The Ideal IRA

The federal government is buried in debt. The Baby Boomers are starting to retire. Pension funds of often under funded. It might be a good time for individuals to save more money.

So why don’t we? Are Americans inherently too stupid to save money? Do we need social science wizards to trick us into putting more money into our 401(k) plans?

I think not. What we really need is a better Individual Retirement Account, one suitable for both working class and professional Americans. And yes, dear liberal readers, this new plan cannot be yet another gaping tax loophole for the super rich. We have some serious national debt to service.

So why don’t Americans put more money in their retirement accounts? Let us count the ways:

1. Interest on bank IRAs is next to nothing. Good luck getting more than a small fraction of a percent interest. Might as well stuff money in a mattress. Either way your savings will be depreciated by inflation.

2. Stock market investing is scary. There be predators out there. Losses happen. Playing the market can be fun when you have extra “play money.” For those without a surplus, it takes a big gain to offset a small loss. (See the The Marginal Value of Money for why.) True, the ups and downs of the market work in your favor if dollar cost average, but the process is unintuitive. When one’s life’s savings are at stake, primal emotions often take over. The stock market is not for everyone. But retirement is for (nearly) everyone.

3. IRS regulations are even scarier. The tax code offers a stupidly complex array of retirement savings options. We have Traditional IRAs, Roth IRAs, 401(k) plans, pensions, profit sharing, SIMPLE IRAs, SIMPLE 401(k)s, Simple Employee Pension Plans (SEPs), and more.

And they interact. If your employer has a retirement plan you can participate in, it affects how much you can put into a Traditional IRA. Just look at the worksheet on page 34 of the 2013 1040 Instruction book:

2. Enter the amount shown below that applies to you. Single, head of household, or married filing separately and you lived apart from your spouse for all of 2013, enter $69,000. Qualifying widow(er), enter $115,000.. Married filing jointly, enter $115,000 in both columns. But if you checked “No” on either line 1a or 1b, enter $188,000 for the person who was not covered by a plan. Married filing separately and you lived with your spouse at any time in 2013, enter $10,000.

Huh?? I have a Ph.D. in theoretical physics and I write software for a living, yet this worksheet makes my head spin. I suspect my local garbage man is even more intimidated.

But wait! Before even attempting this insane worksheet you need to review the eleven point checklist on page 32 first to determine if you can use it.

Members of the One Percent hire professionals to navigate the maze of IRS rules. Too many of the rest of us rely on Social Security, their employers and/or retire broke.

Socialism, serfdom or poverty. Which do you prefer?

4. The government approved retirement path is unnatural. Yes, dollar cost averaging does magical things if you put money into an index fund over a 40 year career. But:

You are flipping burgers at minimum wage and you are going to college next fall. Is this a good time to save for retirement?

You have $50,000 dollars in student loans to pay off. Is this a good time to put money away for retirement?

You rent a small apartment and you want to start a family. You want to buy a house and need money for down payment and moving expenses. Is this a good time to lock away money in a retirement fund?

The children are small. You or your spouse wants to stay at home instead of sending them off to day care. Is this a good time to put money away for retirement?

The children are growing up. It’s time for college! An you don’t want to saddle them with the same student loan debt you suffered through. Is this a good time for retirement?

You are in your peak earning years. Both you and your spouse can work as the kids are out of the (paid for) house and out of college. Is this a good time to save for retirement? YES!!

Thrift and savings make sense throughout life. But locking up all your savings in a retirement account does not. There are houses and cars to buy, medical expenses to pay, periods of unemployment to survive, and maybe a business to start.

Oh, our tax code sort of understands this. We also have ESAs, MSAs, and HSAs or college and medical savings. But having all these separate accounts divide up your money. For those of limited means, divided money means higher bank fees and lower interest rates. And the complexity can be daunting. And for those who wait until the kids grow up to seriously save for retirement, it’s time to save big time. For Individual Retirement Accounts you get to go up from $5,500 to $6,500 per year when you hit 50. Yawn.

There has to be a better way.

An Individual Retirement Account People Will Actually Use

If you want people to save, have a savings plan that is simple and sensible. The best individual retirement account isn’t; it’s a savings account usable for any reason: a down payment on a house, a no-loan auto purchase, time off for childbirth, time off for a sabbatical, self insurance against unemployment and more. Get people in the habit of saving for such things instead of running up credit cards, and they will save for retirement when the time comes. So the first trick is to get rid of the tax penalty for early withdrawal. I’m half tempted to call this a Universal Savings Account, but the acronym USA has already been taken. Let’s just call it something like Ideal IRA, Best IRA, or for those who ever worked for the Pentagon: Universal Merged Tax Deferred Saving Plan Rule Set Framework (UMTDSPRSF!). And let the that account replace all the other tax deferred accounts, including those for health and college savings.

The second feature is to allow people to put in big money in surplus years. Athletes and sexy entertainers make their big bucks while they are young. Professionals usually make the big bucks when the get a bit grey around the edges. Many businesses are feast and famine depending on the economy. Let people put in real money during the good years. The $5,500 per person we have today for Traditional IRAs is ridiculously small. It should be more litk $30,000 or even $50,000/year. Maybe even more. (For you Wall St. Occupiers cringing in the audience, let me remind you that it’s not the 1% which hog the wealth, it’s the 0.01%; the one percent of the One Percent. Let’s have a strong upper middle class to keep power divided.)

Finally, the ideal IRA should be modeled on the Traditional IRA, not the Roth IRA. The super rich can abuse the Roth IRA, and Congress can all too easily break its promises on Roth IRAs. When you put money in you get a tax deduction (up to the individual maximum). When you take it out, it counts as taxable income.

In order to keep the ultra rich from abusing the Ideal IRA, we need three simple restrictions:

1. Only cash can go in or out of the account(s). No sneaking in collectibles, employee options on private companies, or other financial instruments of uncertain values. An no playing games with “carried interest.” If you can buy shares that are not public because you are a partner in a hedge fund, you are using implicit options. Those options don’t fit through the door of the Ideal IRA. Just cash. And you cannot sneak appreciated assets through the door either. You have to cash out, realize your capital gains, put the money through the door and then you can repurchase the same asset behind the wall.

2. You cannot borrow against your Ideal IRA. If you borrow against your savings, you are making use of it. Time to pay taxes on the withdrawal. Some members of the economic elite have been dodging capital gains taxes by borrowing against appreciated assets, and I don’t want to create another such loophole with this new savings plan.

3. You cannot transfer your Ideal IRA. To give away the contents, it needs to be sold and come out as cash first, with income taxes paid. We might make an exception for married couples, but even there maybe not. With the modern high divorce rate and the definition of marriage in flux, it might be time to for the government to treat married people more like individuals. (Discuss amongst yourselves.)

Finally, we might want to allow one violation of these rules. For many people their main savings is the equity on their home. So maybe we could allow people to count equity payments on their homes as part of their Ideal IRA deposits. This would be a replacement for today’s home mortgage deduction. Instead of encouraging people to keep their home mortgaged to the max, how about encouraging people to truly own their homes by paying off their mortgages? Unlike the home mortgage deduction, this does not discriminate against those with too low credit to get a mortgage, since they can get the same tax deferral through bank accounts, stocks, etc.

As for any other subtleties, I’ll save them for a future article, or we can discuss in the comments below.