A Shot In The Arm For America's Drooping Savings Rate

For years, economists have issued dire warnings about America's anemic savings rate. Without savings, America won't have the money to finance new investment. Without savings, economic growth and living standards will suffer.

But don't sweat those fears of apocalypse. Gloomy predictions miss the big story: Tax-deferred retirement savings plans, especially 401(k)s, are turning out to be powerful inducements to save. Since the 401(k) contribution is regularly deducted from a worker's paycheck, "it is psychologically very beneficial to savings. The 401(k) is a system that assists in self-control," says Jonathan S. Skinner, economist at the University of Virginia. More important, most companies match or partially match employee contributions. So a dollar socked into a 401(k) is automatically worth more than a dollar--an offer that employees should not refuse.

Workers are starting to get the message. Participation rates in 401(k)s among eligible employees rose from 67% in 1988 to 75% in 1994, and more than half of lower-income workers and younger employees have signed up. Much of the recent surge in 401(k) participation has been at America's small and midsize companies, places where workers often had no employer-based retirement plan in the past, according to Dallas L. Salisbury, president of the Employee Benefit Research Institute.

Some economists argue that people taking advantage of tax-deferred savings plans tend to cut back on other savings. But much recent research supports the notion that 401(k)s are a net boost to household and national savings. For instance, economists James M. Poterba of Massachusetts Institute of Technology, Steven F. Venti of Dartmouth College, and David A. Wise of Harvard University found that those in 401(k) plans accumulate savings in other financial assets in similar amounts to families of comparable income not eligible for a 401(k).

WEALTH EFFECT. But won't the increases in the value of stocks and bonds in people's pensions in coming years cause savings to decline? After all, when asset values rise, people feel richer, spend more, and save less. Economists call this the wealth effect. They believe, for example, that the savings decline in the 1980s was partly caused by the real estate boom. Increases in the value of tax-deferred savings plans, however, have a much more limited wealth effect, says Allen L. Sinai, chief economist at Lehman Brothers Inc.

Baby boomers are now entering their peak earning years, a time when people traditionally build their nest eggs. With 401(k)s increasingly popular, America's personal savings rate is bound to improve dramatically.

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