Come next year, the way you save for retirement might look a lot different. And depending on who wins the election, the government might try to help with it.
A little background: A couple of weeks ago, I read how the Obama campaign has drawn some of its ideas from behavioral economics, especially in connection with possible changes to retirement savings laws.
I found that very interesting. Behavioral economics is a relatively new field of study that looks at people's decision making, particularly regarding money, and at the ways in which that decision making could be improved. In recent years, this thinking has started to make its way into retirement plan design, and if Senator Obama has his way, that process will accelerate.
Is that a good thing? That depends on your perspective.
Getting everyone on the retirement savings bus
One of the biggest challenges faced by retirement-savings advocates is getting people started in the first place. Every year, Fidelity Investments issues an in-depth report on the state of 401(k)s in America, and for the past several years, only about 63%-65% of eligible employees are enrolled in their company's plan.
The obvious answer to this challenge is auto-enrollment -- sign everybody up automatically and get them contributing unless they take action to opt out. In other words, make it easier to succeed with retirement saving than to fail. Companies have been somewhat slow to adopt auto-enrollment, but according to his campaign website, Obama's proposal would require companies to do it. He'd go even further, requiring any company without a 401(k) to set up direct-deposit IRAs for their employees. Employees would be able to opt out, but the campaign website claims that the number of low- and middle-income workers that would save for retirement could rise from 15% to 80%.
Free money … for some
But wait, there's more: Not only would folks in the lower income brackets start saving, but they'd also get a match.
It's long been conventional wisdom that matching the first few percent of an employee's retirement plan contributions is both an attractive employee benefit and a great incentive for participants to set their savings rate at a reasonable level. The Obama proposal calls for a federal match -- 50% of the first $1,000 of savings for families that earn less than $75,000.
Winners and losers
From a participation perspective, these two proposals seem pretty sound -- the devil is in the details, of course, but as written, I think they make sense and should work roughly as advertised. Whether they're a good idea from a larger perspective is a more complicated question.
That match will cost money, as will adding more participants to existing defined contribution plans. And the IRA requirement will be a bureaucratic burden on tiny businesses that already struggle to keep up with government-mandated paperwork.
But these proposals will definitely get more people saving for retirement. What they won't do, by themselves, is teach folks how to save well.
What Obama doesn't propose
Successful retirement investing takes more than just making those monthly contributions. As I've noted before, many plans with auto-enrollment put those automatic contributions into a money market fund or similar "stable value" investment -- unless the participant opts to invest in something more aggressive. That's a problem.
As we all know, 30 years in a money market fund earning, say, 4% a year is not going to look good next to a basket of stocks, even conservative stocks. For simplicity's sake, let's look at the performance of a $7,000 lump sum invested 30 years ago, with no contributions since:
|
Stock
|
Initial Investment on 9/8/1978
|
Value on 9/9/2008
|
|
American Express (NYSE: AXP )
|
$1,000
|
$34,450
|
|
General Motors (NYSE: GM )
|
$1,000
|
$1,744
|
|
Dow Chemical (NYSE: DOW )
|
$1,000
|
$18,649
|
|
Merck (NYSE: MRK )
|
$1,000
|
$45,787
|
|
IBM (NYSE: IBM )
|
$1,000
|
$13,253
|
|
Citigroup (NYSE: C )
|
$1,000
|
$19,464
|
|
Xerox (NYSE: XRX )
|
$1,000
|
$3,668
|
|
Stock portfolio total
|
$7,000
|
$137,015
|
|
Money market fund at 4%/year
|
$7,000
|
$22,704
|
Source: Yahoo Finance.
As you can see, the difference is dramatic. Getting people to save for retirement is a good first step, but getting them to invest successfully is something else.
And while it's probably not wise for the government to require folks to invest in the stock market, even as an opt-out default, it's clear that even if these proposals emerge from Congressional sausage making intact, there will still be a need for participant education that points out the advantages (and risks, of course) of investing in the stock market.
Which is good, because I'd hate to be out of a job.
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