Category: Uncategorized

Modifications to the Biden Student Debt Policy

A one-time discharge of student loan debt will not mitigate long term problems associated with excessive student debt. These proposals will reduce student debt burdens and encourage savings by young adults, a necessary prerequisite to Social Security reform.

Introduction:

A previous post evaluated several of the Biden Administration’s domestic policy agendas, including the Administration’s proposals on health care and insurance, student debt and college costs, retirement savings, and the fiscal condition of Social Security.  

The evaluation of the Biden Administration’s student debt policies reached the following conclusions.

  • The one-time debt discharge proposed by the Biden Administration may not be upheld by the Supreme Court for a variety of reasons.
  • A one-time student debt discharge does not alter the trajectory towards higher student debt levels and higher college costs.
  • The payment shock from the termination of the COVID-era student loan payment freeze will reduce consumer spending and could facilitate a recession.
  • The Biden Administration proposal for expanded Income-Driven loans is complex and less effective than interest rate reductions.
  • Low levels of on-time graduation remain an important factor in high student debt burdens.
  • Many student borrowers leaving school prior to the completion of a degree have a difficult time repaying their student loans.
  • Proposals for increased assistance for students at two-year college are useful but could reduce access to four-year schools by qualified low-income students.

The objective of this post is to provide and explain potential economically efficient solutions to these problems.

Student Debt Proposals:

Proposal One:  Issue an executive order restarting post-covid student loan payments at a 0 percent interest rate for two years and seek legislation permanently establishing a 0 percent interest rate for the first two years after the initiation of repayment of student loans.

Analysis: The recently enacted debt limit deal includes a requirement restarting the covid-era moratorium on student loan payments.   The abrupt restart of student loan payments will reduce spending and saving for retirement by many households and could facilitate a recession.  A permanent 0 percent interest rate for students starting the repayment of student loans would substantially reduce problems associated with excessive student debt.

Proposed response to the restart of student loans:

  • As per the recent debt-limit agreement, student loan payments restart this year.
  • A new executive order sets the interest rate on student debt at 0 percent for two years.
  • Seek legislation making the two-year 0 percent interest rate on student loans permanent.

Advantages of a temporary emergency elimination of interest rates:

  • I expect the Biden Administration’s student debt discharge proposal will be overturned by the Supreme court.  A temporary elimination of interest charges to mitigate adverse impact of payment shock from the end of the covid emergency is more easily depicted as an emergency measure likely to survive legal challenges than the Biden Administration’s proposal.
  • The restart of student loan payments would increase receipts to the Treasury reducing the need to issue debt.  However, the restart of student loan payments will have a substantial adverse impact on young adults with student debt and the overall economy.  These adverse impacts including lower consumption, higher wage demands by some workers and a likely recession could be mitigated by temporarily setting the interest rate at 0 percent on all student loans.
  • Under the proposal the entire minimum payment would be applied to the reduction in principle and the Treasury would receive substantial revenue.

Advantages of a permanent elimination of interest for first two years of student loan repayments:

A permanent 0 percent interest rate for two years after the initiation of repayment would result in several economic benefits.

  • Delinquencies would fall at the beginning of careers when workers tend to have lower salaries.
  • A lower interest rate and quicker repayment of loans would allow young workers to increase household savings, a necessary prerequisite for many Social Security reform proposals under consideration.
  • Quicker repayment of student loans by young adults should eventually reduce the number of older adults with unpaid student loan balances in retirement
  • An initial interest rate of 0 percent would reduce demand for Income Driven Replacement (IDR) Loan programs, which will benefit both student borrowers and the Treasury.

Proposal Two: Modify the standard 10-year and 20-year federal student loan contract to eliminate all interest charges at the maturity of the loan.

Analysis:  The current system requires student borrowers to choose between a standard loan contract and an IDR loan contract as soon as they begin loan repayments.  Some people make the wrong choice.  Features of The IDR loan contract encourage some people to increase the amount they borrow. A simple modification to conventional loans would reduce demand for IDR loans and make taxpayers and many borrowers better off.

Proposed changes to standard loan contract:

  • Set interest rate on outstanding student loan balances to 0 percent when the loan reaches maturity date.
  • Treat unpaid student loan balances after the maturity of the student loan as a tax obligation spread over 3 to 5 years.

Advantages of proposed changes:

  • The interest rate of zero at the maturity of the loan provides some relief for people who have had difficulty repaying their loan. 
  • This change will reduce the number of people who have their Social Security checks garnished because of outstanding student loan obligations.
  • The proposal creates an incentive for borrowers to select a standard student loan contract instead of an income driven loan contract which can benefit the borrower.  IDR loans create financial uncertainty for borrowers and potential lenders and often prevent borrowers from qualifying for a mortgage.  IDR loan discharges are potentially costly to taxpayers.
  • Under the modified student loan contract, the borrower with a larger loan will always repay more than the borrower with the smaller loan over the lifetime of the loan.  By contrast, under the IDR program it is possible an increase in initial student loan debt does not increase the amount repaid over the life of the loan.

