If you currently save in an employee-sponsored retirement plan, how would you feel if you stopped getting a tax break on your contributions? What if your employer stopped matching because they lost their tax break to do so? On top of that, what if you were forced to contribute 5% of your pay into government bonds regardless of age?
I don’t know about you, but the only real reason I do contribute to a 401(k) is because of the tax benefits. Otherwise, there would be no incentive to save in an account that has limited investment choices and an annual cap on what I can add to it each year. If I wanted to invest more money, have unlimited investment options, and be unable to deduct my contributions, I’d just stick to a brokerage account. The only thing I’d lose is the tax-deferral, and from what I’ve read, that may be gone too. They say we’re struggling as a nation to save money, yet the brilliant people in Washington are thinking about eliminating one of the few benefits to encourage saving.
Basics of the Plan
The biggest concern with this idea is the elimination of the tax benefits. They want to make it so your contributions are taxable. From the sketchy details I’ve seen so far, it looks like the tax deduction on contributions is gone, and possibly even the deferment of taxes on earnings. From the article:
The current system of providing tax breaks on 401(k) contributions and earnings would be eliminated.
To compensate for removing the tax breaks, they suggest giving people an inflation adjusted $600 subsidy. Gee, thanks!
In addition to the elimination of tax breaks, the plan calls to make contributions mandatory. Now, I’m all for encouraging people to save money, but making 5% mandatory doesn’t sit well. We already have a mandatory retirement contribution that we all make, and it’s called Social Security. How about they fix that before dictating that people have to contribute another 5%.
On top of the mandatory 5% contribution, the best part is that the 5% would have to go into government bonds. From the article:
The money in turn would be invested in special government bonds that would pay 3% a year, adjusted for inflation.
What’s so “special” about these bonds? The fact that they don’t even keep pace with inflation? Hey, sign me up!
This Would be Administered by Social Security
I wish I could make this stuff up. But since the government wants to put their hand in our private retirement savings, make contributions mandatory, and invest them in government bonds that don’t even keep up with inflation, they want the Social Security Administration to manage it. Yep, you know, the program that’s in trouble and politicians have been talking about reforming for the past few decades. Obviously, they are the perfect candidate for the job.
What I don’t get is why you need to change the way 401(k) plans work just to give Social Security the option of managing a portion of people’s money. We already pay into the Social Security system, so let’s address how that works before going in and sticking your hands in one of the only viable private investment options out there.
Also, who says that this won’t run just like any other government program where your money doesn’t really go into an account, but it instead goes into some magical trust fund that’s nothing more than a line item on a balance sheet. The government will gladly use your money for whatever wasteful purpose it wants, and only keep track of what they owe you, only to find out in 30 years they don’t have enough money to pay everyone back, and need to print even more money.
Government Bonds and Annuities
The best part of this plan (notice the sarcasm) is that everyone would be forced to lend 5% of their income to the government. Yes, everyone who earns a paycheck would be required to put that money into government bonds, which is just a way to lend them money. No wonder politicians are pushing for this idea. It isn’t because they want to force people to save more, or protect their retirement investment. No, it’s because it would instantly give the government billions of dollars every year.
Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds, suggested Teresa Ghilarducci, an economics professor at The New School for Social Research in New York.
When workers collected Social Security, the guaranteed retirement account would pay an inflation-adjusted annuity under her plan.
Congress should let workers trade in their 401(k) assets for a guaranteed retirement account? Maybe if it is an option, that would be acceptable. Obviously, some people want security of their money, so I say, make that an option. But in no way should that be forced upon everyone.
To make matters worse, they want to pay out your money in the form of an annuity. Hey, we forced you to save, we didn’t pay you hardly anything in interest, and now that you’re retired, we’re going to hold onto your money for another 30 years while we collect more interest and give you a fixed monthly payment. One of the other benefits of a 401(k) is the flexibility of distributions, and they want to remove this aspect (at least on the mandatory funds). Nobody knows what their future holds, their health, or their retirement ambitions, but to take away the option of letting someone withdraw their money as they see fit after saving for years is just horrible.
What Do You Think?
I’m surprised I just heard of this, but I immediately felt my blood pressure rise after reading it. I can see why some of this looks like a good idea on the surface, but trying to address it with the changes that are being proposed seem almost criminal. But that’s just me, what about you? Good idea? Bad idea?
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
I love the advertisement at the top of the page - Why Open an IRA with Schwab? Well, at this point, why open an IRA at all? If these congresspeople in who devised this intelligent idea have anything to do with it, they'll take away the tax benefits for IRAs and make us put that money into the socialst network as well.
