Written by: Corey Janoff
This post was originally published on our previous blog website on March 7, 2017 and has since not been revised and/or updated.
Americans are notoriously bad at saving for retirement. According to the Economic Policy Institute, about half of all American families have nothing saved for retirement. And for people that do have money saved for retirement, the median amount set aside for those on the brink of retirement in their late fifties to early sixties is under $200,000. Not nearly enough to sustain another 20-30 years of life. So how do we fix this growing problem?
This issue will be difficult, if not nearly impossible, to correct overnight. But I have a simple solution that could get every American moving in the right direction. After a generation has cycled through, the entire ship will be on course.
A Simple Solution
The IRS is smart in how they go about collecting taxes. For the majority of wage earners, taxes are withheld from paychecks before the money is given to the employee. If employees were given their entire paycheck and then received a bill from the IRS requesting tax dollars, very few taxes would actually get paid. So rather than giving people the opportunity to spend the money, the IRS takes their cut first. Why don’t we do the same for retirement savings?
Rather than giving people the opportunity to spend their money, there should be a mandatory 10% withholding for retirement. Isn’t that basically what Social Security is? Yes, that is correct. However, the entire balance of the Social Security trust is invested in US Treasury securities. Last I checked, the 10 year Treasury note was yielding under 2.5%. Not exactly the type of return needed to ensure a long healthy retirement.
Instead of creating another pension fund that invests in overly conservative investments, we will have investment companies from the private sector run the portfolios. Since the goal is to keep this as simple as possible, participants will be automatically invested in a target date retirement fund based on their age. This will also enable participants to see their actual account balance at any time and be able to plan for retirement as it approaches.
We Need Some Rules
In order for this to work, we need to have some basic rules put in place with very few (or no) exceptions.
Rule #1 – Mandatory 10% Withholding from all Wages
There will be no exemptions, deductions, limitations, or exceptions. Whether it is W2 income, 1099 income, K1 income, you name it, 10% of gross earnings will be withheld pre-tax and invested in a target date retirement account. Unless you’re being illegally paid cash under the table, there is no way around it.
Why 10%? If people have 10% of every dollar they ever earn over the course of a 35-40 year working career, coupled with Social Security, they should have enough to retire comfortably. No guarantees, but at least they’ll have more than the average person is currently on pace for.
Rule #2 – Participants Won’t Be Responsible for Managing Their Own Investments
The majority of Americans are very bad at managing their own investments and tend to make irrational decisions. So we will take this variable out of their hands. DALBAR Inc. is a company that does an annual study called the Quantitative Analysis of Investor Behavior. Every year, the results are very similar. Over extended periods of time, investors historically tend to realize for themselves about half of the returns delivered by the investments they actually invest in. This is often due to buying and selling investments at inopportune times, rather than staying the course.
The investment companies selected (more on this shortly) will be in charge of managing the investments and participants will be relieved of that responsibility. This will be a major divergence from the way typical 401k plans are run where the onus is on the participants to select and manage their own investments.
Rule #3 – Funds Will Be Invested In Target Date Retirement Portfolios
Again, keeping it simple, the money will automatically be invested in target date portfolios based on the participant’s age. A target date fund is a mutual fund that is considered a fund of funds. Rather than one mutual fund that usually invests in one specific asset class, such as large US stocks, target date funds are comprised of multiple different mutual funds, so the portfolio is well diversified across multiple asset classes. The funds with target dates a ways out into the future, such as the year 2040, will invest primarily in equity securities. As you approach and move past the target date, the fund will slowly become more conservative and invest more heavily in fixed income securities. Like all investments, there are inherent costs and risks associated with these, such as volatility and potential loss of principal. Past performance is no guarantee of future results.
This is the common default investment options for most employer sponsored retirement plans today. We could use a system similar to the low-cost Thrift Savings Plan that government employees have access to. However, if the entire country is investing 10% of their income, one company probably won’t be able to handle the entire pot. To ensure the balances can be properly handled and investments not mismanaged, I propose we have 10 investment companies each manage 10% of the pot. We can have all the major investment companies bid for the opportunity to manage the assets at a very low cost to the participants. So big name companies like Vanguard, Fidelity, T. Rowe Price, etc. will be in charge of managing the assets. Every five years, the bids will be up for renewal. This will foster competitive costs and proper investment management. I would also propose a mandated capped internal investment cost, to keep expenses low for participants.
Rule #4 – Withdrawals Only Permitted After a Certain Age
I would vote for somewhere around age 65, however I am open to other ideas. We could make it an adjustable scale based on mortality tables. This is a minor detail. The major detail is there is no way around it. Unlike a 401k or IRA account where you are supposed to wait until age 60, but can access the funds beforehand with a 10% penalty, this will be a hard line. The only exception I would be open for is if you are diagnosed with a terminal illness and doctors determine you have less than 12 months to live. Then you can liquidate your funds and complete your bucket list.
Rule #5 – Withdrawals Will Be Limited to a Certain Amount per Year
Similar to how traditional pension plans and annuities operate, you will only be able to withdraw certain percentage of the available funds per year. Say 5% initially for example. This percentage can increase as you get older. Once you pass away, remaining balances will pass on to your desired beneficiaries and transfer into their retirement portfolio with the same rules. By putting restrictions on yearly withdrawals, this will ensure people won’t deplete their assets too quickly. Again the only exception I am open to is if you have a terminal illness. Maybe we will even give people the option to annuitize their balance to guarantee income for life.
Rule #6 – Funds Cannot Be Used As Collateral For a Loan
I can see banks quick to lend people money before people are able to access their retirement dollars, with payment plans set up for when retirement withdrawals can commence. This will not be allowed.
There You Have It
Pretty simple and logical, right? In reality, this will probably never happen. With all of the red tape and opinions in our society it will be very difficult to get approved. There will be a major pushback from lobbyists and citizens that don’t want to be “forced” to save for retirement.
However, something needs to be done. Traditional pension plans are going the way of the dinosaur and people are not making retirement savings a priority. This is going to severely burden our society in the coming years as more and more people enter retirement without the means to afford retirement.
So put an executive order on this President Trump and make it happen!
Disclosures:
These are the opinions of Corey Janoff and not necessarily those of Finity Group or Cambridge Investment Research, Inc., are for informational purposes only, and should not be construed or acted upon as individualized investment advice.
