U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

93–761 PDF 2004

S. HRG. 108–532

HELPING AMERICANS SAVE

HEARING

BEFORE THE

JOINT ECONOMIC COMMITTEE

CONGRESS OF THE UNITED STATES

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

MARCH 10, 2004

Printed for the use of the Joint Economic Committee

(

(II)

JOINT ECONOMIC COMMITTEE

[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

SENATE

ROBERT F. BENNETT, Utah, Chairman

SAM BROWNBACK, Kansas

JEFF SESSIONS, Alabama

JOHN SUNUNU, New Hampshire

LAMAR ALEXANDER, Tennessee

SUSAN COLLINS, Maine

JACK REED, Rhode Island

EDWARD M. KENNEDY, Massachusetts

PAUL S. SARBANES, Maryland

JEFF BINGAMAN, New Mexico

HOUSE OF REPRESENTATIVES

JIM SAXTON, New Jersey, Vice Chairman

PAUL RYAN, Wisconsin

JENNIFER DUNN, Washington

PHIL ENGLISH, Pennsylvania

ADAM H. PUTNAM, Florida

RON PAUL, Texas

PETE STARK, California

CAROLYN B. MALONEY, New York

MELVIN L. WATT, North Carolina

BARON P. HILL, Indiana

DONALD B. MARRON, Executive Director and Chief Economist

WENDELL PRIMUS, Minority Staff Director

(III)

CONTENTS

OPENING STATEMENT OF MEMBERS

Page

Senator Robert F. Bennett, Chairman ................................................................... 1

Representative Jim Saxton, Vice Chairman .......................................................... 3

WITNESSES

Statement of Dr. Richard H. Thaler, Robert P. Gwinn Professor of Behavioral

Science and Economics, Graduate School of Business, University of Chicago;

Research Associate, National Bureau of Economic Research ........................... 4

Statement of Robert C. Pozen, Non-Executive Chairman, MFS Investment

Management, John M. Olin Visiting Professor of Law, Harvard Law School 8

Statement of Ric Edelman, Chairman, Edelman Financial Services .................. 11

Statement of Dr. Peter R. Orszag, Joseph A. Pechman Senior Fellow in

Economic Studies, The Brookings Institution ................................................... 14

SUBMISSIONS FOR THE RECORD

Prepared statement of Senator Robert F. Bennett, Chairman ............................ 31

Prepared statement of Representative Jim Saxton, Vice Chairman ................... 33

Prepared statement of Representative Pete Stark, Ranking Minority Member 34

Prepared statement of Dr. Richard H. Thaler, Robert P. Gwinn Professor

of Behavioral Science and Economics, Graduate School of Business, University of Chicago; Research Associate, National Bureau of Economic Research 36

Prepared statement of Robert C. Pozen, Non-Executive Chairman, MFS

Investment Management, John M. Olin Visiting Professor of Law, Harvard

Law School ............................................................................................................ 41

Prepared statement of Ric Edelman, Chairman, Edelman Financial Services .. 49

Prepared Statement of Dr. Peter R. Orszag, Joseph A. Pechman Senior Fellow

in Economic Studies, The Brookings Institution ............................................... 55

(1)

HELPING AMERICANS SAVE

WEDNESDAY, MARCH 10, 2004

UNITED STATES CONGRESS, JOINT ECONOMIC COMMITTEE, Washington, DC

The Committee met, pursuant to notice, at 10:00 a.m., in room

SD-628 of the Dirksen Senate Office Building, the Honorable

Robert F. Bennett, Chairman of the Committee, presiding.

Members Present: Senator Bennett, Representative Saxton.

Staff Present: Donald Marron, Ike Brannon, Brian Jenn, Mike

Ashton, Colleen J. Healy, Chris Frenze, Robert Keleher, Jason

Fichtner, Wendell Primus, Chad Stone.

OPENING STATEMENT OF SENATOR ROBERT F. BENNETT,

CHAIRMAN

Chairman Bennett. The hearing will come to order. I’m told

that there is a vote on the Floor of the House in 15 minutes, and

so we will get started right on time, even though the crowd is a

little slow in gathering.

But we want to accommodate the Members of the House who are

here, and I appreciate Vice Chairman Saxton coming over, and we

will hear from him prior to the time when he has to leave for the

House, and then we’ll hear from our witnesses.

Good morning and welcome to today’s hearing on helping Americans save. We politicians have been bemoaning our nation’s low

savings rate since well before I came to the Senate.

Two years ago, American households saved only 1.5 percent of

their income, an all-time low. Just over a decade ago, households

saved 8 percent of their income, and in the 1970s and early 1980s,

the savings rate was regularly over 10 percent.

Personal saving is low, not only by historical standards, but by

international standards. Nearly every other westernized economy

saves more than the U.S., as do many developing countries.

There are a number of reasons, I think, why we save so little.

Many households experienced a large gain in wealth in the 1990s

from impressive increases in the stock market.

Over one-half of Americans are involved in the stock market in

one way or another. People fortunate enough to own property on

one of the coasts or in certain areas like Chicago saw the value of

their homes increase, as well. A family that’s gained significant

wealth from stocks or housing might safely assume that they can

reduce their saving and still have enough to provide for retirement

in an emergency.

2

But, of course, not every family spent the 1990s calculating their

capital gains. For the typical household, capital gains only modestly increased their wealth, yet, while middle- and lower-income

households experienced sharp increases in income in the latter

years of the previous economic expansion, there is little evidence

that it led to higher saving.

The U.S. tax system does not encourage savings. Economists of

all stripes have noted that our treatment of investment income is

counterproductive.

The U.S. corporate income tax system and the treatment of dividends, capital gains, and interest income lets the governments tax

the return from savings, 2 or even 3 times before it reaches the

worker’s pocket. It’s no wonder that many choose to simply spend

their money before it is taxed again.

Congress has tried to alleviate the pernicious taxation of savings

by offering a plethora of tax-preferred savings accounts. However,

the patchwork approach of tax breaks makes navigating these programs exceedingly complicated, even for the most financially savvy

person.

We have three different types of individual retirement accounts,

medical savings accounts, educational savings accounts, all of

which are separate from any employee-sponsored retirement plan.

Each account has different contribution limits, tax treatments, income cutoffs, and allocation rules.

Professor Richard Thaler’s research has shown that people often

make poor decisions when offered too many choices. I suggest that

that’s precisely what’s happening with IRAs.

In discussing the low U.S. savings rate, it’s important to recall

why saving is important to individual households and society, generally. In the first place, households should have enough wealth at

their disposal to be able to retire comfortably and not have to rely

on the government.

The present value of the total unfunded debt associated with Social Security is calculated to reach trillions of dollars, and as longevity increases and our obligations to entitlement programs balloon, it is not realistic to expect the Federal Government to pick

up the entire tab for everybody’s retirement.

Second, savings finances the investment necessary to spur future

economic growth. The American economy is driven by ingenuity

and entrepreneurship, but even the most ambitious genius with a

business plan can do little without ready access to capital.

The innovators of Silicon Valley, from which flowed much of the

U.S. technological and economic innovation over the last 15 years,

created enormous wealth for themselves and society through the

combination of creativity, talent, hard work, and ready access to financial capital. Each was an essential ingredient.

So, it makes sense to look at institutional factors that inhibit

savings, and consider what kind of low-cost, common-sense reforms

can be adopted to make it easier for individuals to set aside a sufficient portion of their income each year to finance retirement, college education, or other significant financial obligations, and I

think we’ve assembled an outstanding panel to help us deal with

that.

3

Mr. Saxton, we appreciate your being here, and look forward now

to your opening comments.

[The prepared statement of Senator Robert F. Bennett can be

found in the Submissions for the Record on page 31.]

OPENING STATEMENT OF REPRESENTATIVE JIM SAXTON,

VICE CHAIRMAN

Representative Saxton. Mr. Chairman, thank you very much.

It’s a pleasure to be here to welcome our witnesses this morning,

and I thank you for having the foresight to call this hearing, because personal savings is vital for the financial security of households, and it also finances the investment and capital formation

necessary for long-term economic growth.

Unfortunately, and despite recent changes in the U.S. Income

Tax, the U.S. Income Tax still retails a systematic bias against savings and investment. Under an income tax, a dollar saved is taxed

and its return is taxed yet again, yet each dollar of consumption

is taxed only once.

Some of this bias has been reduced through the expansion of

IRAs, 401(k)s and similar vehicles. The longstanding anti-savings

bias in the income tax is the reason that I have supported higher

IRA deductions and 401(k) ceilings over the past several years.

Another problem is that the current tax treatment of mutual

fund shareholders regarding capital gains distribution is illogical,

and, I think, very unfair. Under current law, mutual fund shareholders must pay taxes on capital gains realized by mutual funds,

even though they have not sold one mutual fund share.

Furthermore, they pay such taxes, even when the value of their

shares has plummeted, after it did after the collapse of the stock

market that began in the first quarter of 2000. In other words,

when mutual funds generate huge capital gains, the shareholders

get hammered, even when their own unsold shares have declined

in value.

This is something that should be changed, and when the mutual

funds incur huge capital losses as they did after the bubble burst,

most of these losses cannot be immediately passed on to shareholders. This is a ‘‘heads-I-win/tails-you-lose’’ situation for the government.

