Came across this opinion piece on Newsweek and felt the strong urge to share it! The author, Mr. Joe Hipsky, not only raises excellent and crucial questions but offers solutions that promise to be feasible and realistic, backed by statistics and evidence. The title is slightly misleading because it sounds like Hipsky merely presses the alarm button to simply wake us up. Not true, his is a rare piece with both alarms and suggested solutions.
From Inaction to Default Investing
It is an open secret that the Social Security system as a safety net has long been porous or “Social Insecurity.” We may not have a “retirement crisis” across the board for all taxpayers but definitely for some. “Twenty-one percent of the population do not have any savings left for retirement or even emergencies.” The same people who have no money for emergencies today are definitely unprepared for retirement tomorrow. Jimmy Carter, perhaps the most descent guy among the US presidents, said it well, “The measure of a society is in how they treat their weakest and most helpless citizens.” In reality however, some of the weakest and most helpless citizens also have more financial inertial than others. This must be addressed in order to enable everyone to help oneself.
Hipsky also points out the trend of the “great resignation” that, if nothing else, will push retirement concern further to the back burner. Generational difference is also real, “Those born in the baby boom generation often have huge savings as a result of an exploding housing market, and candidly, better financial habits. Today’s young employees will not be so lucky on the housing front and often don’t even know where to begin on basic financial fundamentals.”
More Financial Talks at Dinner Tables
Chinese has a saying that if you don’t take care of money, money will pass you by (你不理财, 财不理你). While the Chinese think of money too much, almost exclusively, I wish American families were thinking and talking about financial issues at the dinner tables more frequently. Unlike politics, celebrities or foreign affairs, individual family has a lot more direct control over their own financial health. For example, say a family becomes aware of the dwindling amount of funds in social security at tonight’s dinner table, they could start saving tomorrow. Kids need the early exposure to financial talks but if parents do not teach them it will be too late or too little to rely on schools to make citizens financially ready to the real world. I also wish more celebrities making book recommendations to cover not just personal inspirations, social psychology, Sci-fi or other fictions but books of life hacking skills.
The Good & Bad News
So, what are the solutions to the partial retirement crisis? Hipsky was right that “it is the responsibility of each individual to do their part to help maintain that safety net. That’s the social contract.” But what about people who do not want to save for the future or for emergencies? Merely telling them that they must hold their end of bargain for an efficient social contract to work helps little. Some may even contest that their financial decisions are none of the business for anyone else.
The good news is that “a lack of savings is overwhelmingly habitual, not a capacity issue, and all of these problems are fixable within the framework that exists today. No reset button required.” In other words, all we need is a little nudge from the government, as “(T)here are two things that it can do that would materially change things for the better. The first is to implement automatic retirement enrollment across the board” and “the government can do one more thing: reform Social Security.” Essentially, Hipsky suggests to “add an individual account for each taxpayer that is invested and managed on their behalf where, similar to Social Security, it can’t be accessed until retirement.”
An Easier Job Through Existing Options
In my view the job is even easier than Hipsky has suggested. There is no need to “add an individual account for each taxpayer” because we already have options or investment channels for virtually everyone. True, according to this article of Investopedia one third of the US private workers do not have 401(k). But these people are not being ignored by the Congress.
First of all, if they are small businesses owners or sole proprietors, they are entitled to the so called independent or Solo 401(k). According to this article, IRS “allows individuals to put aside $19,500 in 2021 and $20,500 in 2022 in an individual 401(k). Those 50 and older can put away an additional catch-up contribution of $6,500 each year.”
The law has been generous to these taxpayers I must say, because “(a) person who works for one company (in which they have no ownership) and participates in its 401(k) can also establish an independent 401(k) for a small business they run on the side.” That means they will have two streams of 401(k) money when they retire, one regular and another independent — if they do save the money to take advantage of these opportunities and if the total investment in both 401(k) plans does not exceed the IRS contribution limit each year. This article is right to claim that “(j)ust because you are a one-person outfit, a freelancer, or an independent contractor doesn’t mean you have to do without a retirement savings plan or the tax benefits that accompany them.”
