Solving a Looming U.S. Retirement Crisis

The 401(k) has been a failure and should be replaced with new Guaranteed Return Accounts that could be made available to all workers

Google my name, and you'll see my photo next to a blog calling me "the most dangerous woman in America." Why does a U.S. News & World Report blog put me up there with Typhoid Mary and Octomom? In October 2008, just as the financial crisis was gathering steam, I told a congressional committee that it's time to reinvent the 401(k). I suggested a government-guaranteed alternative consisting of diverse and prudent assets such as blue-chip stocks and corporate and Treasury bonds. "The 401(k) is a failure," I told the House Committee on Education & Labor. "I want to spend our nation's dollars for retirement better."

Over the past 30 years, workplace pensions have morphed from defined-benefit plans (in which the company pays retirees a set amount every month from retirement to death) into defined-contribution plans such as 401(k)s, which are primarily funded by deductions from salaries. In a perfect world, an average worker could amass something like $400,000 in a 401(k) by retirement. After nearly three decades of 401(k) contributions, though, the average account balance for people nearing retirement age is about $60,000, far less than what's needed. So it's no surprise that when a recent Gallup poll asked what Americans want most from government, more chose guaranteed pensions than guaranteed jobs or health care.

Most people save less than 5 percent of their income for retirement, and many start withdrawing funds early because of layoffs, divorces, and other unexpected events. The consequence of these 401(k) leaks is that workers retiring in 15 years will do worse than their parents and grandparents, according to the Center for Retirement Research at Boston College. Almost two-thirds of households will probably face declining living standards in retirement.

Taxpayers are shouldering far more of these leaky retirement boats than anyone imagines. All the tax-free contributions going into 401(k)s, Keoghs, and other retirement schemes reduce federal tax receipts by $193 billion a year. And almost 80 percent of the tax breaks go to the top 20 percent of taxpayers.

So let's scale back the tax breaks. Instead, we can use the money to help everyone sock away 5 percent of their pay in safe retirement accounts that would serve as a universal supplement to Social Security. People could keep their

employer plan if it met more stringent standards such as a contribution rate of at least 5 percent, a ban on early withdrawals, and conversion into an annuity at retirement. Anyone without an employer plan would automatically be enrolled in a Guaranteed Retirement Account to which employees and employers would each contribute 2.5 percent. The government would then provide everyone a modest tax credit to offset the employee contributions. The return would be guaranteed by the government at about 3 percent above the rate of inflation--or close to the real growth rate in gross domestic product.

The key to this proposal is pooling individual accounts. These would be professionally managed, but with trillions of dollars in the pools, management fees would be lower than on conventional retirement accounts. That means every dollar in tax breaks would translate into almost a dollar in retirement income instead of going toward fees or being diverted to other purposes by people who make withdrawals before retirement. National savings would get a boost. All Americans, including the 64 million who have no pension plan, would get one at no extra cost. What's not to like?

A lot, apparently. After I finished my congressional testimony, I got so many screaming death threats and nasty e-mails that my employers at The New School in New York became alarmed, and the security chief gave me his cell-phone number. But as the economy continues to slump, discussions of my plan and a half-dozen or so similar proposals have become less vitriolic. There is a recognition on both the Left and the Right that people simply have to set aside more for retirement. And to make that happen, they have to be required to sock away more.

Before it's here, it's on the Bloomberg Terminal.