In addition, given the complexity of the relevant tax provisions,

it is very easy for confused taxpayers to pay capital gains taxes on

mutual funds twice. I have offered legislation, H.R. 496, which

would remedy this inequity by providing a tax deferral on capital

gains distributions, large enough to cover all distributions of over

90-percent of shareholders.

Mutual funds are an important savings and investment vehicle

for middle-income Americans, and the punitive tax treatment of

these taxpayers is unnecessary and counterproductive.

Mr. Chairman, as you mentioned, we’re going to have a vote on

the House side sometime between now and 10:30, and I’m going to

miss, therefore, the question period, so if I may just read into the

record the question that I wanted to ask, relative to this mutual

fund tax situation, I wanted to ask the panelists, and particularly

Mr. Edelman, several questions.

And if I may just read them now, I would appreciate that.

4

Chairman Bennett. We’d be happy to have you do that, or, if

you prefer, you could leave them with me and I will ask them on

your behalf.

Representative Saxton. Okay, that will be fine, and I have a

copy of them here, and if you would do that, I would appreciate it.

[The prepared statement of Representative Jim Saxton can be

found in the Submissions for the Record on page 33.]

Chairman Bennett. I’ll do my best to follow up with the brilliance and incisiveness that you always display.

Representative Saxton. That should be very easy.

[Laughter.]

Chairman Bennett. Thank you, thank you very much. We’ll

look to see the House Members join us a little later when they finish saving the Republic.

Our witnesses are all international experts on savings, and Dr.

Thaler, I apologize for mispronouncing your name the first time

around. I have been appropriately admonished, and will be accurate from here on in.

Dr. Richard Thaler is a University of Chicago Professor of Economics and he’s been at the forefront of developing innovative ways

to increase savings through employer-sponsored retirement plans.

Robert Pozen, who is the Non-Executive Chairman of MFS Investment Management, a law professor at Harvard Law School, author and former Vice Chairman of the Board at Fidelity Investments, which is the hat he wore when we first met. He has a

unique perspective on how institutions can affect savings and what

types of reforms would compliment the work of financial institutions.

And Ric Edelman, who is founder of Edelman Financial Services

in Fairfax, Virginia, is the author of three New York Times number

one best sellers, an award-winning host of radio and television

shows, and has taught personal finance at Georgetown University

for 9 years.

Peter Orszag is a Senior Fellow at the Brookings Institution who

has also published widely on tax policy, Social Security, and pensions. So, gentlemen, we thank you all for your willingness to be

with us this morning. I think we will go in the order in which I

introduced you, which means we start here at my right with Dr.

Thaler.

STATEMENT OF DR. RICHARD H. THALER, ROBERT P. GWINN

PROFESSOR OF BEHAVIORAL SCIENCE AND ECONOMICS,

GRADUATE SCHOOL OF BUSINESS, UNIVERSITY OF

CHICAGO; RESEARCH ASSOCIATE, NATIONAL BUREAU OF

ECONOMIC RESEARCH

Dr. Thaler. Thank you very much, Chairman Bennett and other

Members of the Committee. Strictly speaking, my name should be

pronounced ‘‘tall-er,’’ which you might be interested to know——

Chairman Bennett. Does that go back to the Dutch and is the

word from which dollar came?

Dr. Thaler. Correct.

Chairman Bennett. So, being in the economics business, we

should call you Dr. Dollar?

[Laughter.]

5

Dr. Thaler. That’s right. I’ll answer to that.

Chairman Bennett. Very good.

Dr. Thaler. So, thank you for inviting me to participate in this

panel on helping Americans save. I’m Richard H. Thaler, a Professor of Behavioral Science and Economics at the University of

Chicago’s Graduate School of Business.

I’m an economist by training, but for the last 25 years, I’ve been

exploring ways to incorporate the findings of modern psychology

into economic analysis. As you all know, America’s personal savings rate is hovering near zero, as the Chairman indicated earlier.

Furthermore, as the population ages, there will be growing difficulty in financing Social Security, and future generations face a

very likely prospect of having to finance a large fraction of their retirement on their own.

I thus applaud the attention you’re drawing to the important

question of how to help Americans save, and I come bearing good

news. By incorporating simple lessons of psychology and a little

common sense about human nature, it can be quite easy to help

Americans save.

By tradition, governments are advised by economists on policy

matters such as saving. Unfortunately, the traditional economic

models that economists rely upon for their advice are not very helpful in two main respects:

First, they assume that households are capable of making the

complex calculations necessary to determine how much to consume

and how much to save, and as important, that the households have

the requisite willpower to delay consumption.

Since the time of Adam and Eve, real humans, as opposed to the

imaginary creatures populating economics textbooks, have had difficulty resisting temptation. There’s a news story today about obesity that sort of underlines that point.

Another problem with the standard economic model is that it

does not give policymakers any guidance on how to increase savings. The primary variable under the control of policymakers is the

after-tax interest rate.

But the theory does not tell us whether raising this rate, say, by

making some savings tax-free, will increase or decrease saving

rates. The problem is that increasing the return to saving has offsetting effects. It makes saving more rewarding, and, thus, more

attractive, but at the same time, the higher return implies that

households do not have to save as much to achieve any particular

savings goal.

In contrast, by studying actual humans, we discover new tools

that policymakers can use to increase savings. For example, here

are some useful findings to consider:

One, many Americans realize that they should be saving more.

One survey finds that two-thirds of the participants in 401(k) plans

think they are saving too little.

Two, most people find it easier to accept self-control restrictions

that do not begin immediately. Many of us here in this room today

are planning to begin diets next month, not today at lunch.

Three, money that is put into designated retirement accounts

tends to stay there, compared, say, to money in ordinary savings

accounts.

6

Four, people are loss-averse. Losses hurt more than gains feel

good.

Finally, fifth, there’s enormous inertia in retirement plans and

elsewhere. For the vast majority of participants, once they join the

401(k) plan, they rarely make changes, either to their contribution

rate, or to the asset allocation.

So, although participants agree that they should save more,

many never get around to doing it. We can think about this list two

ways: First, it can be considered a diagnosis, an explanation for

why the savings rate is so low, and, second, and, more helpfully,

it can provide the ingredients for the cure.

So, what can we do to help Americans save more? One simple

step that has been adopted by some organizations is called automatic enrollment. The idea is simple.

In the usual 401(k) plan, when an employee first becomes eligible

to join the plan, he or she receives a form that says ‘‘if you want

to join the plan, please fill out this form.’’ Under automatic enrollment, the employee receives a similar form, but it says, ‘‘you are

now eligible for the plan, and unless you return this form, we’re

going to enroll you automatically.’’

Notice that under the standard economic analysis, these two setups are considered virtually identical. The cost of filling in a form

is small, relative to the long-term benefits of joining the plan, especially when the firm provides a match.

Nevertheless, automatic enrollment can have huge effects. In one

company studied by Madrian and Shea, when automatic enrollment was adopted, the enrollment rate by new workers jumped

from 49 percent to 86 percent. That’s the good news.

The bad news is that under automatic enrollment, companies

must select some default savings rate, an asset allocation, and employees tend to adopt and stick with these default choices.

So, in the company mentioned above, where the plan administrator selected a default saving rate of 3 percent and 100 percent

of the money was invested in a money market account, most employees passively accepted these choices. This is unfortunate, because virtually every expert who has studied the problem concurs

that 3 percent is not a high enough contribution rate, and a money

market account is not a suitable long-term investment vehicle for

100-percent of one’s retirement income.

My collaborator, Shlomo Benartzi from UCLA, and I have discovered a better plan that can be adopted in conjunction with or separately from automatic enrollment. We call our plan Save More Tomorrow, also known as the SMART Plan.

Under SMART, participants are contacted a few months before

their next pay increase with the following offer: They can commit

themselves now to increasing their savings rates later, specifically

when they get their next raise, say, by 2 or 3 percentage points.

Also, their contribution rates will continue to go up whenever

they get a pay increase, until they either reach some specified maximum or opt out of further increases. Notice that this plan incorporates the psychological principles I mentioned above.

People are asked to start saving more in a few months, not now,

and by linking the savings increase to pay increases, participants

never have to experience a cut in their take-home pay. We have

7

now implemented this plan in several companies, but let me report

on the results from the first company to adopt the idea, a mid-sized

manufacturing firm in the Chicago area.

The company was concerned that their employees were not saving enough for retirement, so they hired a financial consultant and

made him available to meet one-on-one with every worker. The

consultant had a computer with software that could help calculate

how much the employee should be saving.

Because the employees were not good savers, the software typically recommended that the employee immediately increase his or

her saving rate to the maximum allowed. However, few employees

were willing to accept this advice, so the consultant typically suggested an increase of 5 percentage points, say, from 3 percent to

8 percent.

This advice was also rejected by most employees, so the consultant would offer these reluctant savers the SMART plan. Specifically, their savings rate would increase by 3 percentage points at

the time of every raise.

This plan proved to be popular with the employees. Over 80 percent of those offered the plan, signed up, and the effect on their

saving rates was dramatic, as shown in my Table 1.

In just 14 months from the time the consultant spoke to the employees, the participants who enrolled in the SMART Plan increased their saving rates from 3.5 percent to 9.4 percent, and after

2 more years, they were saving 13.6 percent of their salary.

Their saving rates have nearly quadrupled, and this is a group

that had been very reluctant savers. Remember that they wouldn’t

accept this advice to increase by 5 percentage points.