WOW!! how's that HOPE and CHANGE thing workin out?
one step closer to the socialist workers paradise that the great and powerfull "O" promised us
I think if you listen to both talk radio and the news you will be barely informed enough to vote. With your table of 4 your missing some risk. 1) social security yes its political, but its also inflation risk. 3) Bond Market has just as must volatility risk as the stock market. It too has inflation risk. 4) Yes it has inflation risk and political risk. Your 401k has political risk. Correct we are not Argentina, but they all thought their private pensions were safe from the hands of government.
Details would be the key to this plan.
1) Would the 5% savings tax be based on gross, after tax or income tax?
2) Would it be extracted from you pay check pretax?
3) Would I still pay this savings tax on passive income?
4) Would I pay this savings tax on SS distributions and Roth IRAs?
5) Would the GSA (government sponsored annuity) start paying at 60, 65, 70, 75, 80 or based on your life expectancy.
6)Would it be distributable in a lump sum?
7)Would you be able to heir it to a spouse or child? Or would it die with you?
8) Could you be means tested out of the annuity? Just like you will be with SS.
These are just some of the question off the top of my head.
Ugh. My apologies for the sentiment, but reading these comments almost makes me wonder who's actually following the news, vs parroting talk radio.
Just to pick one:
Wow, this has got to be one of the worst proposals for the average taxpayer in recent history. This defeats teh purpose of a 401(k).
First, it isn't a bill, it was testimony. There is nothing to "pass."
Second, do you know how well the "average" 401k investor does? I'm talking actual return, after 2% fund expense ratios, 401k plan fees (do you even know what yours are? It's difficult info to get), the buy high and sell low plan, and the extended use of the "stable value" funds? Hint: it's less than you'd expect, some would do better in bonds.
Third, what is the purpose of the 401k? Congress created the tax-deferred plan (actually converted it from a package tailored to corporate executives) for retirement savings to supplement social security. The tax deferment is the carrot to get you to save and not be a burden on society later.
I'd be just as happy if congress put this plan in place and erased the 401k tax deferment. If you're smart, you're already using index funds in your 401k, they are already relatively tax efficient. And assuming it would work like a pension or annuity, this plan would be a great way to diversify risk.
You could diversify out to handle (major) types of risk:
1) social security - political risk
2) stock market - volatility risk
3) bond market - deflation risk
4) govt sponsored annuity - inflation risk
Without this, I'd have to buy into an inflation-adjusted immediate annuity when I retire to cover bare bones living expenses - but then I'd run the risk of having the insurance company blow up because of bad management.
Like I said above, all this assumes that the government lets private parties run the funds (albeit with strict requirements). Otherwise, I'd have political risk in two legs of the stool.
Anyway people, please think!
Jim, it all depends on who is on the supreme court and how the constitution can be pushed. I doubt this will occur, but a constitutional convention would be a disaster!! In between the ** is where I disagree with president elect Obama.
From his 2001 transcript:
but the supreme court never ventured into the issues of redistribution of wealth and sort of basic issues of political and economic justice in this society and to that extent as radical as people try to characterize the warren court it wasnt that radical 40;30 it didnt break free from the essential constraints that were placed by the founding fathers in the constituion at least as it has been interpreted and the warren court interpreted it generally in the same way **that the constitution is a document of negative liberties 40:43 says what the states cant do to you says what the federal govt cant do to you but it doesnt say what the federal govt or state govt must do on your behalf** and that hasnt shifted and i think one of the tragedies of the civil rights movement was that 41:01 the civil rights movement became so court focused i think there was a tendency to lose track of the political and organizing activities 41:12 on the ground that are able to bring about the coalitions of power through which you bring about redistributive change 41:20 and in some ways we still suffer from that
OVER MY DEAD BODY!! THE GOVT. HAS NO BUSINESS IN MY 401K. I WILL SHOW IN D.C. AND ASK THESE OUT OF TOUCH POLITICIANS WHAT THE HELL ARE YOU THINKING!!! IT IS MY MONEY, I SAVED IT, DONT TOUCH IT!!
Just a simple statment. We are on the road to "spreding the wealth around" of the genXer. See the beauty of this plan is that it can be spun to save people from their self destructive ways. If I am reading this statement correctly, she is suggesting that someone could get closer to retirement saving 5% per year @3% interest rate which with compoounding would double your money in 15 years. What are these "Special bonds" Are these the "save medicare" bonds. I wonder if inflation will be headline inflation which was just 2.3% while gas doubled. This is a bad idea, unless they decided to take 5% of the 15% coming from SS tax to lay into and account that would be yours at 59 1/2.
