Towards a Sensible System for Saving
41 Pages Posted: 20 Apr 2007
Date Written: 2006
The American system for saving is propelled by one incentive highly favored by Congress: the special plans for saving now found throughout the tax code. The history of savings plans is short but Congress has created more plans in the last ten years than in any prior period. There are now eight plans for retirement saving: 401(k)s, SIMPLE 401(k)s, 403(b)s, 457(b)s, the Thrift Savings Plan, SIMPLE IRAs, traditional IRAs, and Roth IRAs. Congress recently added savings plans for education, 529 plans and Coverdell IRAs, and its latest initiative is a savings plan for healthcare, health savings accounts or HSAs.
This brief describes the history of current plans and the savers who use them. By some measures, savings plans are a success. They now dominate the private pension system, are highly valued by employees, and have introduced millions to equity investing. Yet, savings plans also exhibit notable flaws and weaknesses:
- Work-based intermediary plans induce saving but many Americans have no savings plan at work.
- Low-income workers are often excluded from work-based plans.
- Most saving occurs in work-based intermediary plans. Few workers use open access plans as a substitute.
- The best predictor of participation in a savings plan is income.
- Savings rates vary widely but average savings rates are low among both lower and higher income savers.
- Increasing contribution limits does not induce more saving.
- Account accumulations are low. Whether current plan designs can induce adequate saving is debatable.
- Matching contributions are a puzzle. Thought to induce more saving, they often don't.
- Complex investment menus deter participation and result in investment paralysis.
- The economics of plan investment and administration are poorly understood by both savers and employers.
To make these plans a universal success requires building a more sensible system for saving. The brief discusses proposals to improve the current system and concludes that a new agenda will be required for the next generation of savings plans. Step one in that process means striving for simplification. Step two means building better plans. Step three means recognizing that what really matters the most for saving in the long run are outcomes. Traditionally, savings plan design has focused almost entirely on the first stage of saving - contributions and their tax incentives. But contributions alone do not make savings plans effective. A more sensible system for saving would set specific savings objectives and design plans capable of achieving them.
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