Designing a Universal Voluntary Retirement Account program

Universal Voluntary Retirement Accounts provide a simple, easy solution to the retirement savings dilemma facing today’s workers. The program offers a convenient way for individuals to save for retirement and enables small businesses to remain competitive by offering a retirement savings program for their employees. UVRAs can provide IRAs for any individual worker who chooses and small employer plans for businesses that wish to offer that option to their employees.

UVRAs are molded after successful deferred compensation plans currently available to state employees. Administrative systems are in place in state retirement systems. This proposal offers a convenient, simple solution to help provide long-term financial security for retirees.

Plan design is the key to providing easy to understand options.  In fact, research shows too much choice lowers workers enrollment in plans.  A universal retirement account should provide a few basic options from which to choose, in conjunction with basic financial education, in order to help new investors better allocate their retirement contributions.

Default investments: Each worker should be presented with a default investment – that is, an automatic decision about where a worker’s contribution goes in the case the worker makes no decision, with the option to modify that selection anytime in the future.

Such a default could be set up in several ways. One would be a more conservative or very safe approach, in which the automatic choice is a fund that is designed to at least keep up with inflation and perhaps return small additional amount. These are sometimes referred to as “principal preservation accounts.” Contributions are invested in high rated bonds, money market accounts and other stable investments.

A second approach might be what are often called “life cycle” funds, in which workers choose a fund based on their target retirement date. For example, a worker who is 38 years old in 2008, and plans to retire at age 70 in 2040, would choose a life cycle fund for that target year. It would utilize a mix of investments that varies over time. In the near term the fund leans toward riskier investments that offer the opportunity for larger returns. As the worker ages, the fund automatically changes the mix of investments to preserve capital and eventually generate regular income after retirement.

Automatic enrollment: The most important benefit of automatic enrollment is that it gets workers started investing. When people start putting money into their retirement accounts, they tend to continue to invest. People who don’t start now or when starting a new job, most often don’t begin investing. If state voluntary retirement accounts allow or encourage automatic enrollment, participation and savings rates will rise and the program will better achieve its goals.

Officials in private companies began using automatic enrollment in 1984 as a way to increase participation,  and it has dramatically increased the number of employees that participate in their company’s retirement plan.  The Pension Protection Act provides additional support for employers to use this strategy to get employees started with saving and investing for retirement. Since its passage in 2006, the use of automatic enrollment has increased dramatically.Vanguard reports that in August of 2008, more than 300 plans they administered in 2007 had automatic enrollment. This is triple the number from 2005.

Payroll deduction: Deducting funds electronically from a worker’s paycheck provides several benefits. First, workers are less likely to feel a loss of income when the money does not come into their personal accounts and then back out, and so are more likely to participate. Second, employers for the most part already have electronic systems in place to directly deposit paychecks and pay various taxes. Adding an electronic payment by the worker for a retirement plan can happen at minimal cost to the employer. Third, it reduces the cost of administering the program by relying on an electronic rather than a labor-intensive paper process.

Pre-tax contributions: UVRAs offer several tax benefits for workers. First, workers are able to put their earning into retirement savings prior to it being taxed, lowering their tax bill. Second, the money that would have been paid in taxes is put to work growing the nation’s economy through investment. Setting money aside for retirement prior to paying taxes has major benefits over time. The money that would have been paid in taxes is instead earning returns in an investment. In retirement, most people’s income requirements are much lower, so when withdrawals are made, they are taxed at a lower level than they would otherwise have been.

Portability: Today’s worker is expected to hold an average of more than 10 jobs during their lifetime.  A mobile workforce needs to be able to continue to invest in retirement savings from job to job. The Universal Voluntary Retirement Account is designed to be able to follow the worker when he/she changes jobs.

Low account fees: The fees that are charged on defined contribution plans are of profound concern; congressional committees have recently held hearings on hidden fees in 401(k)s, in which fees may average as much as 2-3% or more. State government officials will be able to use the economies of scale realized from many investors to negotiate low fees.

Note: This is the fourth in a four-part series based on EOI’s report Stronger Nests, Bigger Eggs. View part 1 here, part 2 here, part 3 here.

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Posted in A Fair Deal at Work, Retirement Security, Retirement Security Accounts

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