"Under Ms. Ghilarducci's plan, all workers would receive a $600 annual inflation-adjusted subsidy from the U.S. government but would be required to invest 5% of their pay into a guaranteed retirement account administered by the Social Security Administration. The money in turn would be invested in special government bonds that would pay 3% a year, adjusted for inflation."
Why is it that the Beatles came to mind....."Say You Want A Revolution, Yea Yea You Know....."
Great post though!
I do believe if we end up with a super majority with Democrats with no checks and balances we will be in big mess with these kind of policies. I wish I had the option to go ahead and pay taxes on my 401k now. It would probably be less than when I would need it for retirement. My dad gets so upset every year when he has to pay on his because he is taxed higher now than when he actually earned the money. And yes, they are looking at this seriously. I believe they would be waking a sleeping giant with these kind of ideas that they want to make reality.
It's time for a viable third party. Republicans and Democrats alike need to be replaced and term limits put in place. We also need personal asset limits for anyone in congress to avoid personal interest over the citizens.
P.S. Granted, I'm not relying on Social Security, but that's a 6.x% drain on my salary from here on out.
"Social Security is NOT in crisis. It is solvent through at least 2040 (in the most conservative scenario), and will continue to take in more than it pays out for another 5-10 years."
Well, in my opinion, that's a crisis because I'll be paying into Social Security my entire life (I'm 23 years old) and at the end of it I'll get a John Doe letter... "I'm sorry, dear taxpayer, but your faith in us as stewards of your Social Security dollars was misplaced. Your money's all gone, we've moved out of the building. Later."
I haven't heard a single Congressperson say this was a legitimate plan - it is a plan by a professor of economic-policy analysis that was submitted to those members of Congress to look at, and has not even come close to being implemented by anyone in either party. Just because it was submitted by a woman outside of government to 2 Democrats does not mean it is a Democrat-sponsored plan. It will never be supported or pushed-forward by members of either party.
Wow, this has got to be one of the worst proposals for the average taxpayer in recent history. This defeats teh purpose of a 401(k). If this were to pass, I would forgo contributing to my 401(k) beyond the required minimum, and I would contribute to regular taxable funds (after maxing my IRA, assuming those were left alone). Ugly.
While I agree that the merits of this plan are questionable, let's get one thing clear - Social Security is NOT in crisis. It is solvent through at least 2040 (in the most conservative scenario), and will continue to take in more than it pays out for another 5-10 years. The problem is Medicare, due to exploding health care costs. This is why it's the height of disingenuity when commentators talk about "the problems with Social Security and Medicare" - they are two separate programs, one in much bigger trouble than the other.
Thanks for the comments annon. You're right, and I only saw the article that came across my feed reader, and I quoted some pieces and shared my initial thoughts. I left politics out of it, because regardless of who proposed the general concepts, in my opinion it is a step in the wrong direction.
But, if you have other information on this proposal that interprets the information differently, or provides more detail, please share. I'd be happy to have more information to go off of.
Like you said, I'm not a newspaper, and when things come across my desk, sometimes I just pick it up and run with it without digging much deeper. I realize that probably isn't the best way to get information out there, but there are only so many hours in the day ;) But that's why the people who leave comments are so valuable, as we can all take the time to educate each other.
BTW: I want to leave an open comment for Jeremy. This is intended to be constructive, not an attack:
If this is really supposed to be a blog for us GenXers to read about finance, please don't blindly believe what you've read elsewhere. There are plenty of right wing echo chamber blogs out there that purport to discuss finance. I realize this isn't a newpaper, but it must have taken quite a lot of time to write that blog entry. By not doing fact-checking, you lower the quality of your blog's brand. (It took me only a couple minutes with news.google.com to find a more objective view, weeding out the more obviously partisan articles.)
@JP: I do think 401ks are beneficial to the middle classes and upper class, and that the "rich" investors consider it a drop in the bucket. (In fact, it took a court order for 401ks to be extended to the "common" folk, originally it was just for the fat cats.)
But many 401k programs are doing a better job at enriching the brokerages - I think Jeremy has written about this before - than they are at enriching the participants. John Bogle (Vanguard founder) rails against this daily nowadays. 401ks have several layers of fees, two of which are completely hidden!
That's why I wish Jeremy would give this the "TIPS" plan a second look. If Vanguard administered it, I'd be very excited about it. One can always use tax-friendly index funds for stocks. As another benefit, it would institutionally encourage saving. 401ks did this too, but in my experience the uninitiated bought high on speculation, and sold low, on fear.