Proposal Three:  Modify IDR loan programs to provide for gradual partial discharges of student debt instead of a complete discharge of the remaining balance at the maturity of the loan.

Analysis: Current IDR loans promise a discharge of unpaid debt at the maturity of the loan, but loan discharges frequently do not occur on time because some borrowers fail to make required payments and some loan servicers fail to accurately report payments. IDR loans create an incentive for people to borrow more because in some instances the increase in the amount borrowed will not result in an increase in the amount repaid.  Both of these problems could be addressed by altering the IDR loan discharge provision. 

Proposed changes to IDR contracts:

  • Provide periodic partial discharges of student loans.
  • Discharge formula might involve 10 percent of previous 24 payments after receipt of 24 payments. 
  • Limit discharge at the maturity of the loan to 50 percent of the outstanding balance.
  • Undischarged loan balance will be restructured into a new short-term low interest rate loan.

Advantages of proposed changes to IDR contracts:

  • The quicker partial discharge gives borrowers an incentive to make payments on time to maximize debt relief.
  • The quicker partial discharge reveals potential problems with the recording of loan payments earlier.  Currently, payment problems are not revealed until maturity when the borrower apples for the complete loan discharge.
  • The limitation of the final discharge to 50 percent of the outstanding loan balance will cause borrowers with larger loans to have a higher debt at maturity than borrowers with lower debt.  This clause reduces the incentive for people to borrow more because monthly payments are determined by income rather than loan size and they anticipate the entire loan will eventually be discharged.
  • The incentive to reduce borrowing could also be achieved by taxing loan discharges.

Proposal Four:  Provide greater financial assistance to all first-year students with the goal of eliminating all student debt incurred during the first year of post-secondary school education.

Analysis:  Increasingly, some education after high school is necessary for career advancement.  Many student borrowers who leave school prior to the completion of the degree have great difficulty in repaying their loans.  Increased financial assistance for first-year students will increase access to higher educations for underserved groups and will assist people likely to have the most difficult repaying loans.

Proposed changes to first-year financial assistance programs:

  • Provide federal grants to institutions that agree to eliminate student debt incurred by first-year students.
  • All state and private institutions that agree to match the new federal/private funds are eligible for the new grants.
  • Participating institution are not allowed to provide federal student loans to first-year students.
  • Tax credits and/or deductions would be offered to taxpayers that contribute to funds providing matching resources for first-year students.
  • Benefit is available at both two-year and four-year institutions.
  • Additional benefits available for first year after transfer from a two-year to four-year college.


Advantages:

  • Program reduces payment problems and default rates by student borrowers that leave college early prior to the completion of their degree.  (Students leaving college without a degree after only one or two years of study tend to have an especially hard time repaying their student loan.)
  • Program will reduce typical college debt levels.
  • Absence of debt could allow a person to reenter school later in life when she is more prepared for higher education.
  • Proposed goal of a debt-free first year of post-secondary education is far less expensive than previous free college or debt-free colleges proposals. 
  • Program allows more highly qualified people to consider a four-year college. 
  • Prospect of additional assistance for transfer students could further reduce costs for students who start their post-secondary career at a two-year college and mitigate impact of credits lost through the transfer process.

Proposal Five:  Modify the bankruptcy code to allow for the discharge of private student debt in bankruptcy and to provide priority to federal student debt payments over all consumer loans in chapter 13 bankruptcy plans.

Analysis:  Student debt has always been difficult to discharge in bankruptcy.  The2005 Bankruptcy reform law discouraged Chapter 7 bankruptcy in favor of Chapter 13 and made it more difficult to discharge private student loans in bankruptcy.  Moreover, in most instances current law results in higher priority for consumer debt over all student loan debt in Chapter 13 bankruptcy plans.  Some student borrowers now leave chapter 13 bankruptcy plans with more student debt than when they entered.  More favorable treatment of student debt in bankruptcy could benefit both student borrowers and taxpayers.

 Proposed Changes:

  • Retain current rules governing access to Chapter 7 and Chapter 13 bankruptcy adopted in the 2004 Bankruptcy reform act.
  • Change bankruptcy code to make private student loan debt dischargeable in bankruptcy.
  • Provide priority to payments on federal student loan payments under chapter 13 bankruptcy plans.

Advantages

  • Retention of means test for use of chapter 7 bankruptcy discourages bankruptcy filings for many people who might be able to pay off their debts without bankruptcy relief.
  • Private student loans with high interest rates is similar to credit card debt and other consumer loans and should be treated accordingly.
  • Helps people leaving chapter 13 bankruptcy obtain a fresh start.
  • Helps taxpayers by increasing and speeding up student debt payments.  
  • Helps the most vulnerable student borrowers.  Should reduce the number of older taxpayers having Social Security garnished because of unpaid student debt.
  • Creates an incentive for lender to better evaluate the ability of borrowers to repay private consumer loans and private student debt.

An assessment of President Biden’s domestic policy record

This memo evaluates the Biden Administration’s record on policies impacting health care, student debt, retirement savings, and Social Security. The analysis presented here supports the view that progress has been limited and change is needed.


