Congress Can't Save Money, But It Wants You Toby
Ask any economist, and you'll hear that Americans have forgotten how to save. During the past decade, American families put money aside at just half the rate they did during the 1960s and 1970s (chart). During all that time, Congress has been struggling to boost private savings. Now, in the tax bill working its way through the Senate, lawmakers have cobbled together two proposals they hope will do the job.
The idea getting the most attention is a proposal by Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.) and Senator William V. Roth Jr. (R-Del.) that would beef up individual retirement accounts, the savings plans that were sharply limited by the 1986 tax reform act. But another proposal, to boost 401(k) plans, could provide a bigger kick.
LIMITS. The IRA proposal, somewhat trimmed back from its original form, would provide extremely generous tax benefits for some savers. IRAs now are limited to individuals earning less than $25,000 and couples earning less than $40,000. Under the Senate plan, they would be available to individuals earning as much as $90,000 and couples earning up to $130,000. More important, the bill would restructure the savings account. Under the traditional IRA, contributions are tax deductible when they are made, and earnings are tax-deferred until they are withdrawn. Under the Senate measure, savers could choose to pay tax on their contributions and avoid all taxes on withdrawals made after five years.
These "back-loaded" IRAs are far more generous in the long run. But they have one big problem: Many economists say that the middle class isn't likely to participate. "I don't like back-loaded IRAs," says National Bureau of Economic Research economist Jonathan S. Skinner. "You have to give the front-loaded inducement to attract people who otherwise wouldn't save." That means participation in the new IRAs mostly would come from savvy investors who would merely shift savings to take advantage of the tax break.
That's why 401(k)s could provide a bigger bang for the buck. The plan's great advantage is that automatic payroll deductions encourage thrift: People can't spend what they don't take home. In 1988, the last year for which statistics are available, 15 million people contributed nearly $40 billion to 401(k) plans--as much as had ever been saved annually in IRAs. And participation has continued to zoom: Putnam Cos., a big Boston fund manager, estimates that the 401(k) business is growing by 15% to 20% a year.
But many middle managers are barred from contributing as much as they would like, because their employers run afoul of Internal Revenue Service rules designed to protect lower-paid workers. The Senate wants to broaden participation by easing those rules. It would allow highly paid workers to contribute the maximum $8,728 a year, as long as their employers matched the first 3% of participating employees' salaries.
HIGHER COSTS. The employer match seems to be a key to getting more highly paid workers to participate. Aggressive education may be the secret to building interest among lower-paid workers. Chevron Corp.'s participation rate is 90%. Benefits manager Alex G. Ross says that is partly because the company publishes a newsletter that helps explain the investment world, and has begun installing electronic kiosks at work sites where employees can check on their accounts. "The communication aspect," Ross says, "is absolutely key to the success of this plan."
Of course, pulling more workers into 401(k) plans will cost business more, especially if tied to a company match. And that has some companies worried. Alpha Industries Inc., a Woburn (Mass.) semiconductor maker, has doubled its participation rate to nearly 70% by instituting a $500 match and an aggressive education plan. But 3% is a bit steep. "We'd like to if we could afford it," says Chief Financial Officer William A. Krein.
The proposals could also prove expensive to the government: Many economists say these ideas won't encourage enough private savings to offset the tax revenue they cost the Treasury. Yet for Americans who didn't salt much away during the 1980s, the new savings plans--particularly the low-profile 401(k) plans--would prove a welcome boon.