If politicians had to be concerned about the same mundane things as the American public I could stomach their bizarre idea. Uutil they stop getting their free cars, free health care, and a golden parachute of a retirement, their all glorified gansters. I could care less how much their salaries are, but start paying for
all the things that we the people do!
How much do you actually benefit from those tax breaks on 401Ks? They mostly benefit the very rich who can afford to put the maximum donation into the plan. For the poor/middle class, the tax breaks only amount to a couple of hundred dollars a year. Would you rather have that couple hundred dollars a year or a guarantee of 70% of pre-retirement income through retirement? Suggest you read up on Ms. Ghilarducci's book When I'm 64--her plan makes a lot of sense.
That quote was from the URL: http://www.shrm.org/hrnews_published/articles/CMS_026871.asp
Before you get all partisan on us, this was only a proposal. This is how misinformation is spread. Here's a more centric report from .
"While no one on the committee appeared eager to adopt Ghilarducci’s proposal, several committee members and hearing witnesses did agree that retirement plans needed to offer broad-based coverage for all workers and provide secure sources of income for retirement."
That said, this is essentially a pretty good yielding TIPS fund. Zvi Bodie has recommended a similar approach for quite a while. Look up his book: Worry Free Investing. There is less return, but there is also less risk, and less risk of operator error. (People who want to retire early would need to take on more risk by buying stocks or more ideally LEAPs.)
We can agree on one thing though, I don't trust the government to hold the funds.
After all, my 401k was lambasted by the deregulation of the "market deregulation" era. I would have made better turn in one year of TIPS than all the years I've been in the market. Sigh.
Political affiliations were left out deliberately because I want to deal with the issue itself, not turn it into a big political debate.
Why is it not mentioned once throughout the entire article that these are Democrats? People should know the party with no fiscal sense is doing this.
Want to keep your 401k? Vote Republican.
Akien, there is a link at the beginning of the post that links to the original story.
But it looks like the main proponents of it at this point are:
House Education and Labor Committee Chairman George Miller, D-Calif. and Rep. Jim McDermott, D-Wash., chairman of the House Ways and Means Committee's Subcommittee on Income Security and Family Support.
Sure, it's all just discussion right now, and since Congress is not in session again until next year, you probably won't hear much more about it in the meantime. But as long as the market continues to fall and people fear losing money, something like this will continue to have momentum and the potential to at least entertain legislation.
6.2% is already taken out of the American's paycheck and matched by the employer. This is for social security, which is going to fail. Now they want to take out another 5% and put it in 3% bonds.
These politicians are idiots.
I think forcing people to save 5% is a good idea, but not to buy government bonds and annuities! From where I am from (Hong Kong), 5% of your income will be taken out of your paycheck, with a matched 5% from the employer every month and put into a retirement account where you can pick your own fund like a 401(K).
If Congress tries to do anything like this it will not be a good situation. It will be total mayhem because many people have invested in their future by investing in their 401k accounts and if they take away the tax benefits it might cause people to take money out of their funds which will be a total disaster.
You keep saying they and them... Who? If I write my congresscritter they may or may not know what I'm talking about. If I write them and say "the so and so department" they at least know where to start looking. MORE INFO PLEASE! At least where you heard about it.
And what do they do w/the government bonds/annuities if you die before retirement, just keep it to themselves, or can it be inherited like a 401k? If not, then that's another ding in it to me. Why would I want to go from something where I'm contributing to it, and if I die my wife, children, or whomever I elect, can get the money to something where the government gets to keep it?
This is not a plan anyone in Congress is seriously considering. Teresa Ghilarducci, who came up with the plan, has no role in Congress and is promoting a book. No chance something like this would make it out of committee, let alone getting to the President's desk.
Well looks like i need to move back into the 7th district in Washington so i can run against McDermott.
These people are idiots.
Looks like I am going to need to start writing congress early on this one. That is a horrible idea. It will hurt the market as well. The money that would be out there invested, growing the economy, and creating more jobs will instead be in the governments hands. This is awful!
So ... voting Libertarian yet? LOL.
We're going to have to hit absolute rock bottom before anyone changes Washington for the better. The good news is, we're heading that way fast and picking up speed.
Yikes! Thank you for bringing this to everyone's attention. This is something that should not stand. At this time, there is no reason to be discouraging saving. And yet, that is what our leaders have been doing for years. This is just another example of our country's transition from a nation of savers.