Retirement Savings: A Boost For The Needy

Government matching would give IRAs a shot in the arm

By Laura D'Andrea Tyson

There is a mounting retirement savings crisis in America. Too many middle- and low-income Americans are saving too little. The plunge in the U.S. household savings rate over the past decade has occurred just as baby boomers should be saving in earnest for their looming retirement. Even worse, personal savings have dipped just as employers have dropped defined-benefit pension plans in favor of defined-contribution plans -- shifting both the responsibility and investment risks of retirement savings onto workers. The good news is that there are some relatively simple and inexpensive policies that could ease this crunch.

Two recent studies from the Retirement Security Project, a joint venture between the Brookings Institution and Georgetown University, demonstrate that savings plans that combine accessible information with ease of use and modest financial incentives can boost retirement savings -- even among middle- and low-income households.

For households on the verge of retirement -- those headed by someone between 55 and 59 -- the median value of savings held in both individual IRA accounts and employer 401(k) plans is a meager $10,000. Despite both tax advantages and matching contributions by employers, only about half of American workers participate in 401(k) and other employer-based retirement savings plans.

WHY AREN'T MORE AMERICANS taking advantage of such options? Many employers still don't offer such plans. Tax incentives for participating are quite small for most middle- and low-income workers who fall in the 10% to 15% income tax bracket. And many workers lack financial experience, training, or time to invest in 401(k) plans. Those obstacles have led to some dismal numbers. According to Alicia H. Munnell, an Assistant Treasury Secretary in the Clinton Administration, fewer than 10% of eligible workers contribute the allowable maximum to 401(k) plans; more than half fail to diversify, especially beyond their employers' stock; few rebalance portfolios in response to age or market returns; and almost half withdraw from 401(k) plans when they change jobs.

A change in tax policy is needed to reduce the "upside-down" nature of existing tax preferences that bestow the largest retirement savings incentives on upper-income households -- and minimal incentives on low-income families. That won't happen soon. In the meantime, according to a Retirement Security Project study, "automatic 401(k)" plans are a simple effective approach to encouraging more retirement saving by middle- and low-income workers. The core features of these plans are automatic enrollment of all employees unless they actively opt out; automatic increases in contribution rates as a share of earnings over time; automatic investment of contributions into balanced low-cost investment funds; and automatic rollover of savings into alternative retirement plans when workers switch jobs. (Workers would have the right to override these defaults.) Today, only about 10% of 401(k) plans have automatic enrollment. Yet the evidence indicates that automatic sign-up would raise participation from about 75% of eligible employees to up to 95%.

IRAs, the other major tax-advantaged retirement savings vehicle, have even lower participation rates than 401(k) plans among middle- and low-income households. A fascinating study by the Retirement Security Project in conjunction with H&R Block (HRB ) finds that providing simple matching incentives can increase both the percentage of such households that contribute to IRAs and the size of contributions. H&R Block employees offered about 15,000 randomly selected clients from predominantly low- and middle-income households a 20% match, a 50% match, or no match on IRA contributions. Only 3% of those offered no match chose to contribute to an IRA, compared with 10% for those offered a 20% match, and 17% for those with a 50% match. Household IRA contributions above the match were four times larger with a 20% match and eight times larger with a 50% match. A 50% government match for IRA contributions up to $2,000 by families making less than $50,000 a year would cost about $15 billion.

According to Treasury estimates, current tax preferences for savings total about $150 billion a year. Yet the lion's share benefits high-income households that already have nice nest eggs. Meanwhile, low- and middle-income families struggle to save enough for retirement. Automatic 401(k) plans and simple-to-use federally funded matches on IRA contributions could help solve their retirement crisis.

Laura D'Andrea Tyson is dean of London Business School (

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