The President’s feel good retirement proposal

2014

It sounds good, find yet another way to help moderate and low income people to save for retirement.

Certainly we need more retirement savings especially for middle income Americans. The proposal to allow another payroll deduction type of government bond is not bad, it’s just that it is redundant and will do little to improve saving. It does, however create the impression of helping middle and lower income Americans. It’s nothing but populist pandering.

Perhaps some of the liberal logic may help. Here is what the Center for American Progress says:

Any workers who are 55 or over who don’t have significant retirement savings—or don’t really trust banks—would now have a safe option to build a small nest egg.

Or don’t really trust banks, don’t you just love it? Don’t trust banks, let the federal government do it all for you. What is this 1934?

If the targeted population was inclined to save or could afford to save there are vehicles already available including direct deposit payroll purchase US savings bonds. Plus IRAs and other programs. They do, however, require individual initiative to set them up.

According to the papers, after an initial deposit of $25, future contributions can be as low as $5.00 a week. The money is invested as a Roth (after tax) IRA in a new government bond where the principal is guaranteed with variable relatively low interest rate, probably in the 3 to 3.5% range over time, (but much lower now), something like a GIC or stable value fund in a 401(k) plan. Over the period since 2004 the S&P 500 has returned an average of 6.1% a year (yes, with ups and downs, but we are talking about investing over thirty years).

But here is the strange twist. Once the account accumulates to $15,000 or is in effect for 30 years, the money must be transferred to a private IRA. Presumably the government bond approach is to address the fears people have of the stock market going down (and up).

What seems to be overlooked here in the quest to be politically attractive is (1) low interest earnings are not going to allow people to reach retirement goals and (2) once the money is transferred to the IRA it can be lost through poor investments at the exact point it is needed. Think 2008-2009.

Let’s assume a person takes advantage of the account at the minimum level first putting in $25 and then $5.00 a week until the $15,000 limit is reached. In 30 years the person would have $12,780 at a 3.5% return. Or double savings and in 30 years they have $25,488 which is currently the annuity equivalent of $156 a month (but the money would have to be removed from the guaranteed account when it reached $15,000).

Let’s look at a low income couple earning $40,000. If they retire in 2014 at age 67 their family annual Social Security benefit is $24,750 or 61.8% income replacement, an amount many “experts” say is sufficient during retirement.

The problem of inadequate retirement savings is very real and we need to find a solution, but whether another new scheme such as described is the answer remains to be seen. It appears to be more designed to fit into the Administration’s equality goals than to significantly increase retirement income. We should also keep in mind that for lower income people, Social Security replaces a much greater percentage of income than others. For example, if in our example above we replace the $40,000 income with $117,000, Social Security replaces not 61.8% but 37% of pre-retirement income. So contrary to popular views, it’s not the lower income who need the most help.

The federal government already has a number of programs and tax incentives designed to improve retirement prospects for older Americans. Studies show, however, that many Americans remain vastly unprepared for when they stop working. Low-income Americans traditionally don’t have IRA or 401(k) accounts as frequently as wealthier Americans. WSJ- 1-19-14

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