The SMART Plan has implemented by several other employers

and companies that administer 401(k) plans, such as Vanguard,

are offering the idea to their employer-customers. We’re optimistic

that hundreds of thousands of employees will be enrolled in

SMART Plans within the next few years, and within a decade, the

plan could reach most employees in the U.S.

At the moment, the idea does not need government intervention,

but two steps are worth considering: First, adopt some version of

the SMART Plan for government employees through the Thrift

Savings Plan.

Second, give some consideration to firms that adopt the best

practice combination of automatic enrollment and SMART, perhaps

exempting these firms from cumbersome nondiscrimination testing.

Such action would simply recognize that in implementing a

SMART Plan, firms have already met the spirit of the Congressional intent that retirement plans should not disproportionately

benefit high income earners. There are other lessons for government to take away from our experience.

First, we’ve found a winning recipe for helping people save. The

key ingredients are: Make it easy to join the plan—the easier the

better—and automatic enrollment is the easiest.

Take the contributions directly from the paycheck. If you don’t

see it, you don’t spend it. Once you get people saving, make it a

default option to keep saving, or even better, keep increasing their

saving rate.

8

Four, put the money into an account where people are not overly

tempted to dip in. These basic principles could be adopted in many

existing and proposed tax-saving vehicles.

I would like to make one other behaviorally-motivated suggestion. One way many Americans do manage to save, albeit, temporarily, is through tax refunds. Most Americans receive a refund

when they file their tax returns.

Unfortunately, that money is often spent when the refund check

arrives, or even quicker, via tax refund loan. One way to get more

of that money into long-term savings would be to allow refunds to

be deposited directly into an IRA, and still qualify for a tax credit

for the previous year.

In other words, people who are now, in March, 2004, filing their 2003 tax returns and claiming a typical $1,500 refund, could send

those funds directly into an IRA account. For traditional deductible, not Roth IRAs, the actual amount deposited would be increased by the taxpayer’s marginal tax rate, so a taxpayer in the

25-percent tax bracket would be given a choice of getting a $1,500

refund or making a $2,000 IRA contribution. That could be an attractive inducement to save.

My principal conclusion is simple and optimistic. We can succeed

at helping Americans save more by employing a combination of

basic psychology and common sense.

If I could add one personal note, helping to save is a cause I believe in. We’re offering this SMART Plan to any organization at no

cost, as long as they agree to provide us with outcome data. This

is not a profit-seeking venture. Thank you.

[The prepared statement of Dr. Richard H. Thaler can be found

in the Submissions for the Record on page 36.]

Chairman Bennett. Thank you very much.

Mr. Pozen.

STATEMENT OF ROBERT C. POZEN, NON-EXECUTIVE

CHAIRMAN, MFS INVESTMENT MANAGEMENT, JOHN M. OLIN

VISITING PROFESSOR OF LAW, HARVARD LAW SCHOOL

Mr. Pozen. Thank you. I’d like to begin by supporting Vice

Chairman Saxton’s suggestion that we change the taxation of mutual funds. As he pointed out, right now, even if mutual fund

shareholders do not sell their own shares of a fund, they still are

taxed on the capital gains realized by the fund, and his proposal

for a deferral of those capital gains until shareholders sell their

fund shares is one that I personally support.

I know that this is a little outside the purview of this hearing,

but I couldn’t help but support the very sound suggestion of your

Vice Chairman.

Let me say that my general theme today is that we ought to consider private retirement plans, together with Social Security. From

the point of view of the retiree, they are obviously considered together, because a retiree has two sources of income.

But in the past, in a lot of legislative sessions, they have been

viewed as entirely separate, so I want to put them together, and

I have suggestions for each area.

In the private retirement area, I think we know that the participation rate of people under $50,000 a year is quite low, and under

9

$25,000 a year in income the participation rate is actually minimal.

And it’s probably not possible to increase the amount significantly

that people can put in a 401(k) plan under $25,000 a year. If they

are married and have two children on $25,000 a year, they just

don’t have enough to live on.

But I believe that we can do a lot for people with incomes be- tween $25,000 and $50,000 per year. We now have a low-income

tax credit which Congress adopted a few years ago. Unfortunately,

it is a non-refundable tax credit. I ran the numbers on a family of

four with two children, who had income of $40,000 a year, and it

turns out that if you just apply the four exemptions, the standard

deductions, and the child credit of $2,000, their total Federal income tax is $49. If we want this incentive for IRAs and 401(k)s to

work, where the low-income tax credit is essentially a form of government matching for these programs, we need to make the lowincome tax credit refundable.

Now, that involves money. I had a preliminary estimate run, and it was roughly a 10-year estimate of about $10 billion or $1 billion

per year (assuming the existing low-income tax credit is already

permanent). This is a relatively modest amount of money that

would make this tax credit viable for that group of people with incomes between $25,000 and $50,000, who would like to save if

given appropriate incentives.

The other proposal I have builds on one of Dr. Thaler’s ideas, and

takes it one step further. We know that employers with fewer than

100 employees are the ones who have the lowest percentage of private retirement plans.

Congress has tried to address this problem by introducing the

SIMPLE Plan, and what I’m proposing is the ULTRA-SIMPLE

Plan, going one step further.

I believe that financial institutions, if the program is simple

enough, would offer this program to every employer. The small employer, at the end of the year, would take all employees that earn

$25,000 or more, and would put 1 percent of their wages into an

IRA. This would be invested automatically in a specified account,

whether it be a money market account or a balanced account, unless the employee chose a different type of account.

And the employee could opt out of the whole program. But if the

employee didn’t opt out, the 1 percent would go into this ULTRASIMPLE Plan for retirement.

I am establishing a minimum of $25,000 to reduce paperwork.

Otherwise small employers will ask: what about part-time workers,

what about temporary workers? So we’re eliminating those issues.

I’m also limiting the contribution to once at the end of the year,

so we know how much money the person has earned. I’m putting

the minimum at $25,000 so that the account size will be $250,

which will be enough to get financial institutions interested. They

are not interested if the number is only $79 or something like that.

So this is an ULTRA-SIMPLE PLAN. It involves no change in

the tax law; it just is a way to create a plan that can be offered

to all employers who now do not have any type of 401(k) or other

retirement plan. It doesn’t really have a cost to employers, and if

the employees don’t want to participate in the plan, they can opt

out.

10

Now, the second subject I want to address is the relationship between Social Security and IRAs. I have to digress a little to explain

something that Peter Orszag is very familiar with, but most people

are not. And that is the difference between wage-indexing and

price-indexing.

In the Social Security area, we usually think of price-indexing

because COLAs after retirement are all price-indexed to protect

against inflation. But sometimes people don’t know that the initial

Social Security benefit is based on wage-indexing. That is, we compute your average career earnings, and then we adjust this average

up by wage-indexing. This is much more expensive than price-indexing. Indeed, if we only moved from wage to price-indexing of initial Social Security benefits, this would have a huge positive effect

on Social Security’s long-term deficit.

Now, what I would like to do is divide workers into three categories: We have all those under $25,000 a year in income. As I

have said, I think it’s very hard for them to save. They have very,

very low levels of participation in IRAs and 401(k) plans.

It’s going to be very hard to significantly increase that participation rate, so they are going to be almost exclusively dependent on

Social Security. Therefore, I would continue to let those people be

on wage-indexing. On the other hand, look at all the people who have $100,000 or

more in career earnings. I would move them all on to price-indexing, because almost all those people have IRAs and 401(k)s. The

combination of slower-growing Social Security benefit with an IRA

and 401(k) will give them more than they would have received

under the original schedule for their Social Security benefits. And the middle ground, say, someone at $50,000 a year, we’d

work out some proportional formula whereby their initial Social Security benefits would be part wage-indexed and part price-indexed.

So this is a way to treat everybody fairly.

We would have three different groups of Social Security beneficiaries, and their Social Security benefits would grow at different

rates. So we would be counting on people to put that 1 percent in

IRAs to make up the difference.

We’ve run the numbers: if the middle and the higher income people would just put 1 percent a year of their wages more into an

IRA, they would come out more than whole. And the beauty of this

proposal is that it cuts Social Security’s long-term deficits by over

two-thirds. Thus, if we went to what I call progressive indexing,

moving partly from wage-indexing to price-indexing, with the lowest income people staying at wage-indexing and the highest moving

to price-indexing, we would cut roughly 68 to 70 percent of Social

Security’s long-term deficit, as computed by Steve Goss, the Chief

Actuary of Social Security, the keeper of the numbers, as we all

know.

In short, I propose two rather modest changes in IRAs that

would help increase the savings rate, moving from a non-refundable to a refundable credit, and introducing the ULTRA-SIMPLE

IRA Plan based on Dr. Thaler’s research. Then if we could increase

the participation rate in IRAs, we could develop an approach that

combines more IRA benefits with slower growing Social Security

benefits for higher earners. As a result of this dual approach, we

11

could keep our retirees at roughly the same total retirement income, while making a big dent on Social Security’s long-term deficit. Thank you very much.

[The prepared statement of Robert C. Pozen can be found in the

Submissions for the Record on page 41.)

Chairman Bennett. Thank you. That was a very provocative

suggestion.

Mr. Edelman.