Introduction:   The Biden Administration can point to several legislative achievements and executive orders. However, actual long-term permanent progress in several areas including expansion and improvements in health coverage, reduction of student debt and the cost of college, increased incentives for retirement savings, and efforts to stabilize the Social Security and Medicare Trust funds has been small.

Health Care:

  • The number of uninsured is higher than in 2016 and will increase due to the phase out of the COVID era Medicaid extension.
  • The improvement in the state-exchange health insurance premium tax credit, enacted during the Biden Administration, is scheduled to phase out in 2025.
  • The continued high reliance on employer-based insurance will result in a rapid increase in the number of uninsured once an economic downturn occurs.
  • The long-term trend towards households having to pay an increased share of out-of-pocket health care costs persists and has not been addressed.
  • The growing use of high-deductible health plans has forced more Americans to reduce retirement savings to fund health savings accounts.
  • Many Americans remain reliant on short-term health plans, which do not insure people with pre-existing conditions, do not assure access to health care for essential health benefits, and do not protect household from large financial losses.  The Biden Administration has not rolled back the Trump-era expansion of short-term health plans.
  • Many Americans with narrow-network health plans do not have sufficient access to specialists and top hospitals.

This memo reviews some of the limitations of the Biden Administration’s health care record and proposes some modifications.

Student Debt and College Costs:

  • The one-time debt discharge proposed by the Biden Administration may not be upheld by the Supreme Court for a variety of reasons.
  • A one-time student debt discharge does not alter the trajectory towards higher student debt levels and higher college costs.
  • The payment shock from the termination of the COVID-era student loan payment freeze will reduce consumer spending and could facilitate a recession.
  • Low levels of on-time graduation remain an important factor in high student debt burdens.
  • Many student borrowers leaving school prior to the completion of a degree have a difficult time repaying their student loans.
  • The Biden Administration proposal for expanded Income-Driven loans is complex and less effective than interest rate reductions.
  • Proposals for increased assistance for students at two-year college are useful but could reduce access to four-year schools by low-income students.

Go here for a discussion of Biden-era student debt proposals.

Retirement Savings:

  • Recently enacted improvements to 401(k) plans in the Secure Act 2.0 do little to assist people at firms that do not offer a 401(k) plan.  
  • It would be useful to create an automatic savings option for workers at firms without a 401(k)-plan similar to the automatic 401(k) savings option.
  • An extremely high percentage of young adults have disbursed funds from their retirement plans early in their career.
  • Incentives for people to disburse funds in a 401(k) plan prior to retirement remain high and pre-retirement 401(k) disbursements are unlikely to fall.
  • The recently enacted automatic contribution rule may steer some workers into 401(k) plans even if a Roth IRA or some other savings vehicle is a better option. 
  • Many 401(k) plans have limited investment options and high administrative fees. 

This essay  describes ideas on how to expand private retirement savings and deal with the impending short falls in the Social Security and Medicare trust funds.

Go here for more details on why IRAs should be expanded.

Recent legislation on private retirement savings described here appears to do more for the investment industry than for savers.

Social Security:

  • A high percent of workers nearing retirement with low levels of retirement savings will be highly dependent on Social Security during retirement.
  • Projected shortfalls in the Medicare and Social Security trust funds would lead to automatic benefit cuts in 2031 and 2033 respectively under current law.
  • No one in Congress is working on a bipartisan solution to the impending Social Security and Medicare trust fund shortfalls.

This memo describes the linkage between Social Security reform and efforts to expand private retirement savings.  Work summarizing different Social Security reform proposal will be available shortly.

Concluding Remarks:  The case for renominating Biden largely hinges on the view that the President is the best candidate to defeat former President Trump.  However, as discussed here I do not believe former President Trump will be the Republican nominee in 2024 and President Biden does not match up well against a younger Republican challenger, especially one willing to break away from parts of the Trump agenda.

The 2024 election should be about how we move forward as a nation.  A candidate should talk about how issues like how we can change insurance rules so people don’t lose their health insurance during job transitions, how we can lower student debt burdens for the people who are most likely to experience payment problems, how we can assist workers in saving more for their retirement and how we can improve the financial condition of entitlement trust funds prior to the implementation of automatic benefit cuts.  I have reached the conclusion that Governor Whitmer or Governor Inslee are better able to move the country forward on these issues than our current president.

Political Insights for the 2022 Midterms

I find writing this column every two years on or near election day cathartic. I have never seen this much hype and so many unforced errors on both sides. My resolution after clicking publish is to stay off cable news for a long time.

Some political insights – November 7, 2022

I find writing this column every two years on or near election day cathartic.  I have never seen this much hype and so many unforced errors on both sides.  My resolution after clicking publish is to stay off cable news for a long time.

Some insights:

The analysis on TV seems more motivated by campaign goals than data.  Republicans are talking up surprise victories in senate races in New Hampshire, Colorado, Washington, even though Senate races in North Carolina, Wisconsin, and Ohio are far closer. Republicans are exciting their voters to the poll.  Democrats are scaring their voters to the poll.   The Democrats may overperform in the Senate because they have good candidates in NC and OH and WI and NV are reasonably close.

