PERSONAL FINANCIAL PLANNING

Personal Financial Planning

Personal Financial Planning

Introduction

The past 25 years have brought a dramatic shift in our nation's pension system away from defined benefit plans and toward defined contribution accounts, such as 401(k)s and Individual Retirement Accounts (IRAs). But many of our public policies have not been updated to reflect the increased responsibility placed on workers to prepare for their own retirement. (Kawachi, Smith & Toder, 2006) The next President can improve and strengthen retirement security substantially through a series of common-sense reforms that would make the defined contribution pension system easier to navigate and more rewarding for American families. Specifically,

The most important change would be to make saving easier and less complicated. One way would be through automatic 401(k)s for workers at firms offering pensions and automatic IRAs for other workers.

Another important move would be to restructure tax incentives for retirement saving. Existing incentives mostly subsidize asset-shifting by higher-income households, rather than encourage new saving by middle- and lower-income households. A simple 30 percent match for everyone would give moderate and lower-income households—some 80 percent of households—a stronger incentive to save.

Finally, implicit taxes on retirement saving should be reduced. These steep and confusing taxes are often imposed through means-tested benefit programs, such as food stamps, Medicaid, Supplemental Security Income, and cash welfare assistance.

This set of policies is much more promising than the alternative of simply raising contribution amounts or income limits on tax-preferred retirement saving. Such strategies merely perpetuate tax preferences for households already well-prepared for retirement and undermine the public policy benefit from these tax incentives. (Joulfaian & Richardson, 2001)

Increasing Retirement Security for Middle- and Low-Income Households

The trend away from traditional, employer-managed retirement plans and toward saving arrangements directed and managed largely by employees themselves, such as 401(k)s and IRAs, is in many ways a good thing. Workers enjoy more freedom of choice and more control over their retirement planning. But for too many households, the 401(k) and IRA revolution has fallen short. (Neuberger, Greenstein & Sweeney, 2005)

The most vivid manifestation of the shortcomings of today's private pension arrangements is the simple fact that many families approaching retirement age have little or no retirement savings.2 In 2004, according to data from the Federal Reserve's Survey of Consumer Finances, half of all households headed by adults age 55 to 59 had $15,000 or less in an employer-based 401(k)-type plan or tax-preferred savings plan account. Although the savings option is there, Americans don't take advantage of it for two principal reasons:

the system is too complicated

incentives to save for retirement are weak or nonexistent

In the face of the difficult choices and limited encouragement presented by the current system, many people simply procrastinate and never save enough for retirement.

The primary policy tool used to encourage participation in employer-based retirement plans and IRAs is a set of deductions and exclusions from federal income tax. The immediate value of any tax deduction or exclusion, though, depends directly on the taxpayer's income tax ...