Another option is Simplified Employee Pension or SEP, which came earlier than the Independent or Solo 401(k). According to this article , “(t)he amount that can be contributed is the lesser of up to 25% of business revenue—20% in the case of a sole proprietorship or a single-member limited liability corporation (LLC)—$58,000 for 2021 and $61,000 for 2022).”
Finally, if nothing else works out, individuals can always resort to Individual Retirement Accounts or IRA, either traditional or Roth. This article says “Whether you have a traditional or Roth IRA, the annual contribution limits are the same. For the tax years 2021 and 2022, you can contribute up to $6,000, or $7,000 if you’re age 50 or older—a “catch-up” contribution for employees approaching retirement age.”
Investing or saving $6,000 a year does not seem a lot, but “if you contribute $6,000 to your IRA each year starting at age 25, you’d have about $1.2 million saved by age 65, assuming a 7% annual rate of return on your investment. However, if you wait until age 35 to start saving, you’d have less than half that amount—$567,000—by the time you hit age 65.” True, very few would start saving for retirement at age 25, nor even 35 — if the investment decision is left to oneself. Once again, government is at the best position to step in to help individuals make opt-in choice by default, promote regular and incremental investment over taxpayers lifetime through monthly payroll deductions, just like we do for Social Security.
IRA Has Been an Underused Option
We have learned it the hard way: If we simply ask people to invest a lump sum into IRA before April 15th of each tax year, many won’t do it. This is happening year after year, many households who are eligible for owning that account are not actively contributing to that account. This research report by Investment Company Institute (ICI) provides some shocking number: “Although most US households were eligible to make IRA contributions, few did so. Only 12 percent of US households contributed to traditional or Roth IRAs in tax year 2019, and very few eligible households made catch-up contributions to traditional IRAs or Roth IRAs.” Overall, “In mid-2020, 37 percent of US households owned individual retirement accounts (IRAs)” despite anyone can own both 401(k) and IRA at the same time.
While the story on the contribution side is disappointing, partly due to confusion of the tax rules plus financial inertia, the story on the distribution side is encouraging, as most withdraws from the IRAs are retirees, which is the way it should be. Now the government can do its job by setting up default payroll deduction IRA investment scheme, instead of letting individuals figure out whether and when they can contribute. If an individual does not have an employer but makes the IRA contributions year after year, even within the current contribution limit of $6,000 a year can still accumulate considerable total amount for retirement. The key is to do it regularly, steadily and incrementally, do not spend all the money one currently makes but put some away for tomorrow.
Regular IRA contributions do not necessarily mean the same amount year after year. Depending on individual situation, the annual IRA savings should allow lapses from time to time. Better yet, one can save a fixed percentage of monthly earnings rather than a fixed sum. If some months see higher earnings while other months lower, individuals will still have the balanced accumulation over time. Furthermore, the “social IRA accounts” administrated by government should allow easy rollover to 401(k), both regular and solo, SEP and even Health Savings Account HSA to fit one’s financial plan and schedule.
This is doing a big favor especially for lower income individuals, who tend to be bad at managing money. If the government acts as the fiduciary agent to do what is the best for them, changes can be made immediately and vastly.
The Social Benefits of Default Investing
Setting up a regular, incremental investment schedule or agenda as the default has social returns as well. In the insurance world, private passengers autos are required by law to have at least liability insurance and look at how popular auto policies are. The same goes to homeowner insurance, which is not required by law, but most lenders would require it before they loan money to you. These laws and rules do make a big difference. The National Association of Insurance Commissioners (NAIC) reported in 2021 that among the seven lines of insurance, private passenger auto insurance required by law takes up more than 34%, while homeowner insurance required by lenders has more than 15% of market shares. Our roads are safer and houses last longer as a result of these rules that most people simply take for granted and never even thought about.
Hipsky is right: All people need is a little nudge.
And that is not all. With more people investing for the future, the opportunities for investment advisors will be greatly increased because there is more money on the table to be managed. This creates a virtuous circle for the economy.