Wisconsin should have been an easy pick up for the Democrats because the Republican candidate is a certifiable crazy. However, their 35-year-old nominee has not been able to address concerns about crime that were highlighted by unrest and vandalism in Kenosha.  

My methods when analyzing elections in Wisconsin is to compare them to races in the adjacent state of Iowa.  The states almost always vote for the same presidential candidate.  The 2016 poll numbers in Iowa suggested to me that Wisconsin could turn red and it did.  This year it is highly possible that the moderate Senate candidate in Iowa will overperform and the more liberal Democrat in Wisconsin will underperform, and the Democrats will lose both races. I expect Evers to win the governor’s race but could be wrong. 

The Democrats are highly dependent on the black vote and the party has nominated several black candidates in states that are overwhelmingly white.   The Democrat’s candidate for governor in Iowa, Deidre DeJear, an extremely young black woman with no experience in government had no opposition in the primary. She is 20 points behind and is not helping the Senate race.  The initial competition to Barnes. Demings, and Beasley was also non-existent or dropped out prior to the primary.  Republicans have tougher intra-squad games, which helps them in the regular season. 

Splits between the Senate and gubernatorial outcomes in several states including, PA, AZ, WI, OH are possible.  This should undercut Republican claims of rigged elections.

Voters in both parties are having buyers’ remorse in PA.  Fetterman should have been transparent about his health and Oz is not a smart wizard.  I personally could never vote for Oz and would vote for Fetterman if I lived in Pa.  However, an independent who sides with Republicans on some issues and wants robust discussion of debates could conclude that Fetterman, due to his health would be a rubberstamp.  The Democrats should have examined Fetterman’s health after the stroke, I believe in May prior to the primary and put in a pinch hitter.

Democrats may lose the House.  I hope it is close. Because centrist could unite and elect a centrist speaker.  Go here for a discussion of why the House is important.

Trump could be the big loser if Republicans underperform and if the most Trump-friendly candidates lose.

Concluding Thoughts:  The Democrats central message is you must vote for the Democrats because the Republicans don’t believe in democracy and a Republican victory will lead to dictatorship.  Well, if true, we have no choice and Democracy is already gone or on life support.

 Eventually, the Republicans will win a cycle.   If the Gambler’s Ruin Problem describes payouts dictatorship is inevitable. 

 Hard to see how Biden wins reelection in 2024 if Trump is gone and 2024 becomes a change election.  Trump may run to freeze the Democratic field.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.

Ukraine and the race for the next speaker of the House

The more conservative members of the Republican House and the more liberal members of the Democratic House are adopting Putin’s position on the war in Ukraine. Can centrists of both parties unite to support Ukraine?

Initially opposition to assistance for Ukraine came from the right. 57 House Republicans opposed assistance in a May vote.  More recently, Kevin McCarthy the potential future speaker stated the House could target Ukraine funding. Former President Trump is supportive of Putin’s position on the war.

A recent letter from 29 members of the progressive caucus inside the Democratic party called on the Administration to support “vigorous diplomatic efforts” to support a negotiated cease fire and a cease fire.   Hard to understand how this approach could lead to success when Russia is bombing civilians and infrastructure, committing war crimes and controls around 20 percent of Ukraine.   

Withdrawing support from Ukraine or putting pressure on Ukraine to accept an immediate cease fire when Russia commits war crimes, has forced deportations of Ukrainian citizens, and still controls substantial Ukrainian territory, is incomprehensible to me.

The extremist Republican and extremist Democrats who basically support Putin’s position in Ukraine are a minority of the House and a minority of America.

Most pundits believe that the Republicans will have most of the next House.  They would force a reversal in U.S. policy toward Ukraine and do other detrimental things including shutting down the government and breaching the debt limit.

Speaker Pelosi has been a strong supporter of Ukrainian aid, but she is under intense pressure from her left flank on a wide variety of issue.

A centrist Democrat or Republican could run for the job of speaker.  The next speaker could be a centrist who supports Ukraine if centrist Democrats and Republicans unite.  

The Speaker of the House does not have to be a member of Congress.  The House could choose to elect a non-partisan respected figure outside of Congress to be the next speaker.

This action would result in America doing the right thing in Ukraine, could prevent future shutdown and debt-limit emergencies.  A speaker who is respected by members of both parties could facilitate the dialogue on a wide range of issues and create a process that leads to more sensible centrist policies.

Authors Note:  David Bernstein, a retired economist has written several papers advocating for innovative centrist policy solutions.

The kindle book Defying Magnets:  Centrist Policies in a Polarized World has essays on policies student debt, retirement savings and health care.

The paper A 2024 Health Care Proposal provides solutions to health care problems that are not currently under consideration.

The proposals in Alternatives to the Biden Student Debt Plan are less expensive to taxpayers than the Biden student loan proposals.  The reforms presented here provide better incentives and reductions for future students while the Biden debt-relief proposal offers a one-time improvement for current debtors.