STATEMENT OF RIC EDELMAN, CHAIRMAN,

EDELMAN FINANCIAL SERVICES

Mr. Edelman. Thank you, Mr. Chairman. It’s a pleasure to be

here this morning. In addition to my work as an author in the field

of personal finance and doing radio and television work in the field,

my firm, Edelman Financial Services, is the sixth largest financial

planning firm in the nation, according to Bloomberg. We manage

about $2 billion in assets for 7,000 clients around the country, all

of it in mutual funds.

I was also named by Research Magazine in November of 2003 as

the nation’s number one financial advisor for focus on the individual client, and it’s that perspective that I think sets me apart

from most folks who come here to speak with the Committee, in

that I’m in the trenches. I deal one-on-one with individual consumers on a regular basis, and that perspective is perhaps a little

bit different from the typical ivory tower environment that we

sometimes find ourselves in.

And I can tell you, from having studied Dr. Thaler’s research for

many years, that one of the most effective things this Committee

can do is basically whatever he says.

[Laughter.]

Mr. Edelman. Because the behavioral side of economics is one

that has been too largely ignored, and I can tell you, from working

one-on-one with consumers, that what he describes in his research

and in his work is exactly what we discover in the trenches, dealing with individual clients.

And to that extent, the number one way to help Americans save

more is financial literacy. Our American education system is widely

regarded as the best in the world. We’re unmatched in our ability

to teach skills to America’s school children, so that they have the

ability to get jobs and earn a living.

What we don’t teach them, however, is to make money with the

money that they’ve made. We don’t teach them how to manage

their wealth. We don’t teach personal financial literacy in our

school systems on a regular basis.

And yet all the statistics show that money has an incredible impact on everyone’s life, including at very young ages. According to

several studies, the first assisted purchases occur at age 3, and

they are not in toy stores, but in the supermarkets. Think carefully

as to who is really choosing the cereal that mom and dad buy. It’s

not mom and dad.

Ask a typical 6-year old where does money come from and the

most likely answer is the ATM. After all, they just watch mom or

dad punch buttons on a box and money comes out. Ask the typical

12

consumer. Ask yourself. What’s the price of a big-screen TV? It’s

not $4,000. It’s $39.95 a month.

So what we have to recognize is that the legal tax and financial

complexities have never been greater. But we have found ourselves

letting children graduate school without any information about how

money works.

Today life is very complex. Americans are changing jobs, on average, every 4 years. Fifteen percent of Americans move every year.

Almost half of marriages end in divorce and more than half of

those will remarry. We’re also having children later in life than

ever. That does not even begin to introduce the concepts of terrorism, technology and new social issues. Everything from gay marriage to euthanasia.

With all these complexities, it’s more important than ever that

our school children graduate understanding the basics of money

management. They are graduating high school without knowing

how to balance a checkbook. They don’t understand how loans

work. They don’t understand compound interest.

But, at the same time, they have access to credit cards and will

rapidly go into credit card debt. The average indebtedness in college of today’s undergrads is over $4,000. High school seniors are

now being offered credit cards. We have to recognize that the access to debt is pervasive.

We’re finding an increase in bankruptcies. We’re finding an increase in indebtedness across all age groups, including seniors. And

what we have to do is give them the education they need to be able

to survive and thrive financially.

So my primary recommendation is to require the nation’s schools

to include financial literacy in their curriculum. This is easier than

it may at first appear, because it doesn’t require, necessarily, a

whole new classroom. It simply says that when you teach history,

talk about the economic implications of the reasons why nations go

to war. Talk about what things cost 200 years ago and what they

cost today.

In math classes, talk about compound interest. It’s a question of

geometry and algebra. Let school children, when they’re learning

how to count, count coins instead of marbles.

Sir, we just need to incorporate money as a routine facet of everyday life. That means in the classroom as well as in the workplace.

I also think we need to delay Social Security eligibility to age 70

for Americans who are currently under the age of 50. One of the

shocking statistics is that 30 percent of working Americans say

that Social Security will be providing most of their retirement benefits. There is an over-dependence, an over-reliance on Social Security today.

We need to get the message across to Americans that their future is more up to them than it is up to the government. By letting

American workers who are younger, those who are in their 30s and

40s today, by letting them know that they can’t rely on Social Security until age 70, they will have a strong incentive to save.

Simultaneously, we should delay mandatory withdrawals from

retirement accounts. Currently, Americans are forced to withdraw

their money starting at age 701⁄2, the exact opposite of encouraging

13

them to save. We’re demanding that they start spending. We

should delay until age 80 the mandatory distribution from IRAs

and retirement accounts. We should also replace the current retirement plan contribution regulations with one universal program.

Currently, where you work determines what plan you’re offered,

whether or not you have a plan, how much money you can contribute and what those choices are. We should not penalize Americans who work at small companies simply because they work at a

small company. We should allow them to have the same type of

program that those who work for large corporations enjoy.

Fifth, we should permit people to save for retirement even if they

are not currently earning an income. There are millions of stay-athome spouses. They’ll tell you they work. They simply don’t earn

an income. We should encourage people to save by permitting them

to establish retirement accounts even if they don’t currently have

an income.

We should also permit people to save for retirement regardless

of their age. One of my inventions is something called a retirement

income for everyone trust, which is a retirement planning tool for

children. It is a vehicle where the parents and grandparents can

set aside money.

Because I’m in the private sector, we had to realistically put the number at $5,000. If we can introduce this in the public sector, we

could knock that figure way down. But a $5,000 contribution for a

newborn child, where they cannot touch it until age 65, that

$5,000, at historical market averages, would grow to $2.4 million

by age 65. Effectively, potentially eliminating the need for Social

Security income. The key is to allow people to save money at incredibly young ages, regardless of the source, in a mandatory environment where they cannot touch it until retirement.

Number seven is to eliminate the ability for workers to borrow

from their retirement plans. Today we allow workers to borrow

from their 401(k). As a result, an awful lot do that. Seventeen percent of all American workers have borrowed from their retirement.

The average loan is 16 percent of the account balance.

The irony is that most of those who have taken loans earn between $40,000 and $100,000. It is not the lowest income spectrum

that have borrowed against their accounts. By borrowing against

the retirement plan, they’re effectively ensuring that they will not

have money at retirement.

Number eight, we should eliminate the ability for employers to

distribute funds to terminated employees. Under current retirement plan rules, if you leave the company and there’s less than

$3,500 in the account, the employer has the right to send you the

cash. When that happens you’re going to pay taxes, plus a 10 percent penalty, and you’ll probably spend the money on something

frivolous. We should eliminate the ability of employers to do that

and, instead, require that the money remain in a retirement account.

Finally, number nine, we should extend to IRAs the same creditor protection currently available to qualified retirement plans. If

you have money in a 401(k) and you are sued, a creditor cannot

go after that money. But they can go after money in an IRA. It’s

an unlevel playing field and serves as a disincentive to move

14

money to IRAs. That should be eliminated. Thank you very much,

Mr. Chairman, for this opportunity.

[The prepared statement of Ric Edelman can be found in the

Submissions for the Record on page 49.]

Chairman Bennett. Thank you, sir.

Dr. Orszag, you get to bat cleanup here.

STATEMENT OF DR. PETER R. ORSZAG, JOSEPH A. PECHMAN

SENIOR FELLOW IN ECONOMIC STUDIES, THE BROOKINGS

INSTITUTE, WASHINGTON, DC

Dr. Orszag. Thank you very much, Mr. Chairman. My testimony

this morning addresses two issues.

First, why it is critical to preserve Social Security’s core insurance features even while reforming the program to eliminate its

long-term deficit. Secondly, how we can expand retirement savings

on top of Social Security.

First, on Social Security, the program provides a well-defined

basic income that is protected against inflation, the risk of outliving one’s assets, and financial market fluctuations. Benefits are

progressive, providing a higher replacement rate for low earners

than for high earners. The program provides families with important insurance against the disability or death of a wage earner in

addition to retirement benefits.

Although we can and should boost retirement savings on top of

Social Security, we must not forget that for the majority of the population, the program provides the key layer of financial security

during particular times of need.

For example, one-fifth of elderly beneficiaries receive all of their

income from Social Security and two-thirds receive the majority of

their income from Social Security.

The average Social Security benefit is only a little more than

$10,000 a year, underscoring the role of the program in providing

a core layer of financial security above which people can build retirement wealth in other forms.

The program does face a long-term deficit and restoring longterm balance to Social Security is necessary. But it’s not necessary

to undermine the program’s important protections in order to save

it.

In particular, in my view, replacing part of Social Security with

individual accounts is likely to undermine the program’s retirement

security features because a real-world system of individual accounts is unlikely to require that benefits keep pace with inflation;

unlikely to require participants to fully annuitize their account balances when they retire (that is, transform the account balances

into something that lasts as long as they are alive); and unlikely

to protect surviving spouses as well as the current system does.

Furthermore, and perhaps most importantly, there is likely to be

very substantial pressure for early withdrawals under a system of

individual accounts, just like we see with 401(k)s and IRAs. Someone with $10-, $20-, $30,000 in an account, a sick kid, and the need

for a new car, is going to exert a lot of pressure to get the money

before retirement. In which case, the money is not there for retirement.

15

Professor Peter Diamond of MIT and I have put forward a progressive reform plan that restores long-term balance to Social Security without any accounting gimmicks and while actually boosting

some of the social insurance features that the program currently offers.

