Analysts grade federal plan to repair retirement

Paul Volcker and his troupe, the President's Economic Recovery Advisory Board, are unlikely to appear on the America's Got Talent stage anytime soon. But retirement experts are giving the group, which just issued a 188-page plan to fix the nation's complicated retirement system, mostly high marks for their effort.

Volcker et al. recently laid out eight ways to simplify incentives aimed at encouraging U.S. workers to save for their retirement. Here are the proposals and what experts had to say in reaction.

1. Consolidate retirement accounts; simplify rules. One reason saving for retirement is confusing is the many types of retirement accounts, including IRAs, 401(k)s, 403(b)s and SEP-IRAs. It can be hard to figure out whether you're eligible for a particular account and how much you can contribute.

"It makes a lot of sense to look for ways to consolidate different types of retirement-saving accounts, such as 401(k), 403(b), 457, and the like," said Peng Chen, chartered financial analyst and president of Ibbotson Associates. "These plans by and large serve the same purposes, with slight differences among them."

Others see it differently. "The American workplace is very diverse, and the range of plan types reflects that diversity," said David Wray, president of the Profit Sharing/401(k) Council.

Wray said the proposed changes will have virtually no positive effect on retirement savings and, if not done right, could reduce the number of firms sponsoring plans, further putting in jeopardy the already precarious state of retirement security.

2. Integrate IRA and 401(k) contribution limits. One proposal would allow all workers irrespective of income to contribute to either or both an IRA and an employer-sponsored plan. In addition, Volcker's troupe proposed that nondeductible IRAs be eliminated since income limits on contributions would be removed.

Wray criticized this proposal, noting that "only a small percentage of lower-paid workers not eligible for plan participation save in IRAs, and if they do the current IRA limits are sufficient for them."

3. Consolidate and segregate nonretirement savings. Volcker and the advisory board also called for consolidating all nonretirement savings programs, including Section 529 plans, Coverdell IRAs, health savings accounts, Archer medical savings accounts and flexible savings accounts, under a single instrument. Contributions could be tax-deductible up to a limit, as is the case for health savings accounts.

Somewhat surprisingly, none of our experts praised or criticized this proposal.

4. Improve savings incentives; expand auto-enrollment. The Volcker group also suggested designing the saver's credit to be more like a match, to increase its effectiveness as a savings incentive. This tax break provides a subsidy to low-income workers who make voluntary contributions to retirement plans.

Some agree that changes to the saver's credit would be beneficial.

"Converting it to a match would make it more effective, both from the standpoint of encouraging more contributions and from the standpoint of getting the tax benefit into the individual's retirement account rather than his checking account," said Kaye Thomas, founder of Fairmark Press. "The cliffs in the current arrangement are brutally arbitrary, so a phase-out would be far better even if somewhat more complicated."

But Wray cited logistical problems. "Those eligible for the credit are among our most mobile workers," Wray said. "The matches by definition will be made after the end of the tax year when as many as 20 percent of those eligible for the match will have changed employers. It will be a mess trying to match them with the right plan."

5. Reduce retirement "leakage." Volcker's panel proposes requiring that, when a worker leaves a job, his account balance be retained in the existing plan, be automatically transferred to an IRA account or get moved to an account with the new employer.

Volcker's "automatic rollover" would ensure that all amounts put aside for retirement continue to grow.

6. Simplify rules for employers sponsoring plans. One idea: simplify the nondiscrimination test, for example by simplifying the definition of a highly paid employee and to provide a standard safe harbor to avoid these requirements. An alternative proposal is to repeal all nondiscrimination rules.

Wray nixed this proposal as a nonstarter. "Our system is a voluntary one," he said. "Employers need the flexibility to design plans that work for their work force and their organization."

7. Simplify disbursements. Volcker's group called for eliminating minimum required distributions for individuals with retirement assets below a threshold. Right now, most retirement account owners must take a distribution after turning 701/2.

The proposal would relieve many taxpayers from burdensome regulations at a relatively small cost. Experts in general praised the proposal -- though it may not go far enough.

"This requirement ought to be totally repealed," Wray said. "The MRD requirement was imposed to increase the collection of federal taxes. It is bad public policy when people are living longer and longer."

8. Simplify taxation of Social Security benefits. The Volcker gang says simplifying the formula for calculating the tax on Social Security benefits would reduce the compliance burden on older taxpayers and improve economic efficiency.