Analysts look at advisory board's proposals to repair federal retirement system

Paul Volcker

BOSTON -- Paul Volcker and his troupe, the President's Economic Recovery Advisory Board, are unlikely to appear on the "America's Got Talent" stage any time soon. But retirement experts are giving the group, which just issued a 188-page plan to fix the nation's complicated retirement system, mostly high marks for their effort.

Volcker, et al., recently laid out eight ways to simplify incentives aimed at encouraging U.S. workers to save for their retirement. Here's a look at those proposals and what experts had to say in reaction.

"We believe these proposals will produce greater 'retirement readiness' for Americans within the existing framework of workplace-based retirement plans," said John "Jamie" Kalamarides, a senior vice president of retirement strategies and solutions at Prudential Retirement.

Consolidate retirement accounts; simplify rules

One reason saving for retirement is confusing is because there are so many different types of retirement accounts, including IRAs, 401(k)s, 403(b)s and SEP-IRAs. It can be hard to figure out whether you're eligible to contribute to a particular account and how much you can contribute.

"It makes a lot of sense to look for ways to consolidate different types of retirement-saving accounts, such as 401(k), 403(b), 457, and the like," said Peng Chen, chartered financial analyst and president of Ibbotson Associates. "These plans by and large serve the same purposes, with slight differences among them."

Others, however, see it differently. "The American workplace is very diverse, and the range of plan types reflects that diversity," said David Wray, president of the Profit Sharing/401(k) Council.

Integrate IRA and 401(k) contribution limits

One proposal would allow all workers irrespective of income to contribute to either or both an IRA and an employer-sponsored plan. In addition, Volcker's troupe proposed that nondeductible IRAs be eliminated since income limits on contributions would be removed.

Wray criticized this proposal, noting that "only a small percentage of lower paid workers not eligible for plan participation save in IRAs, and if they do, the current IRA limits are sufficient for them."

Consolidate and segregate nonretirement savings

Volcker and the advisory board also called for consolidating all nonretirement savings programs, including Section 529 plans (whose rules are set by states and vary widely), Coverdell IRAs, health savings accounts, Archer medical savings accounts and flexible savings accounts, under a single instrument. Contributions to this instrument could be tax-deductible up to a limit, as is currently the case for health savings accounts.

Somewhat surprisingly, none of our experts praised or criticized this proposal.

Improve savings incentives; expand auto-enrollment

The Volcker group also suggested designing the saver's credit to be more like a match, to increase its effectiveness as a savings incentive. This tax break provides a subsidy to low-income workers who make voluntary contributions to retirement plans. At least one expert agreed that changes to the saver's credit would be beneficial.

"Converting it to a match would make it more effective, both from the standpoint of encouraging more contributions and from the standpoint of getting the tax benefit into the individual's retirement account rather than his checking account," said Kaye A. Thomas, the founder of Fairmark Press Inc. "The cliffs in the current arrangement are brutally arbitrary, so a phase-out would be far better even if somewhat more complicated."

But Wray cited two problems with a saver's credit match. One, logistical reasons. "For example, those eligible for the credit are among our most mobile workers," Wray said. "The matches by definition will be made after the end of the tax year when as many as 20 percent of those eligible for the match will have changed employers. It will be a mess trying to match them with the right plan if they are even in a plan when the match arrives."

Two, it won't change behavior, he said. "Those eligible for the current credit and not saving in their plan are mostly trying to figure out how to afford to buy shoes for their children," he said.

Reduce retirement "leakage"

Volcker's panel proposes a rule requiring that, when a worker leaves a job, his account balance be retained in the existing plan, be automatically transferred to an IRA account or get moved to an account with the new employer.

Volcker's "automatic rollover" would ensure that all amounts put aside for retirement continue to grow.

Wray had plenty to say against this proposal. "Pre-retirement access to funds is critical to get employees, especially younger, lower-paid employees, voluntarily to give up scarce dollars today for a benefit decades away," Wray said. "Locking down participant money until retirement in my opinion would greatly reduce retirement savings."

Simplify rules for employers sponsoring plans

One idea: simplify the so-called nondiscrimination test, for example by simplifying the definition of a highly paid employee and to provide a standard safe harbor to avoid these requirements.

An alternative proposal is to repeal nondiscrimination rules entirely and require all plans to meet a safe-harbor standard. Right now, plenty of highly compensated employees can't contribute more than the maximum allowed to retirement accounts because of the nondiscrimination test.

Wray nixed this proposal as a nonstarter. "Our system is a voluntary one," he said. "Employers need the flexibility to design plans that work for their workforce and their organization."

Simplify disbursements

Volcker's group called for eliminating minimum required distributions (MRD), which have among the most complicated rules on Earth, for individuals with retirement assets below a threshold. Right now, most retirement account owners are required to take a distribution after turning 70 1/2 years old.

The proposed change would relieve many taxpayers from burdensome regulations at a relatively small cost. Experts in general praised the proposal, though it may not go far enough.

"Excusing some from the MRD requirement is a positive step, as this requirement ought to be totally repealed," Wray said. "The MRD requirement was imposed to increase the collection of federal taxes. It is bad public policy when people are living longer and longer."

Others agree with Wray. The proposal "makes sense both from the standpoint of simplicity and from the standpoint of helping people with inadequate retirement savings to preserve those savings," Thomas said.

Simplify taxation of Social Security benefits

The Volcker gang says simplifying the formula for calculating the tax on Social Security benefits would reduce the compliance burden on older taxpayers and improve economic efficiency.

Right now, trying to figure out Social Security benefit taxes is the near equivalent of those exercises designed to keep your brain fit in old age.

"Making tax filing easier for seniors would be nice but this change would have little macro impact," said Wray.

Others had a different take. "The taxation of Social Security benefits is unnecessarily and almost absurdly complicated," Thomas said. "Simplification is long overdue."