Is Your 401(k) Obsolete?
Washington Monthly: Ten Miles Square
By: Anne Kim
February 7, 2013
New research by the firm HelloWallet finds that more than a quarter of Americans who have an employer-sponsored retirement plan are raiding these accounts for other uses.
According to HelloWallet's report, Americans are withdrawing more than $70 billion a year from their retirement savings--and often paying big penalties to do so. On top of regular income taxes, early withdrawals are subject to a 10 percent additional tax penalty, which depending on the bracket, could eat up nearly half of a person's withdrawal.
For many people, employer-sponsored retirement plans are the only mechanism "forcing" them to save. Yet the retirement-only focus of the current system isn't versatile enough to meet people's real needs--especially to cope with emergencies such as a job loss or a horrifically expensive car repair.
The depth and breadth of this "leakage" from Americans' retirement accounts means it's time to rethink the kinds of savings accounts that all Americans should own. In particular, new ways to encourage emergency savings could help ensure that 401(k)s don't continue to be an expensive, last-resort piggybank for so many Americans.
According to new data from CFED, 44 percent of American households don't have the cash to survive three months at the federal poverty level if they suffer a loss of income. Among 401(k) accountholders who lack this cash cushion, HelloWallet found that nearly 1 in 3 have "breached" their retirement savings, versus just 3 percent of accountholders who have enough emergency savings put away.
While it's easy to dismiss emergency savings as something every American "should" do--the same way people "should" get more exercise and skip the buffalo wings on Super Bowl Sunday--the reality is that too many Americans either don't make enough money to save or lack the tools and capability to manage their resources optimally.
According to the FDIC, nearly 30 percent of Americans don't own a savings account, while nearly a quarter of households rely on check cashers, pawn shops or other high-cost financial services that eat up people's money and provide no avenues to save.
These issues are part of a much larger failure of our economic system to encourage savings, especially among those with lower incomes who need it most. Indeed, the predatory nature of so much of the financial marketplace in recent years--from payday loans to subprime mortgages to hidden credit card and 401(k) fees--has had the effect of stripping many Americans of much of the modest financial assets they've managed to accumulate.
Reversing these predatory practices is the mandate of the new Consumer Financial Protection Bureau (CFPB), created by the Dodd Frank financial reform law. The CFPB should be allowed to do its job, despite the efforts of some lawmakers who are fighting hard to weaken the agency. We also should be having a national conversation about big reforms, such as "stakeholder accounts" that can help all Americans become better lifetime savers.
But in the absence of political and budgetary appetite for large-scale solutions, policymakers should at least consider some incremental solutions in the short term. For example, here are a few small ideas to help stem the use (and abuse) of retirement savings and to tackle the emergency savings problem:
Encourage employer-linked emergency savings. Especially now that automatic enrollment in employer-sponsored retirement accounts is increasingly the norm, the workplace is one place where employees can count on being encouraged to save.
One idea, championed by David John of the Heritage Foundation, is to follow the lead of the United Kingdom, where "corporate platforms" allow employer-provided contributions to be used for both retirement and non-retirement purposes and where employees can have one-stop-shop access to all of their accounts.
The possibilities under this approach could include "auto-saving" into an emergency savings account or even an employer-sponsored plan to encourage investments in U.S. savings bonds (which are surprisingly liquid and even ideal for workers without traditional savings accounts).
Broaden access to disability and accident insurance. According to the Employee Benefits Research Institute, barely half of workers in medium and large businesses have accident or sickness insurance, while only a quarter of workers in small businesses have any form of short-term disability insurance at all.
While insurance isn't a perfect substitute for savings, it can be a critical means of income "support" for someone who is sick or has an accident and is consequently unable to work. More employers should be encouraged to offer it, and more workers should be encouraged to participate.
Tweak the tax code. The tax code currently takes an all-or-nothing view toward savings, with retirement savings being the only savings to enjoy tax benefits. Why not, as the Urban Institute's Gene Steuerle suggests, "scale" the benefit so that people get bigger breaks (or smaller penalties) the longer the money stays in a savings account? For example, someone who left their money untouched for 20 years would pay fewer penalties than someone who raided their savings after a few years.
Another idea, proposed by the New America Foundation, would be to build on the current Saver's Credit, which currently provides a small federal tax credit for retirement savings by low-income workers. This proposal would dramatically expand the benefit by providing a refundable "match" and allowing it to apply to savings in shorter-term vehicles such as one-year certificates of deposit or U.S. savings bonds. This match would both beef up the emergency savings available for the workers who need it most and incentivize more savings as well.
A potential upcoming debate on tax reform might be the best chance for Congress to rethink how to encourage more savings and help Americans become more secure. If Congress can't get the federal budget in order, it should at least help American households get on sounder footing.
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