Ukraine is the most important issue of our time.  The conflict today in Ukraine reminds me of the conflict in the 1930s in Spain against Franco and fascism.  Kevin McCarthy must not become speaker.

The Opening Salvo of the 2024 Health Care Reform Debate

The paper “A 2024 Health Care Reform Proposal” is available free for a limited number of potential reviewers.  Just go to this link https://app.sellwire.net/p/2Uv

and apply promotion coder REVIEWER1.

Ideas in this paper could reduce number of people without health insurance and improve the quality of coverage.

Proposals Include:

  • Having employers subsidize state exchange health insurance instead of paying for firm-specific health insurance to reduce loss of insurance during periods of unemployment and job transitions.
  • Further modifications to the premium tax credit to reduce worker share of premiums for middle-income young adults without employer-based coverage.
  • Creation of new low-cost comprehensive health insurance plans combined with the elimination of current short-term health insurance plans.
  • Improvements in Health Savings Account for low-income and mid-income households. 
  • Creation of incentives leading to Increased access to top hospitals and specialists.

Again, purchase at a low price of $2.50 or download a free sample copy here.

https://app.sellwire.net/p/2Uv

I hope if you take the free sample, you will provide me with feedback either in the form of an email to Bernstein.book1958@gmail.com or through an on-line review.

Student Debt Proposal #1: Eliminate First-Year Debt

A combination of increased financial assistance for first-year students and restrictions on the use of student loans by first-year students would substantially reduce financial burdens associated with student debt.

Specific Proposed Policy Changes:

  • Design and provide funding and incentives for creation of financial assistance packages leading to a debt-free or tuition-free first year at both community colleges and four-year institutions.
  • Eliminate federal student loans until students have 9 credit hours of college credit from AP courses, community colleges or accredited on-line programs.
  • Provide federal, state, and private funds for programs that increase college-level work prior to college.
  • Increased incentives for quick transfers from community colleges to four-year institutions.

Comments:

  • Students who take out loans and do not complete college are around 3 times more likely to default on their loan than student borrowers who get a degree.   The reduction of first-year debt will reduce the debt burdens of people who leave school early and are most likely to experience payment problems.
  • The stipulation that people complete some college level courses prior to full-time college will reduce initial access to higher education by low-income and minority students.  However, these groups with higher student debt burdens would gain the most reduction of first-year debt.
  • The stipulation for some college level experience prior to full-time college would better prepare people for college and would reduce dropout rates.
  • The elimination or reduction in debt among people who leave college after a year or two could facilitate reentry to college after people get some job experience.
  • Low-income and minority students also stand to benefit the most from new programs that increase access to and use of higher education courses prior to full-time college.  For some students, access to a community college or high-quality on-line course would be preferable to access to an AP course with a high fail rate.
  • Universities would be encouraged to increase off-semester admissions to facilitate the admission of more students after a single semester at a community college.
  • The proposed increase in financial assistance at both four-year and two-year institutions will allow more qualified students to choose a four-year alternative.  By contrast, the Biden Administration free-community college proposal would encourage some qualified applicants to delay or forego four-year options.
  • Private schools and historically black colleges could also benefit from changes in financial assistance packages depending in part on the incentives tied to use of federal funds.
  • The changes in financial assistance programs could differ across institutions depending on the level of tuition and the level of state or private support.

Concluding Remarks:  Many people are unprepared for full time college and the burdens of student debt immediately after graduating college.   The proposals outlined here would help many young adults become better prepared for higher education before taking on any debt. 

Excel Hint #4: Calculating the future value of a mortgage

A key advantage of choosing a 15-year mortgage over a 30-year mortgage is the more rapid decrease in the mortgage balance and increase in house equity. This post discusses the use of Excel to calculate the future value of different mortgages.

Situation:   A person is considering two options for a $500,000 loan.   The first option is a 30-year term at an interest rate of 3.4%.   The second option is a 15-year term at an interest rate at 2.9%.  

  • How can Excel be used to calculate the mortgage balance at 7 years for the two options?  
  • What are the mortgage balances for the two options after seven years?

The Calculation:  The future value of the mortgages above are calculated in Excel with a two-step procedure. 

Step One: 

Calculate monthly payment from the PMT function.

The arguments of the PMT function are – the monthly interest rate, the maturity of the loan in months, and the initial loan balance.

  • The 30-year monthly payment is PMT(0.034/12,360,500,000) or $2,217.41.
  • The 15-year monthly payment is PMT(0.029/12,180,500,000) or $3,428.91.

These monthly payment values are input for the second step.

Step Two:  

Calculate the outstanding loan balance from the FV function.

The arguments of the FV function are — the monthly interest rate, the number of months the mortgage is held, the monthly mortgage payment, and the initial value of the mortgage.

  • The outstanding mortgage balance at 7 years for the 30-year loan is FV(0.034/12,84,2217.41,500,000) or $424,180.
  • The outstanding mortgage balance at 7 years for the 15-year mortgage is FV(0.029/12,84,3428.91,500000) or $293,466.

