This paper outlines a proposal for a default savings plan that is intended to provide an important supplement to retirement income for the bottom half of the workforce, most of whom have little other than Social Security to support themselves in retirement at present. Under the proposal, workers would make a default contribution of 3.0 percent on annual wages up to $40,000. They could opt out from this contribution if they choose. The contribution would be automatically turned into an annuity at retirement although workers would have the option to make a lump sum withdrawal after paying a modest penalty.
The lowest income workers would get a modest contribution paid into the system by the government based on their earnings. This payment would be modeled along the lines of the Earned Income Tax Credit, with the payment increasing with earnings up to $8,000 and then phasing down to zero with earnings above $20,000. There would also be a match of savings that phases down to zero at $40,000.
Based on assumptions derived from research on participation in default savings plans, the Tax Policy Center of the Brooking Institution and the Urban Institute calculated the projected average contribution rate by income and household type. The exercise showed that the plan would lead to a substantial increase in retirement savings for workers in the bottom three quintiles. This increment to savings would increase retirement income for workers in the bottom two quintiles by at least 15-20 percent from current levels, with the increase for the third quintile being somewhat more than 10
The paper notes that this plan would not achieve universal coverage and compares its merits with a mandatory proposal. The discussion notes that a mandatory plan would also not be able to achieve universal coverage, given that there would be some level of evasion, as is currently the case with Social Security. If there is substantial non-participation in a voluntary default program – meaning workers really do not want to save for retirement – then it suggests that workers view forced saving as equivalent to a tax. In this case, a mandate is likely to lead to increased non-compliance with existing tax law, including increased evasion of Social Security contributions.
A second implication is that a mandate would have negative labor market effects, with workers viewing the mandate as leading to a lower after-tax wage. This would lead to somewhat lower rates of employment. In the extreme case, where a worker viewed the entire mandated contribution as a
tax, a mandated 3.0 percent contribution would reduce employment by more than 200,000, with most of the falloff coming at the bottom end of the earnings distribution.
The paper also notes that it may be more politically feasible to institute a voluntary default system than a mandatory retirement system. If this is the case, then there might be a strong argument for moving ahead with a voluntary system even if a mandatory system could in principle be more desirable. There are tens of millions of workers who are approaching retirement with little more than their Social Security to support them.
Each year that the adoption of a new system is delayed ensures that more workers will be inadequately prepared for retirement. This fact would seem to be a strong argument for moving ahead with the system that is most politically feasible, recognizing that any system can always be extended and improved, if there is public support for it.