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[Gene GeRue <genegerue AT ruralize.com>]

How to Retire Rich

Published: January 16, 2005

If you are like most people, your sadness over losing, say, $1,000, would 
be twice as great as your happiness at winning $1,000. That all-too-human 
tendency to feel the pain of a loss more deeply than the joy of a gain is 
called "loss aversion" and is one of the central discoveries of behavioral 
economics - a branch of the dismal science that recognizes that when it 
comes to money, people are motivated by various impulses that are 
measurable and even predictable, but seldom rational.

Behavioral economics has vital implications for retirement savings. But in 
his zeal to privatize Social Security - a quest which is itself driven more 
by ideology than economics - President Bush is obscuring better approaches 
to a comfortable retirement for all Americans.

We all know that the benefits from Social Security do not provide enough 
income for a comfortable old age. But they do provide a guaranteed basic 
level of financial stability for all old people and, in so doing, enhance 
the socioeconomic well-being of everyone. And for the large majority of old 
people for whom Social Security makes up more than half of income, it is 
the difference between destitution and the ability to live with dignity. 
Clearly, the reliability of the income stream is critical. Mr. Bush does 
not want you to believe that such social and financial stability is 
possible. In a forum last Tuesday aimed at persuading "younger folks" to 
support privatization, he said that Social Security would be "flat broke" 
in the coming decades. That is false. The system's trustees expect that 
even if nothing whatsoever is done, the current system will be able to pay 
full benefits until 2042, when it will be able to pay 70 percent of the 
promised benefits. The independent Congressional Budget Office is even more 
optimistic. Of course, no one is suggesting that no reforms be made. But 
modest, straightforward tax increases and benefit cuts, phased in over 
generations, are all it would take to bolster the current system.

•

As the Social Security safety net is strengthened, it is also essential for 
government and business to work together to make it easier for everyone in 
the work force to increase personal savings. Unfortunately, the coming 
fight over the president's plan for privatization will very likely draw 
attention away from the simple and uncontroversial changes that would help 
people prepare on their own for their retirement years, including:

Automatic enrollment About half of employees work for employers who provide 
401(k) retirement savings plans. But only three-quarters of eligible 
employees participate, and of those, participation is steeply skewed toward 
high earners.

The evidence from research is overwhelming that participation increases 
significantly if employees are automatically enrolled in the 401(k), rather 
than being required to sign up, as is usually the case. (Employees would be 
free to opt out if they did not want to participate.) One typical study - 
by Brigitte Madrian, an economist at the Wharton School, and Dennis Shea, 
compensation and benefits specialist at Aetna - analyzed a Fortune 500 
company that switched to automatic enrollment in early 1998. By mid-1999, 
overall participation increased to 86 percent from 36 percent. The jump was 
especially striking among low-income workers, with participation rising to 
80 percent from 12 percent for people making less than $20,000 and to 83 
percent from 24 percent for those making $20,000 to $30,000. Participation 
also soared among younger workers. Studies show that participation rates 
stay high once employees are enrolled.

Automatic enrollment overcomes procrastination, a natural response to 
something deemed painful, such as giving up some take-home pay to save for 
retirement. It also overcomes "status quo bias," which tends to keeps 
nonparticipants from opting into a plan once they've passed up a chance to 
do so.

Automatic allocation The next obstacle for would-be savers is the explosion 
of choices within 401(k)'s and other retirement plans. A typical plan now 
lets employees choose among 15 stock, bond and cash accounts. Too much 
choice leads to paralysis, a response that is especially common among low- 
and middle-income savers. As a result, employees in the lowest 25 percent 
of earners generally invest most of their accounts in low-yielding money 
market or bond funds. An easy solution is to offer employees an option to 
have their contributions automatically invested in balanced, prudently 
diversified, low-cost funds.

Automatic escalation Over all, only 5 percent of employees contribute the 
maximum allowed by their plans. Status quo bias makes it unlikely that an 
employee will change a contribution later. Loss aversion deters an employee 
from increasing the percentage even after a raise, because an increased 
payroll deduction may be perceived as a pay cut. The fix is to enroll 
employees in a program that automatically increases the percentage of pay 
whenever they get a raise.

•

The Bush administration has put forth two fine ideas for increasing 
personal savings outside of Social Security, but has not pursued either to 
the fullest. One would let taxpayers instruct the Treasury to split their 
tax refunds, which average about $2,000 a year, between a checking account 
and a savings account. Alas, the administration has not enacted the 
proposal, even though it requires no new legislation.

The other positive initiative was enacted in 2001 and offers a matching tax 
credit for retirement savings by low- and middle-income taxpayers. 
Unfortunately, the credit suffers from several design flaws. For instance, 
only people who earn enough to have a tax liability qualify for the credit. 
That requirement eliminates 80 percent of the 60 million lowest-income 
filers. Expanding eligibility to that group would cost the government about 
$5 billion a year, bringing the total annual cost of the credit to a 
relatively small $7 billion.

For the most part, however, the administration's savings initiatives, such 
as the retirement savings account, are totally off the mark. Their main 
feature - lofty new upper limits on the amount of savings that can be 
tax-sheltered - has little or no effect on the vast majority of families 
and individuals. In 2001, the Government Accountability Office found that 
raising the contribution limit on 401(k) plans benefited fewer than 3 
percent of participants, most of whom were making more than $75,000 a year.

Social Security privatization and tax incentives for the affluent have 
another major drawback that endangers everyone's retirement security. 
Neither would add to national savings - the sum of government and 
individual savings that is a key determinant of the nation's overall 
standard of living. Privatization would not add to national savings because 
every dollar that goes into a private account would be offset by the 
government borrowing needed to establish the private system. Tax incentives 
for the rich do not add to national savings because they simply induce 
wealthy people to shift current assets from taxable to tax-free accounts.

Put more simply, with privatization and continued high-end tax breaks, the 
few would get richer as the many fall behind. Preserving Social Security 
while increasing savings outside Social Security is a better way to achieve 
a prosperous retirement.

http://www.nytimes.com/2005/01/16/opinion/16sun1.html