The second part of my testimony addresses how to boost savings

on top of Social Security. Various types of savings incentives already exist for households to supplement Social Security in building up retirement wealth. But most of these savings incentives are

upside down. They provide the strongest incentives to participate

to higher income households who, on average, are already better

prepared for retirement and for whom a dollar going into a retirement account is less likely to represent new savings rather than

just asset shifting from a different kind of account, while providing

very little incentive to participate for lower or moderate income

households who are more likely to need additional funds in retirement and for whom additional dollars going into the accounts are

more likely to represent new savings.

In part reflecting this sort of upside sort of incentives, the nation’s broader pension system betrays several serious shortcomings.

First, participation is low, especially among lower earners. Only

about one-fifth of workers in households with income of less than

$20,000 participate in any given year.

Even those who do participate rarely make the maximum allowable contributions. Only about 5 percent of 401(k) participants, and

only about 5 percent of those eligible for IRAs, make the maximum

allowable contribution.

Finally, despite the shift from defined benefit to defined contribution plans over the past few decades, many households approach

retirement with meager defined contribution balances.

The median defined contribution balance among all households age 55 to 59 in 2001 was only about $10,000. The median was

higher for those with accounts. But, among all households in that

age range the median was only $10,000, which does not provide a

very large retirement annuity.

The bulk of the policy changes that have been enacted in recent

years, moreover, move the system further in the wrong direction.

They provide disproportionate tax breaks to higher income households who would have saved the money anyway and for whom the

contributions made do not represent net additions to savings, while

doing little to boost incentives for participation among moderate

and lower income households.

In my view, a better strategy would encourage expanded pension

coverage among those lower and moderate income households,

through the following steps. First, one could expand the income eligibility range for the saver’s credit that Mr. Pozen mentioned and

make the credit refundable. The credit is currently scheduled to expire or sunset in 2006. It should be extended, expanded and made

refundable, in my opinion.

Second, we could reduce the implicit taxes on saving that exist

under various government programs. For example, food stamps and

supplemental security income have asset tests that impose significant, implicit taxes on the savings that lower and moderate income

households do accumulate.

16

Financial education is obviously critical. I would join in the call

to be providing financial education as part of the core primary and

secondary school education, not waiting until people are older before even trying to get to them.

Finally, as the other witnesses have emphasized, I think, perhaps the best thing that we can do is use the force of inertia to

boost savings rather than forcing people to overcome inertia in

order to save. That would include changing the default choices in

401(k) plans as has already been explained and also include a little-noticed part of the Administration’s—well, it wasn’t technically

the budget, but it was in their Blue Book Treasury proposals—a

proposal to allow individuals to split their refunds.

Many people appear to be reluctant to put their entire refund

into an IRA. The IRS has thus far been reluctant to allow individuals to split their refunds into two components. Included in the Administration’s Treasury proposal this year, it doesn’t require a statutory change, but they should be urged to follow-up on this, is a

proposal that would allow people to just check a box on the tax return and put part of the refund into an IRA and part into a checking account or some other more liquid asset. I think that does

make sense.

Finally, I think we also need to be paying more attention, as the

Baby Boomers near retirement, to the withdrawal stage. We’ve focused a lot on the accumulation stage and trying to build up account balances, but we really do need to worry about how individuals are going to take the money out of their 401(k)s and IRAs.

I have some slight differences of opinion about whether loosening

the minimum distribution rules, in general, makes sense. I think

some targeted reforms there would be beneficial. But, more broadly, we do need to be worrying a lot about how people are going to

be taking their money out of these accounts, not just about how

people get the money in them in the first place.

Thank you very much, Mr. Chairman.

[The prepared statement of Dr. Peter R. Orszag can be found in

the Submissions for the Record on page 55.]

Chairman Bennett. Thank you, sir.

Let me ask Mr. Saxton’s questions so that we’re true to the

pledge we made to him before he left.

Mr. Edelman, they’re all directed to you.

[Laughter.]

Chairman Bennett. You get to be Lucky Pierre on this one. So

he says: ‘‘I would like to ask you a few questions about the current

tax treatment of capital gain distributions made by mutual funds

to draw on your experience as a financial advisor.

‘‘Based on your experience, is it possible for ordinary taxpayers

to get confused and effectively pay capital gains taxes twice, once

on distributions and again when they actually sell their mutual

fund shares?’’

Mr. Edelman. It’s not only possible, Mr. Chairman, for them to

get confused, it’s almost impossible for them not to get confused.

The rules are extraordinarily complex. I wrote about this a lot in

my first book The Truth About Money. It’s one of the biggest tax

traps facing mutual fund investors.

17

When you make an investment, say, you put $10,000 into a mutual fund, you typically reinvest the dividends in capital gains. The

mutual fund pays out those distributions and they are reinvested

and then at the end of the year you get a 1099. You hand the 1099

to your accountant, who has you pay taxes on your tax return.

Later, when you sell the fund, you get a check in the mail from

the fund company and the 1099 referring to the gross distribution.

You then give that to your accountant and your accountant says,

‘‘How much did you invest?’’ And you tell him that one day, wayback-when, you invested $10,000.

Your answer is not adjusted for the fact that you’ve earned dividends and capital gains over time, and you paid taxes on them annually. Thus you pay taxes again because you didn’t adjust for all

the reinvestments, which should have increased your cost basis.

We have a simple solution. And that is to do away with the annual 1099 distribution.

Mr. Pozen. I ought to add that most fund companies now, as to

more recent investments, give you your average cost basis which

includes dividend reinvestments.

Chairman Bennett. So they show the increase in basis?

Mr. Pozen. That’s built into the system over the last few years.

But it wouldn’t be possible for somebody who made an investment

20 years ago easily to ascertain his or her basis.

Chairman Bennett. There’s been a lot of controversy recently

about problems in certain sectors of the mutual fund industry. Isn’t

the current tax treatment of mutual funds, capital gains distributions, one of the largest costs imposed on owners of mutual fund

shares?

Mr. Edelman. There’s no question, Mr. Chairman, that the annual cost of taxation on your mutual fund profits is a very significant impediment to future wealth. It’s forcing you to pay taxes on

money that otherwise could have remained invested.

This does not apply to stocks or bonds. If you own a stock for 20

years, it is, in essence, tax deferred for 20 years. You pay no taxes

on the growth until you sell. That same simple rule does not apply

to mutual funds and creates a substantial tax and, therefore, decreased wealth for millions of investors.

Chairman Bennett. Thus, isn’t the current tax treatment of

mutual fund capital gains distributions one of the biggest drawbacks to investing in mutual funds?

Mr. Edelman. It is a very significant drawback, yes. Once investors begin to understand the tax complexity associated with mutual

funds, it often serves as an impediment to their long-term savings.

Chairman Bennett. When the stock market is on an upswing

and mutual funds generate capital gains, this results in immediate

tax liability for shareholders. But when the stock market falls and

the funds incur losses, these can not generally be passed through

to shareholders. Isn’t this tax treatment inconsistent, even if the

fund losses are eventually permitted to offset gains over time?

Mr. Edelman. Yes, Mr. Chairman. It is inconsistent. There’s a

significant disparity between having to pay taxes when there are

distributions and not being able to take a tax deduction when there

are losses.

18

It gets worse than that. Many times, mutual funds are selling securities that they’ve owned for less than a year. So not only are

they issuing you a distribution, they’re offering short-term distributions which are taxes at the top tax bracket of the taxpayer as opposed to the 15 percent long-term gains rate. It’s even worse than

the question would suggest.

Chairman Bennett. Others of you can jump in here. Mr. Saxton

said this should all be directed to Mr. Edelman, but I don’t want

to shut anybody else off if they want to comment.

His last comment, he says: ‘‘Another bill I’ve introduced would

end mandatory distributions from IRAs at 701⁄2 and also end mandatory distributions from 401(k) accounts.

‘‘Essentially, this is another form of tax deferral that would reduce the negative tax consequences for personal savings. Isn’t it desirable to end, at least, delay these mandatory distributions?’’

Mr. Edelman. I’m not an economist, so I can’t really address the

basis or the need to have a date that the money must begin to

come out.

It does seem to be illogical to me, from a financial planning perspective and working with individual clients, because the money in

an IRA or other retirement plan is eventually going to be withdrawn and add tax if only at the individual’s death. It’s nothing

you escape.

Since it can’t be escaped, and we’re not worried about a step-upin-basis at death, for example, which happens on stocks or real estate. Since there’s no step-up-in-basis and we are guaranteed to

have the money eventually taxed, I’m not quite sure why the government cares when it’s taxed. Why does it need to be 701⁄2? Why

not let it be at the taxpayer’s discretion, either death or another

age of their choosing?

Chairman Bennett. Does anyone else want to comment on

that? I am just turning 701⁄2, so I have a very strong interest in

this.

Dr. Orszag. I have a somewhat different view. And I think it’s

important to distinguish the 401(k) rules from the IRAs. Under the

401(k) rules, the minimum distribution requirements are that you

must begin distributing the funds at 701⁄2 or when you retire,

whichever is later. So the rules are different between 401(k)s and

IRAs.

Chairman Bennett. As long as I stay in the Senate, I can hang

on to them?

Dr. Orszag. A lot of people are worried about the incentives provided for older workers to stay in the workforce. The partial effect,

in least in terms of labor incentives from raising that age could be

to weaken instead of strengthen incentives to continue working.

