Universal Savings Accounts are voluntary, citizen-based accounts that could be made available to all workers regardless of job status. They would recast federal retirement policy as citizen-based, rather than employer-based, and they would use matching refundable tax credits, rather than tax deductions. By integrating matching credits with the existing retirement system - and possibly with Social Security - the new system would be able to achieve more truly portable, universal, and equitable asset-building. It would consequently improve individual retirement security while increasing national saving and investment.
An ambitious effort to expand pension coverage ideally should be designed to achieve a number of other goals as well: retirement income adequacy, increased national saving, pension portability, reducing employer burdens, and reducing inequities in benefit and subsidy levels.
I. Match new pension saving with refundable credits: Unfortunately, the debate over Social Security tends to portray individual accounts and the current system of guaranteed minimum benefits as an either-or trade-off. It need not be. A better approach would preserve Social Security's income floor and add a second tier of voluntary accounts to supplement the system's meager benefits (the average benefit is slightly more than $800 a month). As outlined below, expanding coverage using the incentive of matching credits could either be targeted at individuals without adequate work-based coverage or - even better - it could be integrated with the existing pension system and apply to new contributions going forward.
Replace deductions on new pension saving with refundable credits: A tax deduction is neither a powerful nor equitable means to encourage pension saving among the lower-income and younger workers, whether or not they are covered by an employer plan. Instead, a sliding-scale tax credit could give a greater incentive to low-income workers likely to save the least. Recent studies show workers are far more likely to save if their employer offers a generous matching contribution - and once they develop the habit of saving by payroll deduction, most continue even when the match rate is reduced.
An example of an alternative tax-incentive system focused on the eligibility of individual workers could be structured as follows:
Notice that unlike the current system, saving incentives are greater for those less likely and less able to save. I assume matched contributions are neither deducted from earnings nor taxable upon withdrawal. Like the current system, I assume that earnings on contributions would compound on a tax-deferred (and possibly tax-free) basis; that nonqualified withdrawals would be penalized; and that the treatment of existing pension assets would remain unchanged. I also assume that the inherent progressivity of a refundable matching credit would permit generous upper limits on total contributions and with Roth IRA treatment for contributions up to the total annual limit.
Make matches available for both individuals and employer contributions, eliminating the need for anti-discrimination testing: By extending pension saving incentives to all American workers as individuals, employers would have the option to get out of the business of administering pension plans without reducing their employees' after-tax compensation. Matching credits could be earned for contributions to existing plans by either workers or employers. This allows companies to decide purely for business reasons whether it makes sense to sponsor a pension plan.
For employers deciding to maintain a plan, contributions on behalf of workers should be eligible for matching tax credits on the same basis as individual contributions (just as currently all contributions up to limit are deductible from taxable income). This has the advantage of efficiently using the existing pension system - if an employer so chooses -while avoiding the possibility that a stand-alone pension saving credit could siphon off contributions by lower-paid employees and throw the private plan out of compliance with ERISA anti-discrimination provisions. Moreover, because low-wage workers would have a sufficiently strong incentive to participate, a progressive matching system would eliminate the need for complex anti-discrimination and top-heavy rules. Since plan contributions could be listed on the employee's annual W-2 form, for most workers the matching credit can be calculated and deposited upon processing of the annual tax return.
Shift the burden of ensuring retirement security for low-income workers from employers to society: For companies that create or maintain a plan, the burden of subsidizing low-wage workers would be borne primarily by society as a whole. In this sense a refundable pension tax credit is analogous to the Earned Income Tax Credit: rather than make low-wage job creation more expensive for employers, more of the burden of ensuring basic benefits to all should instead be paid for on a progressive basis by society as a whole.
Provide for "Career Account" portability: Making all workers equally eligible for matching contributions can also promote portability and simplification. Workers whose employers do not participate in the matching program should be given two choices: either to open what I call an Individual Career Account (ICA) at the financial institution of their choice; or to choose a default option simply by checking a box on their W-4 at work (or on their annual 1040).
The default option would be aimed at very low-income workers who might initially have very small account balances, or who are otherwise unable to navigate the process of setting up and managing a private account. The federal Thrift Savings Plan TSP would be a good option for managing a clearinghouse for small, unprofitable accounts. The default accounts could be managed at low marginal cost and even include a default asset allocation. For example, small businesses with high employee turnover might choose to set up their accounts and simply remit a monthly or quarterly contribution. (Senators Jeffords and Bingaman introduced a proposal along these lines, called Pension ProSave, proposing a federal clearinghouse to encourage portability and small business coverage.) Whatever option is chosen, the assets in a Career Account should be fully portable and transferable at the worker's option between qualified financial institutions, or into a new employer's plan, at any time. To facilitate complete portability, remaining distinctions between the seven-odd qualified DC plan types should be eliminated.
Allow borrowing only for lifelong skills training or first home purchase: Since retirement security is in large part a function of earnings growth over a career, workers should be able to borrow up to half their account balance to pay for higher education or skills training. Similarly, home ownership encourages steady saving and asset building; it ultimately reduces living expenses, or increases resources, in retirement.
II. Other more incremental reforms to the current system
Working within the confines of the current private pension system, there are several straightforward and incremental reforms that would help the bottom half of the workforce to save for retirement:
Encourage Payroll Deduction IRAs: While the self-employed can take advantage of deductible contribution limits that are comparable to 401(k) plans, employees at firms without pension coverage only have recourse to IRAs. Although pending legislation may well raise the $2,000 IRA limit, lower-income workers would be far more likely to save if they could contribute, for example, $80 per pay period by automatic payroll deduction, rather than try to come up with a year-end or tax-time lump sum deposit. At a minimum, firms with more than 25 employees should be required, at an employee's request, to automatically deduct a uniform amount each month, transfer it to the employee's financial institution, and include the deduction amount on the face of the employee's W-2 form. In addition, Congress should consider a tax credit for small business that would fully offset the cost of administering a voluntary payroll-deduction IRA program open to all employees.
Shorten vesting periods: As noted above, workers at all ages are changing jobs more frequently and often forfeit employer contributions contingent on five-year vesting periods allowed by ERISA. Since employers can already exclude a worker completely from a qualified plan during the first year of employment, vesting should be immediate, particularly for defined-contribution accounts where the worker's motivation to make first-dollar contributions is linked to the incentive of actually earning the employer's matching contribution.
Require automatic plan enrollment: As noted above, 401(k) participation rates drop among lower-wage workers. Yet once workers are enrolled and develop a savings habit, studies show they typically continue to save even when the employer makes the matching formula less generous. Although pension participation should remain voluntary, sponsors could be required to initially enroll new workers; this would ensure that workers who opt out are aware of their eligibility and affirmatively deciding not to participate.
End distinctions between DC plan types: Current tax code provisions create antiquated distinctions between different contributory pension schemes based on the identity of the employer. These differences go beyond the various contribution and compensation limits in I.R.C. sections 401(a), 415(c) and 402(g); they include differences such as whether various plans offer loans, or can be rolled over to an IRA. Whether or not the distinctive identities of 401(k), 403(b) and 457 plans are eliminated, it ought to at least be easy for an employee to transfer his or her account balance from one plan type to another (as well as to an IRA) when changing jobs.