IRA and 401(k) retirement plans, “catch-up” contributions for older workers, and incentives for 529 college savings plans. It also expands the availability of investment advice to retirement plan participants, facilitates automatic enrollment programs, and permits employers to offer better default investment options.
Extend Retirement and Education Plan Incentives. In 2001, Congress enacted—in a tax package known as EGTRRA—a number of incentives to save for retirement in Individual Retirement Accounts (IRAs) and 401(k) plans, and to save for college educations in 529 plans, including:
But most workers would probably be surprised to learn that all these important incentives are set to expire after 2010 (see table at right). To sustain the savings momentum that these incentives have already generated and to reduce the unpredictability that discourages people from planning, Congress should make them permanent as soon as possible. The graphs at right illustrate the potential impact on retirement savings if the EGTRRA incentives are allowed to “sunset.”
Extend Tax Incentives. In 2003, Congress reduced the tax rates on long-term capital gains and on certain dividend income in a tax package known as JGTRRA. These lower rates, set to expire at the end of 2008, have been extended through 2010; the higher rates will be reinstated beginning in 2011. U.S. Treasury data show that 24 million Americans saved an average of $950 on their taxes in 2004 as a result of the lower capital gains tax rate. Dividend increases since 2004 have exceeded all increases between 1994 and 2002 combined—a huge boost to seniors who receive almost half of all dividend income. Both the financial markets and individual investors need certainty in order to plan for the future; Congress should make these lower rates permanent as soon as possible.
Restore Universal IRA Eligibility. Between 1982 and 1986, Congress allowed all workers under age 70½ to make tax-deductible contributions to Individual Retirement Accounts. In 1987, limitations on deductible contributions were reintroduced, together with complex rules for determining eligibility. Contributions dropped off drastically (see graph at right), even among households who continued to be eligible. For individual savings to represent a meaningful part of retirement income, the IRA rules need to be simpler, clearer, and stable. Congress should restore universal eligibility for tax-deductible IRA contributions.
Facilitate Automatic Enrollment in 401(k) Plans. Recent research has shown that one of the most effective tools to boost participation in 401(k) plans, particularly among lower-income workers, is automatic enrollment (see graph at right). However, many companies have not incorporated automatic enrollment into their plan designs due to regulatory uncertainties and legal concerns. Congress should address these concerns to encourage widespread adoption of automatic enrollment.
Minimum Age for Required Distributions. Steady accumulation of savings while working is one challenge; managing those savings after retirement is another. As life expectancy continues to lengthen, Congress should revisit the minimum age for required distribution of retirement savings, currently 70½. Raising this age will allow retirees to postpone drawing down their assets, helping to ensure their retirement income lasts as long as they need it.
Lifetime Payment Accounts. Much has been written suggesting that annuitized retirement income is disappearing. Yet, for most people, a significant portion of their retirement income is already “annuitized” and they need flexibility in their remaining savings. Currently, more than 75 percent of all retirees receive two thirds or more of their retirement income in the form of an annuity, through a combination of Social Security, defined benefit plan income, and other annuities. Retirees need to use mutual fund and other retirement investments in a manner that lets them remain invested for the growth needed to fight inflation, to hold costs down, and to retain the flexibility to tap savings if health emergencies or other unanticipated needs arise, without incurring expensive debts or penalties.
Lifetime Payment Accounts (LPAs), otherwise known as systematic withdrawal programs or periodic distribution plans, meet all these needs. LPAs have been around for a long time and are a common element in financial planning guidance. Just as no one savings plan is right for every individual saving for retirement, no one approach to drawing down assets is right for every retiree. LPAs are an important tool for efficiently managing retirement income for a lifetime, preserving both investment growth and flexibility.
Investment Advice. Current laws restrict the availability of investment advice to retirement plan participants. Financial institutions that provide investment options to retirement plans are effectively prohibited from offering specific, individually tailored advice to plan participants—no matter how prudent or objective the advice. Yet four out of five 401(k) investors want such advice. Individualized counseling could also significantly increase plan savings and participation rates. Congress should support reforms to provide professional advice to plan participants.
Investor Education. As Americans acquire greater and greater responsibility for securing our own financial futures, our need for education has intensified. Accordingly, Congress should encourage financial literacy and investor education as national priorities. This support should include the Congressional Financial Literacy Caucus, the federal Financial Literacy and Education Commission, state initiatives to improve financial education requirements in schools, and innovative private and nonprofit programs.