It’ll depend on individual circumstances, but there is, at least, an

important distinction between the IRA and 401(k) rules.

Here’s also, I think, an important question, which is, why are we

providing the incentives for IRAs and 401(k)s in general?

In my view, the reason is to provide an incentive for retirement

saving. The minimum distribution rules, and I don’t want to defend

them in their entirety because I think they are too complicated and

there are some reforms that are worthwhile, but it is important to

remember the goal. The goal is to make sure that that saving is

19

actually used during retirement and not as an estate-planning device or for some other purpose.

If there are other ways, and I think there are, of ensuring that

the bulk of the saving is serving the public policy purpose for which

the tax incentives were provided, that should be explored. I do

worry about either eliminating or substantially raising the age because I think it then undermines that public policy objective for

putting the rules in, in the first place.

I’d also note one other point. We face, as you know, a very substantial long-term fiscal deficit. That long-term deficit already incorporates, into the projections, trillions of dollars in present value

in taxes on withdrawals from 401(k)s and IRAs, which had a tax

break up front and tax-free build-up and then are taxed on the way

out. I think you—you meaning policymakers in general—are going

to come under increasing pressure in the years ahead to reduce

those taxes.

A lot of people don’t realize that when they’ve got $15,000,

$20,000, $30,000 in their 401(k), they will be taxed on those funds.

If we start to reduce those taxes, we make an already really bad

fiscal situation that much worse. So anything that crosses the line

of either reducing or eliminating the taxes on withdrawals, I think,

is risking a very severe loss of revenue. Because I don’t know how

you stop the ultimate effect from adding up to trillions of dollars

in an already bad fiscal outlook.

There is such a danger with regard to the minimum distribution

rules. Because as was noted, relaxing those rules is effectively reducing the implicit tax on the withdrawal that you start moving in

that direction. That’s another consideration to take into account.

Mr. Pozen. Mr. Chairman, I have a slightly different view,

though it’s not inconsistent. A lot of the current rules allow people

to take money out of IRAs and 401(k)s for purposes other than retirement. And I know there’s a lot of pressure on Congress to keep

expanding the range of permissible withdrawals. Buying a home is

a worthwhile objective, but the problem is that these withdrawals

undermine the retirement objective, which should be the primary

objective. I think we should do more to keep that money in plans

for retirement.

Another subject that we struggled with when we were on the

President’s commission was the form of distribution from a retirement plan. For a lot of people, it would really make sense not to

take a lump sum out of their IRA, but rather to buy an annuity

so they would be assured of having money for the rest of their life.

But you then meet with somebody who has $200,000 a year in

income and they say, ‘‘why should I buy an annuity?’’ For that reason, it probably doesn’t make any sense. But I would follow Professor Thaler’s idea hereby making the presumptive choice of annuity. And then if people didn’t want an annuity, they could opt out.

I think that lifetime annuities, joint and several annuities, are

quite important for a lot of families. And if people just take a lump

sum out at retirement to buy a car, or they take money out of their

plans before retirement, for example, to buy a house, they are really defeating a lot of the purpose of having a retirement plan.

20

So I would try to keep a choice available. But I’d like to use the

force of inertia to push people toward retirement objectives rather

than other objectives.

Mr. Edelman. One other point I would like to make about the

mandatory distribution rules and I would suspect that I won’t get

any objection on this point because it’s free. It’s not going to cost

anybody any money or alter policy in a significant way and I know

you love to hear things like that.

You had mentioned that you’re turning 701⁄2 this year, Mr.

Chairman.

Chairman Bennett. This month.

Mr. Edelman. That does not mean happy birthday.

[Laughter.]

Mr. Edelman. Happy day, but not birth. That does not mean

you have to withdraw money this year from your retirement account. It means you have to do it by April 1st of the year following

the year you turned 701⁄2. That rule is absurd. To tell ordinary consumers that they have to begin taking the money out by April 1st

of the year following the year they turned 701⁄2 is silly.

It’s far too complex and it should be simply changed to say you

have to take out money by December 31 of the year you turn 70

or 71, pick one. But that whole phrase of April 1 following the year

in which you turned 701⁄2 is a mathematical jumble that is just

pointless and it’s a good example of how the tax code is unnecessarily complex.

Chairman Bennett. I have exhausted Mr. Saxton’s questions.

Let me ask a few of my own.

In 1986, Congress imposed income limits on IRAs so that workers above a certain income level were no longer permitted to receive the tax benefit of an IRA. Following the imposition of those

limits, IRA participation levels fell, even among those low-income

workers who were still eligible to participate. Any ideas as to why?

Dr. Thaler, you’re the psychologist here.

Dr. Thaler. I think it’s no big mystery, which is that the financial services industry no longer viewed this as an activity that was

worth spending a lot of money advertising.

In the early 1980s, around this time of year, it was hard not to

see ads asking people to invest in IRAs. And when you cut that

market down, they’re going to spend less money advertising.

Mr. Pozen. I would tend to agree. The limits then were that you

couldn’t get an IRA deduction for a family unless you were earning

less than $40,000 a year. And, as we’ve seen, those deductions are

not that valuable for people at those income levels. Many of them

have a hard time saving. The financial institutions are interested

in the larger accounts and, of course, higher participation rates. So

if you’re advertising in a market where only a small percentage are

effectively eligible, and even a smaller percentage are actually likely to contribute to IRAs, it’s not really worth spending large dollars

on IRA advertising.

One of the benefits of having a more universal IRA is, without

the government paying anything, you do get the advertising dollars

of the financial institutions.

I agree with what Mr. Edelman says about financial literacy. In

designing savings programs, you ought to try to do something that

21

implicitly gets the financial services industry behind you and let

them carry the ball to a large degree on financial literacy. They

will if they see a reasonable return on their advertising investment.

Mr. Edelman. For many in our field, Mr. Chairman, the IRA is

a loss leader. The amount of revenue we can earn from opening an

IRA account is minimal. But if it enables us to grab additional assets from a client who has other assets, then we’ll go through that

marketing effort. When you limit us to dealing with individuals

whose sole investment is going to potentially be that IRA, then as

these two gentlemen have said, we’ll shrug or shoulders and not

bother.

Dr. Orszag. Senator, I think while agreeing, in part, with the

other panelists, there are a couple of other perspectives that are

important.

First of all, there was a decline for those below the income limits

post-1986. In many cases, it was a pretty modest one. For example,

if you look at tax filers with adjusted gross income of less than

$20,000 in 1984, 5 percent of those made an IRA contribution. In

1988, 2.4 percent did. So, yes, there’s a decline. But it’s not like

you’re going from 90 percent to 15 percent.

Mr. Pozen. I think you’re making my case about why you

wouldn’t advertise for 2.4 percent of those eligible.

Dr. Orszag. There you go.

Chairman Bennett. You’re dealing in a political world. On the

floor of the Senate, that would be trumpeted as it’s cut in half.

[Laughter.]

Dr. Orszag. That is right.

The second thing that is important to realize is the type of advertising matters, also. One advertisement in The New York Times in

1984, for example. I’m just going to quote it for a minute: ‘‘If you

were to shift $2,000 from the right pants pocket to the left pants

pocket, you wouldn’t make a nickel on the transaction. However, if

those different pockets were accounts at’’—and I’ll leave out the

name of the financial services firm—‘‘you’d profit by hundreds of

dollars. Setting up an IRA is a means of giving money to yourself.’’

That is an advertisement for asset shifting. That is not an advertisement for new saving. The type of advertisements that are likely

to attract higher-end clientele are not necessarily the type of advertising that will attract where I think the focus should be. I’m getting new saving from the lower and moderate households or middle

income households who most need to save more.

I agree that advertising is important. I just want to caution us

both to put the magnitudes in perspective and, also, obviously, the

type of advertising will affect the type of response that one gets.

Chairman Bennett. Of course, every investment is a form of

asset shifting. I have $2,000 in my pocket. I can spend it on a fancy

trip or I can invest it in this situation.

Dr. Orszag. Senator, it matters a lot whether the contribution

is coming from reduced consumption, i.e., forgoing that trip, or

shifting assets from your mutual fund, for example.

Shifting assets from the mutual fund doesn’t generate any new

savings. It’s just moving existing assets from one pocket to another.

22

Forgoing the trip is a form of raising overall net saving. That’s

really where we need to be focusing.

In my view, the empirical evidence strongly suggests that as you

go up the income ladder, more and more of the dollars that are deposited into the tax deferred accounts do not come from reducing

consumption, but rather from shifting assets from other accounts.

Chairman Bennett. We can argue the psychology of that. But

let me, Dr. Orszag, get into an area you made reference to. You

talked about Social Security. I’d like you and Dr. Pozen, if I could,

to get into dialogue with this because he talks about matching the

savings with Social Security in an overall plan. And you talk about,

perhaps, keeping the two separate so that they don’t get matched

in the saver’s mind.

One of the major problems with Social Security that has come in

the last 30 years, and is accelerating, which nobody wants to talk

about because it sounds kind of callous; but, in fact, one of the biggest problems with Social Security is people are living longer.

If they just had the courtesy to die on the same schedule that

was anticipated when Otto von Bismarck invented it, when the life

expectancy for males was in the low 60s, so if you could live long

enough to beat the odds, and live until you were 65, then the government would take care of you for the rest of your life with payments from other people who were betting that they, too, would

live. But the odds were that most of them would not.

