Tuesday, September 15, 2009

The New Initiative for Retirement Savings

President Obama recently announced a new initiative that will make it easier for Americans to save for retirement. This is an important step. The stock of personal U.S. savings took a big hit in the midst of the financial crisis, and many families have been left scrambling to make ends meet. Before the crisis, the saving rate had been hovering around zero. Depending on which definition is used, anywhere from a quarter to just over a third of Americans are asset poor. The importance of having savings cannot be overplayed. Having savings guarantees security after retirement and can provide a buffer against shocks. A recent survey, conducted by the market research firm TNS, revealed that almost half of Americans doubt that they could come up with $2,000 in 30 days—whether from savings, borrowing, friends, or family—to meet an unexpected financial need. But the good news is that American families seem to have recovered an appreciation for saving and this new initiative will help people continue to save.

There are four new and important components of this initiative. The first component uses the “make it simple” approach to retirement saving, using automatic enrollment to default workers into retirement saving plans, with the ability to opt out if an individual so chooses. Large companies have successfully used automatic enrollments for years, but this initiative will make it easier for small companies to offer the same benefit. An effort to simplify saving may seem to be common sense but, in fact, is a radical departure from what models of saving have traditionally focused on. Both academic research and policies to stimulate saving have overlooked and underplayed the difficulties that people face in making saving decisions, in devising a saving plan, and in implementing such a plan. The new initiative will make it possible for more people to easily enroll in pensions. By defaulting workers into a pension, saving becomes the rule rather than the exception. And when saving is made simple with automatic enrollment, research indicates that workers make the choice to stay enrolled in a pension plan.

The second new component of this initiative is to facilitate the saving of federal tax refunds, which 100 million American families receive. If tax filers have a retirement account, they can have their refund deposited directly into that account. Notably, filers will be able to check a box on their tax return to receive their refund as a savings bond. This is not just simple, it is brilliant! This idea was originated and tested by Peter Tufano of Harvard Business School and Doorways to Dreams (D2D), the not-for-profit he founded in 2000. In 2007, the Federal government distributed $250 billion in 2006 tax year refunds to Americans, of which nearly $115 billion went to families with incomes under $40,000. Households or individuals with adjusted gross incomes under $40,000 received refunds of approximately $1,679. Research has shown that families, including low income families, aspire to save at least a portion of their tax refund. Yet, until now, there has been no simple way for them to do so. Savings bonds offer many attractive features. They comes in small denominations, charge no fees, generally pay a competitive rate, guarantee no principal loss, and are exempt from state and local taxes. Moreover, many people seem to know about savings bonds. According to Tufano’s research, as many as 89% of individuals in low income families are familiar with savings bonds. Multi-year research work in this field and pilot studies offering savings bonds to tax filers have demonstrated that such an initiative makes it possible for low income families to save (for more information about this research, visit http://www.d2dfund.org/). Now, every family that receives a tax refund has a simple way to put that money away: as simple as the stroke of a pen.

The third new component of this initiative is to enable workers to convert their unused vacation or other similar leave into additional retirement savings. In other words, it will now be possible for employees to put payments for unused vacation and sick days into their retirement plan if they wish. Another simple way to help people save!

The fourth component of this initiative is the guide that the Treasury and the IRS will put together to help workers and their employers better understand the available options for tax-favored retirement saving. Again, this will be written in simple and clear language. This is an important innovation. People need to have a reputable source of information to rely on, and they need to know where to go to access that information. The importance of such a guide should not be underestimated. Automatically enrolling people in a pension plan is a great way to foster retirement savings, but workers could make the decision to withdraw or borrow from a retirement account, sometimes incurring tax penalties, or individuals might fail to roll over a pension into another tax-advantageous account when leaving a job. My hope is that the guide will not limit itself to offering information about retirement savings; people are dealing with a lot of financial decisions and all of these decisions are interrelated. For example, it may not be wise for a worker to contribute to a retirement account if he/she carries a lot of high-interest credit card debt. And, judging from some of the behavior that the recent financial crisis exposed, some debt management tips should be included in the guide, too.

Our society has made it easy to consume, now this policy makes it easy to save!