Concluding thoughts:  The more rapid build-up of equity from the use of a 15-year mortgage can allow a person to sell a home and pay off the mortgage even if housing prices fall.  The calculations presented here were used in finance tip #4, a discussion of the advantages and disadvantages of 15-year and 30-year FRM.   

The case for greater use of Roth retirement accounts

  • Many workers should increase their utilization of Roth retirement accounts. 
  • Young workers should open a Roth account as soon as they enter the workforce.
  • There is very little downside for contributions to Roth accounts by low-income workers because the worker opening the Roth has immediate access to contributed funds without tax or penalty and the tax advantages from contributing to a tax-deductible account are small.
  • There is no reason to choose a traditional retirement account over a Roth if your marginal tax rate is zero and if the employer does not match contributions to a traditional retirement plan.
  • Roth contributions are likely to result in a better outcome than traditional contributions for most workers with a marginal tax rate less than or equal to 22 percent, especially when the employer does not match contributions.
  • Most workers at firms with matching contributions to a traditional plan should divert additional contributions to Roth accounts after maximizing the employer match. 
  • Roth accounts are usually superior to traditional accounts for workers without emergency funds or high debt levels who might tap retirement funds prior to retirement.
  • Households experiencing a decrease in income because they or their spouse temporarily leave the workforce should convert traditional retirement asset to Roth assets when their marginal tax rate is low.
  • People leaving a position can rollover 401(k) assets to an IRA and then convert the traditional IRA to a Roth IRA.
  • Some firms with Roth 401(k) plans allow for in-service rollovers.
  • Retired workers should spend from assets outside their retirement plan and convert traditional retirement assets to Roth assets prior to claiming Social Security and disbursing traditional retirement assets.

Introduction:

One of the most important decisions for workers preparing for retirement involves the choice between use of traditional and Roth retirement accounts.   

Contributions to the traditional retirement accounts are not taxed in the year the contribution is made. Contributions to the Roth IRA are fully taxed in the year of the contribution but are not taxed when disbursed prior to age 59 ½.   Moreover, Roth distributions are not included in AGI and do not increase the amount of Social Security subject to tax.

All funds (both initial contributions and investment returns) inside a deductible IRA or a traditional 401(k) that are withdrawn prior to age 59 ½ are fully taxed and subject to a 10 percent penalty.  By contrast, contributions to a Roth retirement account are fully taxed in the year they are made but disbursements of contributions from the account prior to age 59 ½ are not subject to a penalty or tax.  The tax penalty for early withdrawals from a Roth is only applied to returns on investment.

Many workers overutilize traditional retirement accounts and underutilize Roth accounts.  The tax savings from incremental contributions to a traditional retirement account are often small.  The cost of converting traditional retirement assets to Roth assets is often low. Retirees with a mixture of Roth and traditional retirement assets often have substantially higher after-tax income and are less likely to outlive their retirement assets than people with all retirement assets in a traditional retirement account.

A Roth retirement account should be a key feature of your financial plan. We discuss steps you should take to increase savings though Roth accounts:

Set up a Roth account as soon as you get your first job:

Any person with income reportable to the IRS regardless of age can set up a Roth account.   A teenager can and should establish a Roth. It is possible for a young person doing real work for a family business to establish a Roth, but this type of transaction could be audited by the IRS.

Most teenagers who work don’t think about setting up an IRA but there is basically no downside from Roth contributions by young workers.  The Roth contribution could be disbursed or spent if necessary and only investment income is subject to tax.  The gains if left in the account until age 59 ½ will compound for a long time and will never be taxed.  The mere existence of a Roth IRA in a student’s name does not reduce the ability of a student to qualify for financial assistance for college.   

A working teenage with modest income would never choose a deductible IRA over a Roth because there is no immediate tax savings for a taxpayer that earns less than the standard deduction, $12,400, and disbursements in future years could be subject to tax and penalty.  The teenager is entitled to a standard deduction of earned income plus $300 even if the parents claim the child as a dependent.

Most young adults entering the workforce should choose a Roth IRA over a traditional 401(k) plan or a deductible IRA when the firm does not offer a 401(k) plan with an employer match.

Around one-third of employees at private firms do not have access to a retirement plan and around 49 percent of employers with 401(k) plans do not match employee contributions.

The choice between a Roth retirement account and a traditional retirement account is straight forward when there is no matching contribution.  The after-tax contribution to a conventional IRA or traditional 401(k) plan is the pre-tax contribution minus the immediate tax savings. Workers should make contributions to Roth accounts when their marginal tax rates are low and make contributions to traditional deductible accounts when their marginal tax rate is higher. 

A person filing an individual return making $12,400 or a married couple filing a joint return making $24,800 in 2020 claiming the standard deduction would pay $0 in tax.  These taxpayers could also reduce tax on additional earning by contributing to a health savings account.

The savings from contributing to a deductible IRA would be $0 because the person does not pay any tax. It is basically irrational for this person to contribute to a deductible IRA instead of a Roth IRA because the tax preferences are larger from the Roth and there is no gain in working years from contributing to the deductible IRA.