So the lucky retiree who beat the odds and stayed alive past 65

was getting the benefit of what everybody else was paying in. That

sounds a little like a Ponzi scheme if you want to put that particular face to it.

Now we’re all living pretty much past 65 and we’re all getting

the benefits. But the guy who now doesn’t live to 65, pays in his

entire life, dies and doesn’t get a dime and his heirs don’t get a

dime. So there is no wealth creation.

I realize the advantage of what you’re talking about when you

say if they get a lump sum that can disappear. But if they get an

annuity, which Social Security is, they get paid for as long as they

live.

And we’ve got people who are now over 100 who have been drawing Social Security for over 35 years and the amount they’ve drawn

out is staggeringly higher than anything they paid in. They’re

being paid by the people who are coming in at the bottom.

At some point in this whole retirement situation, particularly in

the African American community, which demographically does tend

to die more rapidly than the white community, they’re not accumulating wealth in the way their white counterparts are, or their

healthier white counterparts are.

They have children they would like to leave estates. They would

like to have wealth accumulated in their own name that they could

do something with in their retirement years. But if their whole

focus is on a program that just pays them as long as they stay

alive, and allows nothing to be accumulated in their own name in

the form of assets, they are missing out on something fairly significant.

Mr. Pozen, you talk about tying the two together so that they

move forward and the advantages that Dr. Orszag talks about of

23

having the payment made as long as you live. If you live to 101,

it’s still going to be there. That’s an enormous, enormous advantage, an important thing.

But the flip side of it is, you turn 65 or 70—right now it’s 67 and

it’s going to be for the Baby Boomers by the time they retire. If it

comes to be 70, as you’re proposing, Mr. Edelman—and Chairman

Greenspan is talking about that, too, whatever the date is, it would

be nice to have a mixture of both.

That you have the certainty of the payouts, but you also, from

the all the money you have been paying in, some of it has been

going in under your name and you have a significant chunk of

wealth that at retirement you can do something with because

maybe you do need to make a down payment on a house and a little bit of wealth will allow you to do that. Then you can live in the

house on the income.

Discuss that whole mix of where we are in these benefits, if you

would, the two of you. Because I caught different vibes from the

both of you and I’d like to have that conversation.

Dr. Orszag. I can go first. On life expectancy, I just want to emphasize one thing that I think is very important for policymakers

and that I was struck by in writing the book with Professor Diamond. While life expectancy is increasing, as you’ve noted, it is increasing at a particularly rapid rate for higher earners and higher

educated workers. In other words, the gap in mortality rates or in

life expectancy over the past three or four decades has increased

markedly.

Many demographers expect that to continue, both because lifepreserving health behaviors are more likely at the upper end of the

income distribution and because a lot of the life-extending technologies are really expensive and they won’t filter all the way down

the income distribution.

The partial effect of that trend is to make Social Security less

progressive on a lifetime basis because the higher earners are, on

average, getting their benefits for an increasingly longer number of

years. And I think it has broader implications for a variety of policies. I just wanted to mention that.

On the mix between the two, my view, it really comes down to

how much saving one thinks households will do, even as you move

up to the 50th percentile, 60th percentile on top of Social Security.

Again, just to put some numbers in our head, the average Social

Security benefit may now be up to $11,000. But it’s only a little

higher than $10,000. We’re not talking about $50-, $60-, $70,000 a

year. It’s a very modest benefit for the vast majority of the population.

When we talk about substantially scaling that back and replacing it with some non-annuitized form of income, I worry that, basically, you wind up with too little being provided, especially, to the

widow. We have to remember that widow poverty rates are already

much higher than married women’s poverty rates, 3 times as high.

When we don’t annuitize wealth, and, particularly, when we

spend it up front, the person who’s really getting hurt is the widow.

That is the reason I’m concerned about substantially scaling back

annuitized income. But I think you have identified a fundamental

tension in individual account plans, which is, do you force

24

annuitization of the whole thing or not? The trade-offs there are

very difficult. It becomes even more difficult when you think about

if the annuitization age were 65 and you had the elderly woman

who has cancer and knows she’s going to die in 2 or 3 years.

If you’re forcing her to annuitize also, that’s a substantial loss of

wealth that you are imposing on that person in order to protect the

widows who live a long time.

Chairman Bennett. Mr. Pozen.

Mr. Pozen. I agree with your basic idea. It’s a positive social

goal for Congress to allow families, including moderate income families, to have some form of retirement account that they can call

their own, and that they can bestow on other members of the family.

But the challenge for many of the proposals for personal retirement accounts is that they are of what I call a carve-out nature.

That is, they’re taking some portion of the 12.4 percent in payroll

taxes, let’s say 2 or 3 percent, and putting that portion into a personal account.

As you point out, we already have this big overhanging deficit.

The problem with carving out is that you wind up in an even deeper hole for 30 or 40 years until you can get those people who carve

out the 2 or 3 percent to take lower Social Security benefits many

years later. So you wind up with, essentially, a requirement for a

large loan from the government to the Social Security trust fund.

What I was trying to do with my proposal is to reach your goal,

but avoid the budgetary problems of carve-outs from Social Security. Also, my proposal avoids the administrative cost of creating a

whole new set of personal accounts.

Why don’t we declare victory with the IRA as the personal account? The IRA is already there. It has an administrative structure. And if we can encourage people and incent people to build up

their contributions to their IRA, that’s where they will have their

wealth.

But the question remains: how will you deal with Social Security’s deficit? That’s why I’ve made a proposal for progressive indexing; it allows you to recognize what Peter says. The life expectancy of the higher-income people is diverging more and more from

that of lower-income people. Therefore, we should have a slowergrowing Social Security benefit for high-income workers because

they’re going to live longer.

If we bring in progressive indexing on Social Security, we help

the financing of Social Security. We offset, to some degree, the

greater life expectancy of the higher income groups. And if we combine progressive indexing with more incentives for IRAs, we

achieve your goal of building wealth without having the problem of

impairing the financial solvency of Social Security.

I’m trying to say to those people who want personal retirement

accounts—use the IRA. We have the administrative structure. Let’s

use that, instead of taking money out of Social Security, because

then you’re raising a whole set of other budgetary issues that are

very difficult to resolve.

Chairman Bennett. I think what you’re saying makes sense,

but, having said that, you are cutting into one of the fundamental

25

principles, political principles of Social Security, which is that it

cannot be means-tested in any way.

Mr. Pozen. I don’t think I actually am. Social Security, at the

moment, is progressive, but it’s currently not means-tested; rather

it is tilted in a progressive manner. As higher-income people live

longer, however, they receive larger total Social Security benefits

over their lifetime.

Thus, the progressivity that’s currently in the system gradually

is undermined and reduced, so I’m not means-testing anything. I’m

just bringing in a little more tilt to take into account that middleand higher-income people are living longer than lower-income people. Therefore, on a lifetime basis, the total value of Social Security

benefits are changing on a relative basis.

Chairman Bennett. You’re not means-testing directly.

Mr. Pozen. I’m tilting the system, but I’m tilting the system to

take into account the point Peter is making. Right now, if you have

a person who makes $100,000 a year, his or her chances of living

to 90 are much greater than a person who’s making $30,000 a year.

So I’m just tilting the system to make the average lifetime Social

Security benefit be roughly the same for all income groups.

Chairman Bennett. I happen to agree with that, but it’s interesting that people who keep saying, well, the tax system is unfair

because we should make the people at the upper end pay most of

the taxes, well, actually, they do. Nonetheless, we should make

them pay even more and more and more, but when you get to Social Security, you’ve got to send Ross Perot exactly the same size

check you send to one of the clerks that works at EDS, if they have

the same earning pattern during their years.

You can’t say, but Ross Perot doesn’t need it.

Mr. Pozen. Under my system, if Ross Perot and the clerk both made $50,000 a year as a career average, they would both get the

same Social Security check. However, the person who now makes

$100,000 a year, rather than $50,000, doesn’t get twice the earnings check of the person with $50,000. Let’s assume the higher

earner receives 1.6 times the benefit of the lower earner, so there

is a progressivity tilt already built into Social Security.

If we say that we want to maintain the current relationship between the person at $100,000 who gets 1.6 times the check that a

person receives at $50,000, we must consider that the person at

$100,000 is now going to live 5 years longer than the person at

$50,000. We should adjust that tilt a little to reflect this difference.

Chairman Bennett. Dr. Thaler, get into this.

[Laughter.]

Chairman Bennett. Talk about automatic enrollment plans and

how they might impact this and how the government could encourage automatic enrollment plans. What would the default investment be and where would you be in this whole question of trying

to get something other than just the Social Security into people’s

deductibility situation, all the way through?

Dr. Thaler. The fortunate thing is that a lot of the things that

I’m talking about don’t really need the government to get involved.

So, the private sector is taking initiatives.

Some companies are doing automatic enrollment, some are

adopting our Save More Tomorrow Plan. Many of the companies

26

that administer 401(k) plans, such as Vanguard and Fidelity,

TIAA-CREF, ADP, are offering these escalating savings plans, offering to do the administrative work to allow employers to offer

these options.

I will say that we sometimes talk to employers who are reluctant

to do this, because they are afraid of getting sued, and probably the

most important thing the government can do to facilitate these

things is to create safe harbor rules, and the Treasury has been

good about issuing rulings, making it explicit that it’s fine to automatically enroll people into plans, and automatically.

