Rescuing Retirement from the ‘Rescuers’

Delegates to last week’s NAPA DC Fly-In Forum were treated to a discussion about a proposal touted as “rescuing retirement.” But the math (still) doesn’t seem to work. And it’s likely to kill the 401(k) (or at least its tax benefits). Here’s how.

The proposal itself isn’t new – its the Guaranteed Retirement Account (GRA) concept initially introduced by the New School’s Professor Teresa Ghilarducci, now somewhat modified, and embraced by Hamilton E. (Tony) James, President and COO of money management Blackstone. This newest version was rolled out earlier this year. Writ large there seem to be two significant differences in this newest version (packaged in a nice 119-page softbound book, Rescuing Retirement):

• James’ involvement, which lends some investment cred to the assumptions of the proposal; and
• a reduction in the mandatory contributions from employer and employee (the original proposal called for 5%, the new one only 3%).

The Ghilarducci/James team firmly believes that the current tax preferences inordinately benefit higher-paid workers, and therefore they have no trouble taking those away from all workers (they’ll let employers keep their current preferences for sponsoring the plan) in order to “pay” for the $600 non-refundable tax credit that is supposed to make the mandatory 1.5% employee contribution “free” for lower-income workers.

Under the GRA proposal, workers won’t be able to access the money prior to retirement – no more loans or hardship withdrawals. They assume, and perhaps rightly so, that emergency savings shouldn’t be taking place in your retirement account. Additionally, when you do retire, you will have to access the money in an annuity form – no more lump sums, and no bequests. You annuitize the payment at retirement (it can be a joint and survivor), but once you pass, any residual amount stays in the pool.

Ghilarducci and James actually seem to think they are doing employers a favor by giving them a way “out” of the bother (and expense) of providing workplace retirement plans. (James went so far as to refer to some conversations he’s had with some Fortune 500 CEOs, and apparently they’d love nothing more than to be done with these plans.) Oh sure, for those who have not previously offered a plan their new 1.5% mandatory contribution will represent an additional cost – but for everyone else, that 1.5% is likely a drop in the bucket compared to what they are spending now – and they won’t have to deal with the administrative responsibilities or fiduciary liability of a qualified plan.

But aside from my very real sense that killing the tax preferences for 401(k) savers would also serve to “kill” the 401(k), policymakers can’t help but be drawn to the notion of a proposal that purports to “rescue” retirement without costing the taxpayers. Well, without “costing” the taxpayers more, anyway (remembering, of course, that these are deferrals – a postponement of taxation, not a permanent deduction).

But does the proposal actually do what it claims?

First off, it does nothing for Boomers. As James aptly noted at the Fly-In, “It’s too late for them.” So whose retirement is being rescued? Well, younger workers – Millennials particularly, but more specifically, lower income workers – who in some cases are also part-time, part-year. Those workers are less likely to have access to a plan at work, and – likely because of their lower incomes — are certainly less likely to take full advantage of it.

Still, if today’s savings rates are deemed insufficient to help today’s retirement savers achieve their goals, how in the world can a combined 3% savings rate (employer and employee) possibly “rescue” retirement?

Well, despite their book’s auspicious title, from our discussion last week (and there were a couple of hundred witnesses), the only people who are being “rescued” are those who aren’t saving anything at all now (they’d be forced to save under this proposal) who also happen to be making $46,000 a year or less. That’s the group that Ghilarducci and James say will, under this proposal, achieve a 70% replacement rate (assuming Social Security, and no reductions there) in retirement. Everybody else? Well, you can keep saving for retirement, but Ghilarducci and James don’t see any reason to “underwrite” that responsible behavior by allowing you to defer paying taxes on compensation you haven’t yet received.

But even if you’re only focused on shoring up the prospects of lower-income workers, could a 3% contribution be enough? Even with the 7% return¹ that Ghilarducci and James assume for their GRAs, I just couldn’t see it adding up.

So I asked Employee Benefit Research Institute (EBRI) Research Director Jack VanDerhei to run the GRA program assumptions – for younger workers only (ages 26-30) – and asked him to compare that to what those same workers might get if they simply continued in their 401(k)s.

The EBRI analysis took actual balances, contribution rates and investment choices across multiple recordkeepers from more than 600,000 401(k) participants, looking at those currently ages 26-30, including those with zero contributions, with 1,000 alternative simulated outcomes for stochastic rate of returns based on Ibbotson time series (with fees between 43 and 54 bps), including the impact of job change (an assumption was made that 401(k) participants would continue to work for employers who sponsored 401(k) plans), cashouts, hardship distributions, loan defaults, and with contributions based on observed participant data as a function of age and income and asset allocation based on observed participant data as a function of age. For the Ghillarducci/James GRA, EBRI assumed no cashouts, hardship distributions or loan defaults (they aren’t allowed), assumed a deterministic 7% nominal return with no fees, and took their assumptions about the 3% mandatory contributions. And then compared the two outcomes at age 65.

The result? Well, as you can see in the chart to the right , the median for all income quartiles fares worse under the GRA proposal than under their current 401(k) path. (To download a full-page pdf of the chart, click here.) That’s not to say that every 401(k) path will provide sufficient income in retirement, of course – but it does affirm the common sense logic that if current rates of saving aren’t sufficient, 3% – even mandatory, and even with no leakage – won’t match the performance of the 401(k).

Of course, we know that today not everyone has access to a 401(k), and we’re all working to change that. But those truly trying to rescue retirement should probably do so with a life preserver, not an anchor.

- Nevin E. Adams, JD

Footnote

1. They view this return as conservative next to the 8.5% returns assumed by public pension plans, and think 401(k) investors only get 3-4%.