Interestingly, it is also almost irrational for a person in the 0 percent tax bracket to fail to contribute to a Roth.   The worker has immediate access to his Roth contribution without penalty or tax and only pays penalty and tax on investment returns prior to age 59 ½. 

At higher tax rates the tax deduction from the traditional IRA becomes more valuable.  A taxpayer facing a 12 percent marginal tax rate for the last $6,000 in AGI would have identical working year spending by contributing $6,000 to a conventional IRA or $5,280 contribution to an after-tax Roth account.

When the last $6,000 is taxed at 22 percent the taxpayer can either contribute $6,000 to a pre-tax traditional plan and pay no additional tax or contribute $4,680 to a Roth and pay $1,320 in additional tax.

The potential tax savings from the use of Roth assets both to the taxpayer in retirement and the person who inherits the Roth account can be very large.  Most taxpayers are better off using a Roth instead of a traditional retirement plan if their marginal tax rate is less than 22 percent.

Consider selecting a Roth IRA over a 401(k) plan with matching contributions if you have high levels of debt and/or have not met 401(k) vesting requirements.

Many financial planners argue that all workers at firms with 401(k) plans that match employee contributions should maximize the employer match because the employer match is free money.  My view discussed here is that even when firms match employer contributions new workers with substantial debt should prioritize debt repayment over saving for retirement.

The failure to pay debt on time can lead to a bad credit rating and higher borrowing costs for an entire lifetime.  The contributions in a Roth can be used to avoid this outcome.

Many young adults entering the workforce with substantial debt in the form of student loans do not have funds for an emergency.   As a result, many young adults with traditional retirement plans disburse funds early and incur taxes and penalties.  A person with a Roth account could disburse Roth contributions without penalty and tax.  The retirement account would remain open and hopefully the worker would not touch capital gains.

Often new workers will not receive the employer matching contribution unless they stay at a firm long enough for the contributions to vest.   Many workers will be better off leaving for a better job instead of staying for the employer match. 

Workers who have not met the vesting requirement for employer matches and who are not likely to meet the vesting requirement should invest in a Roth IRA rather than a firm-sponsored retirement plan.

Contribute to a Roth IRA after taking full advantage of matching employer contributions to your 401(k) plan.

Many employers with 401(k) plans match employee contributions.  Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary.  

The employer matching contribution to 401(k) plans is an attractive benefit if you are not drowning in debt, have funds for basic emergencies and will not lose the matching funds or be unable to move to a better job due to a vesting requirement.

Workers can divert additional retirement plan contributions to a Roth IRA once they obtain the entire 401(K) match from their employer.   Direct contributions to Roth IRAs are not allowed for higher income workers, however, higher income workers can contribute to a Roth through a backdoor IRA. 

The strategy of contributing to a 401(k) plan to obtain the full employer match and then diverting additional contributions to a Roth IRA will leave the worker with a mix of traditional and Roth assets in retirement.

Consider contributing to a Roth 401(k) plan instead of a traditional 401(k) plan if one is offered at work.

Roth 401(k) plans became available January 1, 2006. Prior to that date, after-tax or Roth retirement options were only available through IRAs. Seven in ten firms now offer a Roth 401(k) option. However, only around 18 percent of workers contributed after-tax dollars to their 401(k) plan in 2016.

The Roth 401(k) plan has two advantages over a Roth IRA.  First, contribution limits are much higher for 401(k) plans than for IRAs.  Second, employers can match employee contributions to all 401(k) plan including Roth plans but cannot match contributions to IRAs. Note, employer contributions to Roth IRAs are placed into a traditional account and are fully taxed at retirement and are subject to tax and penalty if disbursed prior to age 59 ½.   Go here for a discussion of features and rules governing Roth 401(k) plans.

The decision rule for the choice between contributing to a traditional 401(k) plan or a Roth 401(k) plan depends primarily on the marginal tax rate of the worker, assuming the same level of matching contributions.  Workers should contribute to a Roth when marginal tax rates are low and contribute to a traditional plan when marginal tax rates are high.

The use of a Roth 401(k) plan will result in the worker retiring with a mix of traditional and Roth retirement assets, which substantially reduces taxes and improves financial outcomes in retirement.

Convert traditional retirement assets to Roth assets in years when household income is low:

Tax law allows people to convert traditional 401(k) plans and IRAs to Roth IRAs.  The conversion can occur at any age.  Most conversion of 401(k) assets occur after the employee departs from a firm and transfers 401(K) assets to an IRA.  However, some firms with Roth 401(k) plans allow for in-service conversions for older workers.

The amount converted is treated as ordinary income and the cost of the conversion is the additional tax paid due to the increase in reported income.   

The conversion of traditional retirement assets to Roth assets when the household has a marginal low marginal tax rate is profitable and can substantially reduce the likelihood of a person outliving her retirement resource.  The cost of conversion is zero if the taxpayer is in the 0 percent tax bracket or when the taxpayer earns less than total deductions.

The profitable conversion of traditional to Roth assets could occur when a person leaves the workforce for part of a year.  This commonly occurs when a person returns to school or when a spouse temporarily leaves the workforce.

