Americans instinctively turn to the free market. That approach has been immensely successful. The profit motive attracts suppliers. Consumers have choice. Competition drives down price and drives up quality. We see the result in our cars, our cell phones, our entertainment, our toothpaste. The role of government is typically restricted to regulating health and safety, and litigating fraud.
However, at times the something we desire is deemed to be a social good. And for that, if the free market does not provide the broadest distribution that society needs, then we have turned to government to play a larger role, either through tax incentives or by providing the product.
That “social good” exception to our free market paradigm is what brought government into the business of retirement savings: Social Security, plus tax incentives to businesses to encourage private pension, and tax incentives to individuals to encourage supplementary savings. For many years that combination has sufficed to meet the social need.
Recently we have witnessed a disturbing shortfall in the effectiveness of government policies towards retirement security. Many businesses are eliminating or reducing the pension benefit notwithstanding government incentives. The IRA has not grown in coverage to make up the difference. Today nearly 50 percent of private sector workers are looking forward to an old age income that limited to just Social Security, which is inadequate to stay out of poverty.
Why are we now falling short? The Connecticut Retirement Security Board studied this question, examining the attitudes of workers and employers. The CRSB found that many employers feel they cannot afford to offer a pension and they believe their workers don’t want to contribute to a 401k, or could just as easily go directly to an IRA provider. However, nearly 80 percent of workers who do not now have a retirement saving option at work would welcome and would participate in such an option.
So why isn’t the private sector IRA filling this gap? Many providers offer a product, and consumers express the need. The answer is fees.
It costs a lot to market and to service an IRA. Those costs together with profit are covered by taking fees out of the retirement accounts. Most of the people who do not have an IRA are low wage and moderate wage workers.
A full time worker making $15 per hour who wants to put 6 percent of her savings into a retirement plan will be contributing only $36 per week. Since most of the cost of marketing and servicing accounts is fixed, the fee can’t be set high enough on low-balance accounts to cover provider costs with a reasonable profit. So the focus of marketing is on higher net worth individuals who can afford to make the maximum contributions to their IRA that tax law permits. For everyone else, the high fees take so much out of the potential accumulation of savings as to render the accounts inadequate to elevate the retiree from poverty.
The CRSB proposal to offer a state-run IRA with contributions through payroll deduction and with low fees would mostly repair the shortfall in Connecticut retirement savings.
The role of participating businesses is limited to being the conduit for the payroll deductions. The role of the state is limited to accumulating the savings and overseeing the program. The actual administration is to be contracted to a private sector provider. The investment management is also to be contracted to the private sector. This is new money coming into the marketplace of the financial services industry. It’s not subtracting from the free market because it’s drawing savings primarily from workers who are not now being serviced by the free market.
Taxpayers can look forward to a reduced budget burden, with fewer impoverished seniors straining the social safety net. I see that as win-win-win for the free market, future retirees, and taxpayers.
Kenneth J. Floryan is a member of the Connecticut Retirement Security Board.