Retirement Planning Needs Simplification

September 7, 2017

What is a simple and effective retirement plan?

When you read that question, do you start to think about how different the answer is to every individual? Of course, there are myriad ways to manage your investments to help assure that enough money is set aside for the day you decide to stop working full time or retire from work completely. There are many different investment resources and financial products as well as unlimited ways of combining them into a savings or retirement plan. In short, the choices for how you structure your retirement plan are virtually limitless.

Studies have shown that when people have a decision to make and are faced with too many choices, they tend to make no decision at all! Professor of psychology, Barry Schwartz, wrote about this in his book The Paradox of Choice: Why More is Less. The book is used by marketers when developing their plans to sell more products and consultants when advising their clients how to improve sales.  In one study referenced in the book, researchers set up two displays of gourmet jam at a food store. Ten times more product was sold when the choice was limited to six varieties compared to twenty-four varieties of jam. Could it be that savings levels in our country are too low because there are just too many choices for savers?

Too Many Choices?

Professor Schwartz notes that in planning for the future, we’re faced with so many choices and types of plans, it’s no surprise that so many people have put off decisions and are unprepared for the future. Record levels of cash remain in bank accounts earning almost no interest.  Studies of retirement plans administered by Vanguard found that for every ten mutual funds in a retirement plan, participation rates drop by two percent with some employees even foregoing employer matching contributions.

Because of having so many investment vehicle choices, many individuals end up keeping their money in the bank earning next to nothing. When saving for the future, decisions need to be made whether the funds should be directed toward retirement, education, home improvements or other goals.  When directing funds toward retirement, there is always the concern that the funds would be needed early if there is a loss of job or medical need or another unexpected event.  Moreover, there can be significant tax consequences on decisions as well as potential penalties for withdrawing money prior to certain dates, even in an emergency.

Business owners often want to help their employees save part of their income toward retirement but must choose from among many options including 401(k), Simple IRA, SEP IRA, pension plans, profit sharing plans, and more.  There are different contribution limits for each type of plan and distribution rules are complicated which vary by type of plan.  The cost to administer the complexities of these plans may even prevent some businesses from adopting an employee retirement plan altogether.

Once invested in a retirement plan, there often are hundreds of different types of accounts to choose from. Some plans allow for pre-tax contributions, Roth contributions, and post-tax contributions or a combination of these and some plans allow for in-plan conversion of funds between the accounts. And often, transactions that are made in one plan are not allowed in another plan because the complicated rules relating to retirement plans are interpreted differently by each plan administrator.  There are even some investments in retirement accounts that may cause a tax liability.  Is your head spinning yet?

Increase Savings Rates through Simplification!

As politicians in Washington continue debating the issues of savings and taxation, consumers continue to be confused. As recently as 2014, the government created a new savings account called the myRA.  This account added to the countless choices savers have and was terminated recently. Rather than creating new types of accounts to encourage people to save, why not simplify the system so that we don’t face so many layers of choice which, as demonstrated, actually stagnates savings growth by making investment decisions more difficult. It’s confusing enough trying to pick what type of investments make sense. The type of account should not add further confusion.

A new type of account called a Universal Savings Account has been proposed by several Congressmen.  The plan is simple and anyone over the age of 18 can contribute up to $5,500 per year to the account.  The money can be invested however desired and withdrawn for any reason without taxes or other penalties.  Plans like this have been successful in Britain and Canada with wide adoption by people at all income levels and of all ages.  In the U.S. around twenty percent of people have Roth IRAs but in Britain, 43 percent hold these type of all-purpose savings accounts, and in Canada, the number is 54 percent with more than half of account holders contributing additional funds each year.

Only a quarter of Americans that have Roth IRAs add to the accounts each year. Single purpose accounts like Roth IRAs have many rules for contributions and withdrawals while the all-purpose Universal Savings Accounts, or the British or Canadian equivalents, have no rules on withdrawals.  In the U.S. only 7 percent of those with incomes under $50,000 have Roth IRAs. In Britain, 55 percent of savings account holders have incomes under $25,000.

Many individuals and couples seek the advice of advisors like me because of the complex set of choices they face in making decisions not only how to invest their money but what type of account is most advantageous.  Frequently I meet new clients that have accumulated large sums of money in bank accounts or in their retirement account but have not allocated those funds to an investment.  I am sure the factors that Dr. Schwartz presented in his book about too many choices are the primary reason for this.

Saving and investing need not be so complicated. People save to achieve their personal financial goals rather than get a tax deduction or benefit. A single type of account for all individuals whether they work for a large company, small company, or are self-employed should be created to replace the numerous choices that now exist.

Elements of a truly simple retirement plan:

– Current balances should be allowed to be rolled over into the new plans.

– The plan should allow something like $25,000 in annual contributions which is comparable to the British plan.

– All withdrawal restrictions should be removed so that no one would hesitate to invest.

– The accounts should be as simple to open as a checking account at a local bank.

Though there is a widespread debate about laws and regulations affecting the environment, healthcare, and banks, I am sure most would agree that the rules affecting individuals and their savings choices should be simplified. As a financial planner, much of my work involves making our clients’ investment decisions simpler or at least more understandable. If the rules affecting investment decisions were simplified, I believe that individuals would more readily choose to save and invest for a better future.