Forced Savings: The Only Way to a Reasonable Retirement

by Will Ashworth | December 3, 2012 7:15 am

[1]The creation of the 401(k) was intended to provide workers with a tax-deferred vehicle to save for retirement.

When used properly, it’s true that a segment of the population has benefited greatly from the 1982 legislation … but for the most part, its intended consequences haven’t come to pass. The investment industry — along with the richest Americans — have profited handsomely while the majority have no chance of retiring at 65[2].

In fact, Matthew O’Brien, associate editor of The Atlantic, calls the 401(k) a $240 billion waste[3]. Is he right?

Hell yes.

It’s no coincidence that some of the greatest profits in the history of corporate America have been generated over the past 30 years. Transferring the responsibility for an employee’s retirement from corporations and the government to the employee himself/herself has compromised the financial well-being of millions of Americans for many reasons, most of which I won’t get into.

However, one statistic from UC Berkley’s Center for Labor Research and Education[4] puts into perspective the biggest problem associated with 401ks:

“In 2011, tax breaks for retirement pensions and accounts cost the federal government over $140 billion in forgone tax revenue. Roughly 80% of these tax subsidies for retirement savings accrue to the top 20% of the population. Only 7% accrue to the bottom 60% of the population.”

O’Brien’s $240 billion figure in his opening paragraph[5] refers to the Congressional Budget Office’s estimate of the annual cost of retirement subsidies to federal coffers for the next 10 years. Using a Danish study, O’Brien explains how one dollar in retirement subsidies produced exactly one penny in additional saving by the people of Denmark. Figures in the U.S. aren’t much different.

In other words, the U.S. government will spend $240 billion annually to produce retirement savings of $2.4 billion. That’s a poor use of government money, but unless Congress is willing to reverse a 30-year movement toward defined contribution plans, it’s likely that we’re stuck with 401ks.

So what’s the solution? In two words — forced savings.

The 401(k) is an abysmal failure in producing this effect. In California, almost half the state’s workers aren’t offered a retirement plan by their employer; only 44% of employees who do have a plan actually participate. It’s pretty hard to save if you’re not participating in the process itself.

This isn’t something unique to California. The system is failing all over America and Canada as well. Financial literacy — which educated types flaunt as the source of your salvation — will never be the answer to solving the retirement shortfall. Know why? Because most of us will never have the inclination nor the time to actually achieve this goal.

Those past the age of 20 are probably too forgone. If financial literacy is to be part of the answer, all our efforts should be focused on those in elementary school where a school curriculum begins in kindergarten going all the way to 12th grade and graduation. Every subject taught in school has a financial application; the sooner we incorporate this thinking into early education, the sooner we can stop graduating as financial nincompoops.

Enough of the sermon — here’s what I propose needs doing.

Eliminate mortgage interest deductibility — sort of. The deduction costs the government $100 billion annually, with most of the benefit flowing to the wealthy. Why not allow homeowners to transfer their house into their 401k?

For example:

If you have $75,000 equity in your house, you would be able to apply that amount toward future 401k contributions. Let’s assume you’re 50 and married; you’d be able to make the maximum allowable contribution of $22,500 in 2012, which would reduce your taxable income this year by an equal amount.

If you sell your house, the IRS states that the first $500,000 in profit (married couple opposed to single person) is excluded from tax. The only difference in my proposal is that the dollar value of the exclusion would depend on the median house price where you live. If you’re an owner in San Francisco, where the median house price (according to[6]) is $735,000, your exemption would be $235,000 higher than the existing $500,000.

The idea here is to harness your home ownership with your 401k to produce a more meaningful retirement savings plan. After all, you’re already saving to pay off your mortgage. This would only encourage you to pay it off at a faster rate.

Bottom Line

The 401k isn’t working. Neither is mortgage interest deductibility. Meanwhile, in Canada, home ownership is nearly 70% compared to 65.4% in the U.S.; we don’t have mortgage interest deductibility in Canada, yet our rate of ownership is higher.

At the same time, we are equally inept when it comes to saving for retirement … our RRSPs are just as woefully ignored.

Americans and Canadians have proven time and again that the only thing we will routinely save for is a home. Let’s use the only concept of forced saving most of us are capable of to help more of the people — and not just the wealthy.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

  1. [Image]:
  2. no chance of retiring at 65:
  3. calls the 401(k) a $240 billion waste:
  4. UC Berkley’s Center for Labor Research and Education:
  5. $240 billion figure in his opening paragraph:

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