IMHO: Savings “Bonds”

In my experience, there are three major reasons that people save for retirement.   

There’s the lure of the “free money” represented by the employer match, the benefit in deferring the payment of taxes, and there’s the hopefully obvious benefit of helping make sure you have enough money set aside to provide a financially satisfying retirement.  While one might hope that the last represents the dominant motivation for most, I suspect it’s almost incidental.

Anecdotal evidence would suggest that the match exerts a powerful influence on savings behaviors.  Sure, any number of participant surveys emphasize its importance as a factor, but to my eyes, the most compelling evidence is the clustering of participant deferral rates—in plan after plan—at the level at which the employer has deigned to provide that financial incentive.

As for the tax advantages, outside of Warren Buffett, I can count on one hand the number of individuals of my acquaintance who feel they are “under-taxed.”  More importantly, I can still remember the first time I had someone explain to me how not forking over a chunk of my hard-earned pay to Uncle Sam now made it possible for me to save more without actually reducing my take home pay.  Moreover, how that “extra” savings, through accumulated earnings and the “magic of compounding,” could help my savings grow even more, and even faster.1  It was then—and remains, IMHO—a powerful incentive for individuals to save.

That said, of late, the taxation of these contributions—or perhaps, more accurately, the TIMING of the taxation of these contributions—has been much on the minds of those looking to solve the nation’s debt situation by raising revenue, most notably in the so-called “Gang of Six” proposal’s reported adoption of the National Commission on Fiscal Responsibility and Reform’s notion to cap annual “tax-preferred contributions to [the] lower of $20,000 or 20% of income” for 401(k)-type retirement plans.” This stands in sharp contrast to the current structure, where the limit on the combination of employee and employer contributions is the lesser of a dollar limit of at least $49,000 per year and 100% of an employee’s compensation. 

Simplistically, it’s hard to imagine that many workers today are setting aside 20% of pay for retirement.  Even someone who is deferring 6% and receiving a very generous dollar-for-dollar match would presumably still be well within the comfort zone of those new limits.  The $20,000 cap is, of course, more problematic.  Still, I’m sure that those who proposed that cap of $20,000—particularly when the current limit on pre-tax deferrals is $16,500, and the median deferral less than half that sum—think it won’t matter much to “regular” folks.  At least they might have thought so, had they not paid mind to a recent analysis by the nonpartisan Employee Benefit Research Institute (EBRI), not just for the highly compensated, but for those who today may not be, but who would hit those limits during their later working years (see Capping Tax-Preferred 401(k) Contributions Would Hurt Workers).  

Indeed, when you examine EBRI’s projections, you begin to appreciate the truly insidious impact those kinds of limits would impose on savings over time—all to satisfy the kind of accounting gimmickry that allows lawmakers to claim they have saved the taxpayer money by generating revenue in the near-term while completely ignoring the long-term collections, and longer-term implications of such a shift in policy.2

A focus that IMHO is, as that old English proverb once cautioned, penny-wise—and pound foolish.

1 Of course, in those days, we were also being told that when we withdrew those funds, we’d likely pay taxes at a lower, post-retirement rate—a message that I’m betting has fallen by the wayside in most enrollment meetings these days.

2 For an expanded analysis of the impact, check out “ASPPA Speaks out against Retirement Measures in Budget Proposal” , as well as ASPPA’s report on “Retirement Savings and Tax Expenditure Estimates”.