Comments on: Retirement Proposals

By: Jim Robinson

Jim Robinson — Sat, 03 Dec 2005 09:45:46 +0000

mbhunter, you raise some very real concerns. Making sure the government
continues to be able to operate is important. I do think it is important to
also examine future costs of operations when examining the current situation.
If my reading of the OASDI Trustees report is correct, we’re all facing some
potentially very serious shortfalls in the future:

http://www.socialsecurity.gov/OACT/TR/TR05/VI_OASDHI_dollars.html#wp129340

I’m pessimistic when it comes to government, so I think it’s better to eyeball
the projected high costs. Of course, many many people disagree and foresee no
crisis (low to intermediate cost assumptions, in the OASDI report).

I still think the cap should be raised to be based off a flat percent on
earned income. I’m also one of those dreamers who likes the idea of flat tax
rates, consumption taxes, etc. (but this isn’t alt.rant.govt)

Anyway, I agree taxes are almost assuredly going to be higher for us when we
retire than it will be for our parents when they retire. Now, that doesn’t
mean we should discount the growth we can see by accumulating our nest egg in
a tax free environment. You’re always going to see faster potential growth in
a tax free environment than you are in a taxed environment, at least I think
that is the case.

Let us say for example that you get a 6% return on your investments. If you’re
in the 33% tax rate you, that amounts to a 4% growth after taxes. If you save
$1.00 over a period of 43 years I think we find:

– With taxation as earnings are paid, $1.00 grows to (1.04)^43, or $5.40.
– With tax deferral, $1.00 grows to (1.06)^43, or $12.25.

$1.00 is your basis, so $11.25 is your earnings. At 33% tax, you pay $3.71 to
the government. 1 + (11.25 – 3.71) = 8.54 nominal dollars, that’s a bit
better than 58% more than tax-as-you-go. Factoring in a 50% tax rate on
earnings still leaves you with $6.25, 15% better than you were under taxed
growth, right? (assuming the 50% tax kicks in the year you retire instead
of it having been in put place 10-15 years before retirement, chipping away
at earnings in your taxable account)

Also, some plans don’t require a lump-sum payout when you retire. If you can
take only what you need to live on, or the IRS Minimum Required Disbursements,
your 401k sheltered nest egg can continue to grow tax deferred, right?

Are my assumptions missing important factors? Please be kind if my math is
wrong, I may have flubbed something obvious.

By: mbhunter

mbhunter — Sat, 03 Dec 2005 04:55:06 +0000

For the people who are contributing to their 401(k) it really doesn’t matter whether people are automatically enrolled or not. All in all, if people won’t contribute, they won’t contribute. The 2% automatic contribution is not going to be taken kindly by most businesses.

Jim Robinson, thank you for giving an aggressive savings percentage! I agree. 25% is a good benchmark. 10% means you probably won’t depend on your kids too much, but 25% will let most people live in style. I don’t think the contribution limits are a joke though; the contribution limits serve to limit the government’s loss of current tax revenue. People can max out their 401(k) and put the remainder in a non-qualified account.

Having said that, I’m not so sure about maxing out the 401(k) though. I put in enough to get the full match, but the delayed taxation of the 401(k) is a double-edged sword. Who knows what’s going to happen in 30 years? A 50% tax on distributions to pay for everyone on Medicare? Who knows?

By: thc

thc — Sat, 03 Dec 2005 03:12:02 +0000

There are currently no minimum matching contributions for 401k plans and if shortened vesting schedules are mandated companies will provide even less in the way of matches.

By: Jim Robinson

Jim Robinson — Sat, 03 Dec 2005 00:07:07 +0000

Sorry, I didn’t mean to imply FICA/OASDI was related to 401k. What I meant was that the intent of
the FICA/OASDI taxes (supplemental income in old age) was linked to the idea of saving for
retirement. If people saved enough in their 401k, you might have less need for Social Security
and Medicare/Medicaid.

By: jim

jim — Fri, 02 Dec 2005 20:51:22 +0000

Jim,
I didn’t think that the FICA OASDI (FICA Old Age Survivors and Disability Insurance) had anything to do with 401(k), it’s just a “tax” like Medicare. I think the automatic enrollment in the 401(k) is a separate issue, you aren’t putting more money into a government program, such as Social Security, you’re putting it into your company’s 401(k) and you can decide how to invest it (to a certain extent).

I think the contribution limits are an attempt by the government to encourage contributions while not taking away a significant amount of tax revenue. By having automatic enrollment, they are encouraging people to save even if it is a relative pittance.

I’ll have to put the Kotlikoff & Burns book on the reading list…

By: Jim Robinson

Jim Robinson — Fri, 02 Dec 2005 19:28:23 +0000

Automatic enrollment is not really very different from what we have now, with FICA/OASDI withholdings. I happen to object to it, since I trust myself more than the pyramid scheme the Government has going, but I understand it probably is never going away.

Neither is the 2% for employers, given that they have to sock away 6.2% of the current years OASDI cap already. It’s not clear to me if the 2% you discuss would be shifted from FICA/OASDI to 401k/403b matching? Again, I happen to agree with you that it is silly to force employer to save a paltry amount for an employee if the employee isn’t willing to put up money themselves.

I think the contribution limits are a joke. People should be trying to save at least 25% of their gross income if they expect to be able to retire and live as well as when they are holding a job (that numbers assumes saving from the get-go, when they start working — it goes up if you wait before contributing). Government ought to be encouraging people to save, if they did there might be some chance that, down the road, the AARP wouldn’t kill any official who suggests that Social Security and Medicaid need a complete overhaul.

By the way, folks who are interested in this topic might want to take a look at a book written by Kotlikoff and Burns, named “The Coming Generational Storm.” The authors lay out a picture that scares me to death regarding the overwhelming financial problems which are going to be facing Generations X and Y.

Jim