BW Online, FEBRUARY 18, 2003

COMMENTARY
By Aaron Bernstein

Bush's Retirement Rx Is Bad Medicine



The far more liberalized rules he's proposing sound good -- until you realize how many people could wind up with no savings at all



The Bush Administration's ambitious proposals to overhaul the U.S. retirement system are designed to get Americans to save more for old age. By replacing the familiar 401(k) with a more flexible plan and creating several new ones, the White House hopes to offset the long-term decline in retirement security that began more than two decades ago (see BW, 2/24/03, "The Investors' Dream Act of 2003").

The more companies and experts look at the new schemes, however, the more worried many are becoming that the net result could be fewer Americans saving for retirement, not more. The reason: The new plans would remove many of the incentives small-business owners now have to set up 401(k)s or other nontaxable savings plans for their employees. Even large employers might wind up abandoning 401(k)-type plans in favor of the proposed new ones, leading many employees to stop saving for retirement.

As a result, the ranks of Americans without a retirement plan could soar -- especially among low- and middle-income workers, already the least likely to put money aside. "Employers are worried about undercutting our current retirement system," says Janice Gregory, vice-president of the ERISA Industry Committee, a Washington (D.C.) pension lobbying group for large companies. "Most big companies are in favor of encouraging savings, but not this way."

BOOST FOR THE RICH.  The Administration's proposals surely would be a boon for higher-income employees, who would be free to sock away a lot more in tax-exempt accounts -- up to $30,000 a year -- than under current law. That means much of the billions in new tax cuts provided by Bush's plan would wind up in the hands of those who already have extra cash -- boosting the retirement security of those who need it the least even as those who save little lose out, note some labor economists.

While 401(k)s have done an inadequate job of boosting the number of Americans with retirement plans, the new schemes would slice away many of the incentives they do provide. Right now, most small-business owners can get a 401(k) for themselves only if they also include their employees, under so-called nondiscrimination rules. The same goes for most other tax-exempt savings plans.

Bush's proposed Lifetime Savings Account (LSA) would allow anyone to put away $7,500 a year with tax-free withdrawals at any time -- plus another $7,500 for their spouse. A second proposal, called a Retirement Savings Account (RSA), would allow employees -- including small-business owners -- to stash an additional $15,000 a year, with no taxes due after age 58.

"NO-BRAINER."  "That's probably enough for most small employers, who could jettison doing anything for their employees and still get enough of a tax break," says Jack VanDerhei, a Temple University business professor affiliated with the Employee Benefits Research Institute, which studies benefit plans. "It's a no-brainer that 401(k) coverage will drop as a result."

Certainly, no small-business owner is likely to set up a new 401(k) under such circumstances. The real question is how many existing 401(k) plans would be ditched. Most likely many would, since small companies usually have to shell out at least several thousand dollars a year just to run a 401(k), not to mention all the paperwork hassle.

The result could devastate 401(k) coverage, since about 350,000 of the country's 400,000 401(k) plans have less than 100 employees, says David Wray, president of the Profit Sharing/401(k) Council of America, an employer group that promotes employee savings.

NO PENALTIES.  Some large employers might ditch 401(k)s, too. Bush's proposal would automatically convert existing 401(k)s into something called an Employer Retirement Savings Account -- basically a 401(k) with a little more flexibility. ERSAs would retain a key 401(k) feature: requiring employers to do annual nondiscrimination tests to ensure that lower-paid employees are participating in the system. If they're not, the company must cut back on the amount higher-paid workers can save. This provides employers with an incentive to match employees' 401(k) contributions, to lure lower-ranking workers to sign up.

Many employees will probably prefer to put their money into an LSA, however, which, unlike a 401(k), allows withdrawals at any time with no tax penalty. Most workers whose companies offer no 401(k) match would be crazy not to. Even some who do get a match might prefer to give up that extra money in exchange for having access to their savings for emergencies or other needs.

However, if too many lower-paid workers bail out, the ERSA won't pass the nondiscrimination test. So even some large employers might wind up abandoning the idea. Theoretically, the low-wage workers who leave the system could save just as much in an LSA or RSA, at least if you discount any employer match they give up. But without the discipline of a regular payroll deduction, many are likely to slack off on saving over the long haul, experts warn.

BUY A CAR.  Of course, those employees who know they can't save on their own but were forced out of an ERSA because their fellow employees abandoned it would have no choice in the matter. "Many low-wage workers won't save on their own, and if they do [under the new plan], it won't be for retirement, since they could use the money for anything, emergencies, cars, whatever," says Wray.

The Bush Administration is right to focus on the need to reverse the long-term slide in retirement coverage. But a growing chorus of experts say that goal might be better served by directing the proposed new tax cuts into the current system, instead of inventing a flawed new one.


Bernstein is a senior writer covering labor and workplace issues from Washington
Edited by Douglas Harbrecht



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