Thursday, December 12, 2013

Whose Savings Is It Anyway?

Have they got a deal for you! (at your expense, of course)

'Tis the season of giving, and Congress certainly gave us a mess instead of simplicity when it comes to saving for retirement. Traditional IRA. Rollover IRA. Inherited IRA. Roth IRA. Inherited Roth IRA. 401(k). 403(b). SARSEP. SEP. SIMPLE. Ugh.

College savings is a little more straightforward. Like a lot of families in the Commonwealth, we save for our kids' college expenses via the Virginia529 Plan. We're fortunate to have a high-quality, highly rated plan with relatively low costs. Savers in other states aren't so lucky.

But Virginia529's costs are higher than they need to be. If I could go directly to an investment firm, I could avoid all the processes and fees of a state-chartered middleman. In fact, Virginia529 seems quite proud of its expanding overhead:
Virginia529 is the largest Section 529 plan in the country and our staff continues to grow as our accounts grow. Our diverse team includes professionals in Administration, Compliance, Finance, Human Resources, Information Technology and Legal divisions.
Virginia529 has two plans: inVEST and prePAID. And if I don't like Virginia's plans, I can shop for 529 plans in other states (though I won't get the Virginia income tax deduction).

Saving for retirement is far more complicated and choices aren't equivalent. For instance, I'm 52 and I can save (with some restrictions) up to $6,500 each year in an IRA. But if my employer offers a 401(k) plan, that annual limit is currently $23,000. So under my employer's plan – which, by the way, has a cost to my employer and limits my choice of investments – I can save $16,500 more each year than if I do it myself? Makes no sense to me.

Complexity, loss of control, and fewer options bring confusion, inertia, and complacency.

We're often told that Americans don't save enough, and a lot of what we do save is locked up in owner-occupied housing. It's curious that our income tax systems encourages us to take on debt – dissave, if you will – by subsidizing housing through the deductibility of mortgage interest and other programs. Trust me: I'm not suggesting that we need more subsidies by subsidizing savings. But government programs shouldn't encourage indebtedness so we "invest" in a single undiversified, immobile, illiquid asset such as housing.

My preference is for anyone with a Social Security number to contribute up to $25,000 a year in a unified tax-deferred account that can hold cash, bonds, and stocks. All gains in that account would remain tax deferred until withdrawn and then taxed at that individual's income tax rate. For most full-time students, that's basically tax free. For retirees, that withdrawal would be at a lower tax rate than during their working career. And for everyone else it would encourage saving over consumption because that money's getting taxed when it comes out of the account. Easy.

Sure – 529 plan administrator won't like this idea because they're out of a job. Same thing for 401(k) and 403(b) plan administrators. Employers will like the idea because they won't have to sponsor and pay for retirement plans. And savers will like the idea because they'll have more choice with less confusion and higher returns (from lower costs).

In 2002, Congress implemented dynamic scoring to estimate the revenue and economic effects of tax proposals. Since tax-deferred retirement savings are imbedded in the tax code, perhaps Congress could also score the favoritism imparted by proposals that take us out of the driver's seat when saving for the future.