Ray Boshara, Corporation for Enterprise Development
Promoting Individual Development Accounts
and More Uniform Pension Coverage
Making Individual Development Accounts (IDAs) available to greater numbers of low-income Americans and promoting more uniform pension coverage are two complementary policy options that could address two pressing national issues: an unacceptably low national savings rate and inadequate retirement savings. Individual Development Accounts (IDAs) are matched savings accounts designed to help low-income individuals save regularly and accumulate financial assets. They are not able to nor designed to meet the lifetime needs of low-income families, but IDAs serve as an entry point to the mainstream financial system and should be complemented by public policies that promote savings and asset accumulation for people of all income levels.
Community-based non-profit organizations, through partnerships with financial institutions, are currently the primary IDA providers, but new systems are being developed to deliver and administer IDAs at a lower cost through a variety of institutions. Alongside these systems, public policy has a large role to play in ensuring that IDA participants achieve long-term economic security through transitioning to saving in college savings plans, IRAs, 401(k)s, and other tax-favored plans.
IDAs Highlight the Need for Expanded Pension Coverage
Across America, thousands of low-income adults who have never before saved are now saving regularly in their Individual Development Accounts (IDAs). Whether their goal is to buy a home, further their education, or open a small business, these IDA savers are on their way to achieving greater economic security through asset ownership. With continued opportunities and incentives for savings, they and their families might attain lasting prosperity.
Though still a relatively new economic development tool, IDAs are reshaping attitudes towards low-income Americans and sparking new thinking about the kind of public assistance that will help them reach economic independence. Evaluation data from the American Dream Demonstration (ADD), the first nationwide demonstration of IDAs, provides evidence that low-income adults can and do save when provided with infrastructure, incentives and institutional supports. As of June 2000, 318 ADD participants had made matched withdrawals from their IDAs, and hundreds more were researching asset purchases as they approached their savings goals. Based on an average savings period of 13.3 months, the average ADD participant had total net deposits of $353 and average monthly deposits of $25.42. In total, 2,378 ADD participants in 14 IDA programs had made aggregate net deposits of $838,443. When combined with earned match funds, aggregate savings totaled $2,482,951 (Schreiner, et al., 2001).
Since ADD was launched in fall of 1997, about 250 additional IDA programs have emerged in 41 states, and 29 states have passed laws in support of IDAs. This steady proliferation of IDAs at the state level has contributed to bi-partisan support for IDAs at the federal level. In growing numbers, Republicans and Democrats are gaining awareness that low-income individuals, like their middle- and high-income peers, can be encouraged to save and invest in their futures when provided with information, financial education, financial incentives and improved access to financial products. Even policymakers who were formerly conditioned to think of low-income people as a drain on the national economy are now beginning to see their potential as homeowners, skilled workers, and business owners.
While this increasing bi-partisan support for IDAs is encouraging, proponents of asset development policies know that this is just the first hurdle on a challenging course toward a universal asset building system. It will take much more to extend the policy infrastructure for savings and investment to all Americans. IDAs can effectively promote regular savings and investment behavior in low-income households, but they are not able to nor designed to meet the lifetime needs of low-income families. Rather, they are designed to help low-income individuals purchase that first asset-a home, a better education, or a business-that will increase their financial security and open up doors to other savings and investment opportunities. In this sense, IDAs serve as an entry point to the mainstream financial system. If IDA participants are to achieve long-term economic security, they must transition to saving in college savings plans, IRAs, 401(k)s, and other tax-favored plans.
Public policy has a large role to play in ensuring that this transition occurs, especially with respect to facilitating participation in retirement savings plans. Recent data suggest that fewer than 50% of all U.S. households own any stock and fewer still (40%) have access to a pension plan (Wolff, 2001). Given increasing demands on Social Security and evidence that low-income and middle-income households are excluded from pension coverage, the need for policies to promote more widespread and equitable pension coverage is great. Absent such policies, the goal of economic security for all will not be attainable.
What sorts of policies are needed? One of the key lessons gleaned from IDA experience is that coupling financial incentives with institutional supports is a powerful way to motivate savings. Matching contributions are a good lure, while financial education, financial counseling, and the removal of barriers to saving all contribute to sustained savings behavior. The latest IDA research suggests that as few as 7 hours of financial education can lead to statistically significant increases in saving (Schreiner, et al., 2001). Similarly, research on 401(k) plans suggests that the provision of matching contributions by employers leads to higher participation rates, but not higher savings rates. But financial education in the workplace-in the form of seminars, newsletters, and interactive tools-can lead to higher participation rates and higher monthly contributions, especially among non-highly compensated employees (Bayer, Bernheim & Scholz, 1996; Bernheim & Garrett, 1996). Thus, in addition to providing financial incentives and convenient access to retirement savings plans, employers can also provide important institutional supports that are not otherwise available to some employees.
These findings suggest that public policies designed in the interests of businesses and employees could play an important role in encouraging retirement savings among working adults. It is troubling that the tax bill recently passed by Congress effectively removes incentives for employers to sponsor 401(k) plans, when additional incentives are needed to increase retirement savings. Inflexible rules and large penalties for early withdrawal also limit pension plan participation, especially among low-wage workers. And given the rate at which low-skilled and low- to moderate-wage workers change jobs, long vesting periods and lack of portability also serve as disincentives for participation. Finally, policies that extend pension coverage to greater numbers of independent workers (contractors, freelancers, temps, contingent workers) are also needed. According to the nonprofit group Working Today, independent workers comprise nearly 30% of the work force, and this growing segment enjoys no pre-tax incentives for retirement savings.
Making IDAs available to greater numbers of low-income Americans and promoting more uniform pension coverage are two complementary policy options that could address two pressing national issues: an unacceptably low national savings rate and inadequate retirement savings. If policymakers recognize that IDAs are a smart first step toward economic inclusion, they should also see the wisdom of providing low- and moderate-income Americans with better opportunities and incentives for long-term savings. Together, these two policy options could have a powerful effect on our national economy.
Bayer, P. J., Bernheim, B. D., & Scholz, J. K., 1996. "The effects of financial education in the workplace: Evidence from a survey of employers." National Bureau of Economics, Working Paper No. 5655.
Bernheim, B. D. & Garrett, M. D., 1996. "The determinants and consequences of financial education in the workplace: Evidence from a survey of households." National Bureau of Economic Research, Working Paper No. 5667.
Schreiner, Mark, Michael Sherraden, Margaret Clancy, Lissa Johnson, Jami Curley, Michael Grinstein-Weiss, Min Zhan, & Sondra Beverly, 2001. Savings and Asset Accumulation in Individual Development Accounts: Downpayments on the American Dream. Center for Social Development, Washington University in St. Louis.
Wolff, Edward N., 2001. "The rich get richer.And why the poor don't." The American Prospect, Feb. 12, 2001.