You want to make it clear that it’s fine to automatically enroll

them into something other than a money market, like a balanced

account. As I said in my testimony, another good thing the government could do would be to set up a showcase by doing this for their

own employees through the Thrift Program.

Chairman Bennett. I’m never amazed at the inventiveness of

the plaintiff’s bar.

[Laughter.]

Chairman Bennett. I can’t conceive of the basis on which a suit

would be brought here.

Mr. Pozen. Unfortunately, I can.

[Laughter.]

Mr. Pozen. The complaint would say that you’re automatically

enrolled, unless you opt out, and that the worker wasn’t sufficiently

appraised of the opt-out, so that would be one basis of the complaint. Then, second of all, if the money did go into a balanced account or in a stock account, which in a particular set of years did

less well than a Treasury bond, then the worker might complain

that you automatically put me in an investment with a lower return.

Chairman Bennett. Okay.

Dr. Orszag. I think it’s important to realize that it’s actually not

even primarily—my understanding is that it’s not Federal law here

that’s the problem. There are state labor laws that could cause

problems here in terms of suits. Frankly, we should just have Federal preemption and narrow-targeted Federal preemption of state

labor laws to allow these kinds of plans, and I agree that’s one step

that the Federal Government could take to try to remove impediments to their adoption.

Dr. Thaler. Let me give you one trivial example of the sort of

things that we run up against at my own University. Every November we have to log onto the Web and enroll in open enrollment

to choose health plans and so forth and so on.

With our retirement plan, we have a generous retirement plan,

and faculty can put an additional amount of money, up to $9,000,

into some kind of supplemental retirement account. You have to go

onto the Web every year and do that.

Now, I’m trying to convince them to make it so that if you do

nothing and you saved last year, you save the same amount again

this year, and there is some lawyer who is worried that if we do

that, that will violate some rule. I don’t think there is any rule it

violates, but people are worried that there is such a rule, and we

can, by simply making it explicit, that it’s perfectly fine to assume

27

that you want to save the same amount as you did last year, that

would help a lot.

Chairman Bennett. Of course, the individual participants in

the plan would get no benefit from the lawsuit, but the lawyer who

brought it would get rich, presumably run for the Senate——

[Laughter.]

Chairman Bennett. [continuing.]——and go on from there.

Let’s talk about matching. All of this conversation has been about

what the employee would put in. Let’s talk about matching, incentives to match. Are there lawsuit possibilities on matching?

Mr. Pozen. I don’t think there are a lot of lawsuit possibilities

for matching, but when we’re talking about this low-income credit,

that’s essential to increase IRA contributions. We know from the

401(k) experience that matching brings in higher contributions

from workers.

People love matching. It’s the equivalent to going to the store

and seeing a bargain sale. People really like matching. It has a significant effect on participation rates.

However, if you’re talking about people who are not in employerbased programs, or people with lower incomes in IRAs, then the

question is: how do we create a match? The low-income tax credit

is designed to create a government match, a partial match to be

precise.

The problem is that the credit is constructed in a way that

doesn’t really work for a lot of people. In order for the credit to be

effective, you have to be paying a significant amount of income tax.

The good news is that people with lower incomes aren’t paying a

significant amount of tax; the bad news is, to the extent you’re giving these people the match in the form of a non-refundable credit,

the match is not effective.

So, I think the match idea makes a lot of sense, but because income tax rates have been brought down and other credits and deductions have been increased, like the standard deduction, if we’re

going to have a government match to encourage IRA contributions

by lower-income workers, we need to alter the design of the match.

Chairman Bennett. We’re running probably later than we

should, but let me ask about just one more issue. One of the first

public policy questions I got involved in back in the 1960s when I

first came to Washington had to do with President Kennedy’s proposals with respect to pensions.

It was one of the first recognitions of the fact that Americans

were shifting from the old paradigm where your pension and your

healthcare and any other form of ‘‘benefit,’’ was provided by your

employer. We shift employers every 4 years, did I hear that statistic around or something along that line?

Let’s talk about portability. The Kennedy proposal was the first

towards creating portable pensions.

I did an analysis for myself when I turned 50, just to kind of

quantify it, and from the time I turned 20 until the time I turned

50, I changed jobs or situations—this included going to school,

going to the Army, what have you—17 times. I had 17 different situations in that 30-year period.

I’ve gotten a little more stable.

[Laughter.]

28

Chairman Bennett. Since I turned 50, the 11 years I’ve put

into the United States Senate is the longest period of time I have

drawn a paycheck from the same signatory in my life. So, I have

a whole series of little buckets that were accumulated along that

way, some of which, quite frankly, I have emptied to pay for the

new car, to send my kids to school, to do whatever, but some of

which I have clung to, and——

Mr. Edelman. I would argue, Mr. Chairman, did you cling to the

ones which were later or the ones earlier?

Chairman Bennett. I clung to the ones that were smaller.

[Laughter.]

Mr. Edelman. It wasn’t worth bothering.

Chairman Bennett. And my wife now looks at these statements

that come in every month and says, ‘‘What is this? Why don’t we

dump this all into a single vehicle, so that when you die, I don’t

have to go through all of this and find out what’s there?’’

Let’s talk about this whole portability question.

Dr. Thaler. Portability is great. One of the advantages of the

whole 401(k) style systems is portability. The idea of unifying all

of these tax-favored savings accounts into one type also has some

elegance and appeal.

The thing I think that’s vital to remember is that for the relevant income group—and I would say it’s somewhere between

$25,000 and $125,000, relevant meaning they have enough that

they could possibly save, and they’re not so wealthy that they’re

kind of saving automatically, for that group, the only way people

successfully save is if the money is taken out of their paycheck.

If they have to go write a check, that’s a huge problem to overcome.

Chairman Bennett. Mr. Pozen runs the ad, so they would.

Mr. Pozen. On the portability issue, I think you’re making a

very good point. We now have the rollover IRA. Theoretically, you

should be able to consolidate all these small retirement accounts

into one rollover IRA.

The problem is, since many of these accounts come from different

retirement programs, it is an accounting nightmare to try to figure

out the consolidation. For instance, if you paid no tax on all contributions to these accounts and they all had the same distribution

rules, then you could put them all into the same IRA and you

would know that the tax basis was zero. Then you could make distributions and know the tax implications.

The problem is that some accounts may be partially contributory,

some of them may not. Some of these accounts are subject to 401(k)

rules and some of them not.

I think the key problem is that we have different rules for 457s

and 403(b)s and 401(k)s. As Mr. Edelman says, this is crazy. We

ought to have one uniform set of rules called by any name you

want.

Another thing we ought to do is try to provide some relief for

people who pour this money into rollover IRAs. There should be

some sort of mechanical rule about what the basis is in these situations. I’ve tried it myself sometimes with a rollover IRA. I had a

rollover IRA from a 401(k) plan, then I had an IRA that was a nonVerDate 03-FEB-2003 14:07 Sep 30, 2004 Jkt 093761 PO 00000 Frm 00032 Fmt 6601 Sfmt 6601 D:\DOCS\93761.TXT SSC1 PsN: SSC1
29

deductible IRA, and I tried to put them together. It was a nightmare.

So, we need to make those rules simpler. Maybe we can’t do it

all into one rollover IRA, but at least we ought to be able to do

two—one for all retirement plans where there was no tax on the

way in, and second of all, everything else, where you might have

had some tax basis.

I think that simplification is the key for consolidation: we need

to simplify the rollover; the rollover is the vehicle that should be

available to you. You ought to be able to roll over all of those accounts to one account, then be able to invest that account any way

you want, but the accounting is a nightmare.

Mr. Edelman. The remaining issue on that is the rule that allows employers to distribute. Seventy-two percent of retirement accounts that are between $5,000 and $10,000, 72 percent of them

are distributed prior to retirement, because workers leave; they go

somewhere else, and although the portability rules are in place, effectively enough, to a degree, what happens when you leave work?

On your final day of work, your HR person or the business owner

says, ‘‘So what do you want me to do with your retirement plan?

Do you want to roll it over, or do you want me to send you a

check?’’

And, 72 percent of the time, the worker screams, ‘‘Sure, send me

a check,’’ especially if they are laid off and they don’t have another

job to go to. They take the check.

We need to prohibit that. We need to require that the money either stay in the account or roll to an IRA.

Mr. Pozen. We do have a rule that says that if you don’t roll

to an IRA, you are subject to withholding, and we penalize you in

that sense. I think when that rule came in, you saw a much greater number of people who rolled over.

To have a rule prohibiting withdrawals doesn’t recognize that

there are some people who are laid off and they actually need the

money. I don’t know whether we might increase the penalties in

terms of not rolling over——

Mr. Edelman. Or create the default environment.

Mr. Pozen. We do have the default environment in the sense

that the money presumptively either stays in the plan now or

transfers to a financial institution. But we could make the default

a lot stronger by increasing the taxes on withdrawals.

Chairman Bennett. Let me thank you all for your participation.

I think it’s been a stimulating discussion, and I appreciate the

interchange between witnesses. I’m sorry that our associates from

the House weren’t able to come back and join us, but I think we’ve

created a very significant record here, and I appreciate your willingness to help us do that. The hearing is adjourned.

[Whereupon, at 11:35 a.m., the hearing was adjourned.]

(31)

Submissions for the Record

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

Æ