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Saturday, January 22, 2005

What to do about retirement and Social Security

This will probably be the last things I say about Social Security here. Having started the discussion, though, I will finish it.

So what should be done about Social Security to better its funding? Three things. First, means test benefits. Second, do away with the cap on the amount of income that is taxed (of the two payroll taxes, Social Security and Medicare, only Social Security is capped). Third, slightly raise the retirement age. These are all very simple things to do, and they would make Social Security solvent practically forever.

What about private accounts? Well, we already have private accounts. Too many, in fact. We have IRAs, Roth IRAs, 401(k)s, 403(b)s, and 457s. There are probably more, but those are the big ones. Every single one is different, which complicates both people's planning and our tax code. Since I believe in tax code simplification, I think we can kill several birds with one stone by consolidating and simplifying these accounts.

My proposal is this: everybody will be able to open two kinds of retirement accounts (of course, they can open one or the other, or none at all; this isn't mandatory): a tax-deferred account (like standard IRAs and the 401(k) family of things) and a tax-exempt account (like Roth IRAs). There will be a combined yearly contribution limit, indexed to inflation in $500 increments. We could start it at $15,000, for example. Of that amount, up to $5,000 could go in the tax-exempt account, and that amount is reduced as your income goes up (Roth IRAs currently have an income threshold above which you are not eligible to contribute). Obviously, the total amount you can put in both accounts would be unchanged, so if your income was so high that you could only put $3,000 in your tax-exempt account, you could put $12,000 in the tax-deferred account.

You would open these accounts at any financial institution of your choosing. Your employer would be required to automatically set up electronic transfers to your accounts if you so desire. Contributions to the tax-deferred account would be done pre-tax, and contributions to the tax-exempt account after tax. Since you own this account, changing employers does not change anything. No need to worry about rollovers or similar garbage. You also aren't limited to the investment choices offered by your employer, which is how it works with 401(k) plans now. Employers could add to your contribution just as they can add to your 401(k)s now; I really haven't thought about whether employer contributions should count towards your limit or not. Details, details.

I think this would greatly simplify things and give people much more choice and flexibility in how they save for retirement. Sounds like a win-win to me.


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