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The USA Retirement Funds Act Is Good Legislation

The USA Retirement Funds Act Is Good Legislation by Morningstar Investment Research

Seconding the Motion

Last week, I summarized Sen. Tom Harkin's proposal for revamping the 401(k) system. At the time, I did not pass judgment other than to note that it was a big, ambitious idea and that it had provisions worthy of further discussion. Upon further thought, however, I will take the next step and endorse the legislation. The plan fits with the U.S. approach to retirement planning (reason number one), and it addresses two problems that stem from such an approach (reasons number two and number three).

An Individual Solution

The USA Retirement Funds Act does not call for additional government expenditures other than the modest costs of overseeing the program. Nor does it burden employers. In fact, by creating a nationally available 401(k) lineup--the USA Retirement Funds--that automatically satisfies ERISA standards, the Act would relieve employers of their current, fiduciary-related costs.

In placing the responsibility for retirement saving on the individual rather than on the government, the Act follows the American tradition for retirement planning. As shown in the graph below (taken from Pensions at a Glance 2013: [English may not have been the authors' first language--the document has 368 pages!] Retirement-Income Systems in OECD and G-20 Countries), U.S. senior citizens receive a relatively low share of their income from the government:

Sources of Income

In most developed countries, government payments account for 60%-plus of income for those over the age of 65. In the United States, that figure is less than 40%, with the gap filled by higher private pensions (once defined-benefit schemes, paid from company coffers, but increasingly 401(k) plans, funded primarily by the individual worker) and by employment, as Americans are likelier to work at older ages.

None of this matters to me. I can live with an individual solution, a government solution, or an employer solution. But I realize that only one of the three appears to be feasible politically. The government solution requires higher tax rates and the employer solution would raise businesses' costs. There is little collective appetite for those sacrifices. Thus, I believe, successful 401(k) legislation must emulate the USA Retirement Funds Act in retaining the existing retirement framework.

(For a dissenting view, see Jane White's The Senate's Plan for Our Retirement: Inadequacy for All, as well as her white paper on ensuring America's retirement. White fervently argues for the employer solution.)

Raising the Floor

The USA Retirement Funds Act doesn't do much for those at the top of the retirement heap. It mandates the availability of a low-cost 401(k) plan, and it automatically enrolls all participants at a 6% savings rate. Those who now work at a relatively large company with a good 401(k) plan and who invest at 6% or more will see few benefits from the Act.

Instead, the Act is aimed at those further down the ladder. For the rank-and-file, tens of millions of whom currently do not have a 401(k) account; or who may have an account but must invest in high-cost funds because they work at a small company; or who theoretically could open a 401(k) but who need the prod of automatic enrollment to get started, the Act would be of great assistance.

That seems appropriate. If the U.S. is to retain the individual system, then it should address one predictable outcome: The results will be uneven. When individuals run the show, the richer become richer than they would if government or corporations are in charge, and the poor become poorer.

Note the chart below (again, from Pensions at a Glance):

Median Mean Financial Wealth

The USA Retirement Funds Act helps that graph's relative losers, at no cost to the relative winners, who may continue to invest in their current 401(k) plans, holding their current funds, and saving at their current rates.

Rationalizing Fiduciary Duties

As I mentioned earlier, the USA Retirement Funds would meet ERISA fiduciary standards. As a result, employers who make those funds available to their workers would not need to conduct costly due diligence, with documentation, to protect themselves against lawsuits. Nor would they incur monitoring costs.

This idea is long overdue. Why should employers, who have their businesses to run, become part-time fiduciary experts? They should not. How is that an efficient use of America's business resources? It is not. Today's fiduciary customs are barbaric. They are the byproducts of the 401(k) plan's accidental birth from an obscure IRS tax code. The Act correctly addresses the current deficiency.

The Options

In the first chart, which showed the level of government support to retirees, four countries rated below the U.S.: Israel, Mexico, Korea, and Chile. Three of those countries require both employees and employers to contribute to defined-contribution plans. The fourth, Korea, has no such requirements--and it has the highest retiree poverty rate among any developed country, at an abysmal 45%.

Just above the U.S. lie Canada and Australia. Canada's system is broadly similar to that of the U.S.--although Canadian retirees effectively have higher incomes, as their health-care costs are lower--while Australia's is emphatically employer-supported.

In summary, U.S. retirement policy would appear to face four options--

1) Strengthen the government solution by raising taxes;

2) Create an employer solution by mandating 401(k) participation, at both the employer and employee level;

3) Improve the individual solution through the USA Retirement Funds Act, or something similar;

4) Do nothing and hope that the U.S. ends up looking like Canada, not Korea.

If the first two options are not possible, then surely the third option is preferable to the fourth.

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