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Who Needs Uncle Sam?
By Louis S. Harvey, CEO Dalbar, Inc. on Jun 03, 2013

Who Needs Uncle Sam?

While both critics and advocates of the current defined contribution retirement system seek Federal Government support for their proposals, neither have seriously considered the fact that support may be unnecessary!
All will agree that the retirement crisis can be greatly relieved with an increase in retirement savings. If more people simply saved more of their current income for retirement, the problem of underfunded retirement would diminish and ultimately disappear at some point in the future. Our estimate is that retirement savings should average between 15% and 20% of current income. And this can happen without any new laws or regulations and without a dime of Federal spending.
The fact is that enormous increases in retirement savings can be achieved within the existing regulatory and tax structure by removing the imaginary and structural saving roadblocks.
The imaginary roadblocks from critics of the current defined contribution (401(k)) system are that employers will not offer plans, participants will not save enough or will not invest wisely enough for retirement security without Federal intervention. They point to the uneven income distribution, arguing that those with insufficient income cannot possibly save enough for their own retirement.
The imaginary roadblocks from advocates of the current system are that savings are limited by maximum limits placed on tax advantages and that it is uneconomical to serve the low income community without some form of Federal subsidy.
Both of these imaginary roadblocks are patently false.
Imaginary roadblock number 1: 401(k) plans did not become the primary retirement savings vehicle by a Federal action. The dominance of defined contribution occurred because employers chose to support their employees’ retirement and the 401(k) was a better way than the traditional pension plan. Participant investing has been improving as more tools and investment packages become available. As for saving enough, 401(k) deferral rate actually declined with the Federal intervention that called for a 3% default!
Imaginary roadblock number 2: There is a mountain of research showing that the tax advantage is not a major factor in the decision to participate in a 401(k) plan. While removing current subsidies would cause great harm, additional subsidies are unnecessary. The fear of the high labor cost of serving the low income community was justified in the era it required man-hours for the enrollment, transaction, servicing and communication processes. The labor cost is not a factor in today’s world when participants are auto enrolled into a default investment, transactions are handled electronically, servicing is done through the Website and communications are delivered electronically.
The structural roadblock to achieving a 15% to 20% retirement savings is that current retirement systems are constructed to block all savings above the tax advantaged rate. Instead of blocking requests for savings over the maximum, when a participant requests a savings deduction of 25% and that person is limited to 15% tax deferred, why not put the additional 10% in an after tax account?
As incredible as it may seem, the retirement industry will not accept perfectly legal after tax (non-Roth) contributions!
This means that a participant has no practical path to adequate retirement savings unless he/she is cunning enough or committed enough to jump through the hoops necessary to put away some after tax savings. The participant is never told how to exceed the tax advantaged limits and what is worse, they are told they cannot do it!
The solutions are straightforward.
First is to create the awareness in the financial community that more assets can be gathered by permitting after tax retirement savings. This will create the motivation to pursue the revenue!
Second is to communicate to participants that there is a way to increase their retirement savings to a level that will actually support them for their entire lifetime. This can be accomplished immediately through direct deposits. Not all participants will act on this immediately but those that can afford to will. In time others will take advantage.
Third is making it easy and automatic. This need not be done immediately since it will involve changes to systems and the payroll interface.
Does anyone have a reason not to do this?

BenefitJack is mistaken!
Created by Louis S. Harvey, CEO Dalbar, Inc. in 6/10/2013 9:45:52 AM
BenefitJack, like so many others in the retirement business today, have been sadly misled by meaningless surveys and flawed belief systems.
Starting with BenefitJack's comment "no matter what survey you examine, people simply don't frequently bump up against such [contribution] limits"... Of course not! People don't "want" to deprive themselves and contribute more to their retirement. The fact is you should view contributions as MEDICINE. No one wants more medicine, but they are happy to take it to relieve an ailment. In this case the ailment is suffering through retirement in a one room shack, eating scraps and dog food because you save 3%. Presented that way, the results of every survey would change.

Lets now answer BenefitJack's other issues...
1) Too many workers don't have access to an employer sponsored plan,
...That is the case today, but the issue can be remedied if service providers promoted payroll deductions from after tax income to avoid the misery of an underfunded retirement... and no fiduciary liability for the plan sponsor!
2) Too many workers fail to join the plan when eligible,
... This may have been an issue before auto enrollment but is no longer an issue today, when enrollments approach 90%.
3) Too many workers who do join fail to save enough,
... This issue occurs simply because the "dosage" of the default rate is far too low. The default needs to be at 10% to 15% for a reasonable chance of retirement security.
4) and Even where workers have access to a plan, elect to join when first eligible and contribute a substantial amount, too many access those funds when changing employers - leakage.
... The leakage issue is substantially mitigated if workers have a vivid understanding that the loan, hardship withdrawal or failure to rollover means retirement in a one room shack and fighting with the dog for scraps!

After Tax Savings
Created by BenefitJack in 6/7/2013 11:06:33 PM
Many plans, and certainly IRA's allow for after-tax contributions. Most American workers probably qualify for Roth IRA contributions as well - garnering additional tax preferences.

However, your example, where you state a concern that a plan might limit employee contributions to 15% under a tax advantaged plan, even though the employee "wants" to save 25%, has very limited application. That is, no matter what survey you examine, people simply don't frequently bump up against such limits. For example, in the 2012 Vanguard study, how America saves, only 12% saved $16,500 in 2011 (the 402 (g) maximum), and the median total contribution (employee and company) was only 9.6% of pay.

The basic issues remain:
Too many workers don't have access to an employer sponsored plan,
Too many workers fail to join the plan when eligible,
Too many workers who do join fail to save enough, and
Even where workers have access to a plan, elect to join when first eligible and contribute a substantial amount, too many access those funds when changing employers - leakage.

Why not... outside the plan?
Created by Louis S. Harvey, CEO Dalbar, Inc. in 6/5/2013 8:40:01 AM
Mr. Foley's comments are quite accurate, the point however is that tax savings outside of a plan is a perfectly viable alternative for workers and for service providers.

Why are service providers not interested in accumulating trillions of after-tax dollars OUTSIDE of a plan? Instead service providers will wait forever for Washington to act...

New Comment
Created by Patrick Foley in 6/4/2013 6:48:11 PM
After-tax contributions are subject to nondiscrimination testing under Internal Revenue Code Section 401(m) along with employer matching contributions, limiting their use by the high-paid within plans. Of course one can always accumulate after-tax savings outside of any plan, but service providers aren't interested in assisting in that.

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Louis S. Harvey
President & CEO



Founder and leader of Dalbar, Lou Harvey is relentless in the search for the forces that are shaping the world of financial services today, tomorrow and for years hence. Using Dalbar’s research capabilities, Lou Harvey seeks insights from inside and outside the industry to understand and anticipate changes in customers’ needs and the ways products are distributed.


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