Profitable Roth conversions can also be implemented early in retirement prior to the retiree disbursing funds from a traditional 401(k) plan or claiming Social Security benefits. The strategy of Roth conversions early in retirement described in this recent article requires the household  use assets outside of her retirement plan to fund current consumption.

Money converted from a traditional IRA or retirement account to a Roth is subject to the five-year rule.  Converted funds that are disbursed before five years from the end of the calendar year of the disbursement are subject to tax and a 10 percent penalty.

Contribute to a backdoor Roth IRA if you have excess cash at the end of a year.

Tax rules establishes limits on household income for allowable direct contributions to Roth IRAs.  Direct Roth IRA contributions are prohibited for single filers with income greater than $140,000 and married joint filers with income greater than $208,000.  (The phase out of direct Roth contributions occurs at $125,000 for single filers and $198,000 for married joint filers)

People with income above these limits can make indirect contributions to Roth IRAs by first contributing to a non-deductible traditional IRA and then immediately convert the funds in the non-deductible IRA to a Roth IRA.  This technique is called a backdoor IRA.

The contributions in the non-deductible IRA are not subject to tax at the time of the conversion because funds in the non-deductible IRA were taxed in the year the contribution was made.  The funds in the newly created Roth IRA are subject to tax and penalty if disbursed prior to five years from December 31 of the year of the conversion even after age 59 ½.   The goal of the five-year rule is to prevent immediate gains from the conversion. 

A reconciliation bill recently passed by the House would abolish backdoor IRAs. One rationale for abolishing the backdoor IRA is that it favors the rich.  However, many incomes do not have income levels persistently above the contribution thresholds and not all households making backdoor contributions are wealthy based on a lifetime income concept.  In my view, the proposal to abolish backdoor IRAs is misguided because tax law should encourage additional savings in good years.

 Concluding Thoughts:

People are becoming more aware of the advantages of Roth retirement accounts. Households retiring with a mix of both traditional and Roth assets are much better positioned than household that are dependent on traditional assets.  A recent CNBC article found that many millennials are now recognizing the value of Roth IRAs.  

However, the use of Roth accounts remains counterintuitive to many households. Contributions to Roth accounts and conversion of traditional retirement accounts are more profitable when household income and marginal tax rates are low when it is harder to save for retirement.  

401(K) Plan Features and Worker’s Investment Decisions

Firm-sponsored 401(k) plans differ in several important features and overall quality. Many workers could build a more secure retirement by diverting funds from 401(k) plans to an Individual Retirement Account (IRA), a Health Savings Account (HSA), tax-deferred EE-Bonds and I-Bonds issued by the U.S. Treasury, and in some cases an annuity.

Introduction:

The tax code provides generous tax savings and deferral of tax for workers who contribute to a 401(k) plan.  Virtually all financial advisors advocate extensive use of firm-sponsored 401(K) plans for retirement savings and much has been written on the amount of funds a worker needs to place in a 401(k) plan to retire comfortably.  A recent survey found that 68 percent of firms with a 401(k) automatically enroll new workers. 

However, 401(k) plans differ in several important respects with some plans offering more generous and useful options than other plans.  The features offered in a firm-sponsored retirement plan can have a large impact on returns and wealth realized from saving through a firm-sponsored retirement plan.  Workers at firms with less generous or low-quality 401(k) plans can often achieve better outcomes by using an IRA and through alternative investments outside of a retirement account.

Some of the features impacting outcomes from investing in a 401(k) plan include — (1) the existence of an employer matching contribution, (2) vesting requirements on employer contributions, (3) the allowable employee contribution, (4) fees, (5) the availability of a Roth option, (6) loan and early withdrawal features, (7) investment options, and (8) payout options.

Matching contributions from employers: 

The tax code allows both the employee and the firm to make contributions to a 401(k) plan.  However, firms are not required to make contributions on behalf of their workers and the level of employer contributions varies substantially.

Around 49 percent of employers with 401(k) plans do not match employee contributions.

Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary.  

The employer matching contribution to 401(k) plans is an attractive benefit.  Most financial planners advise their clients to always take full advantage of employer matching funds.   

I have argued that new entrants to the workforce with substantial debt can delay all retirement savings until their debt is reduced to a sustainable level.   

Some workers at firms that match employee contributions will set their contribution limit to the level that takes full advantage of the matching contribution but will divert any additional saving for retirement to an IRA.

Employees at firms at 401(k) plans that do not match employee contributions may be better off contributing to an IRA. The choice between using an IRA or a firm-sponsored plan depends on other characteristics of the firm-sponsored plan, including the level of 401(k) fees and whether the firm offers a Roth 401(k) option.

This study by EBRI reveals that many workers are now choosing to contribute to a health savings account instead of a 401(K) plan even when the firm matches contributions to the 401(k) plan.  People who cannot afford to contribute to both a 401(k) and a health savings account might in fact be better off by contributing to a health savings account even if the 401(k) includes an employer match because contributions to the health savings account are not taxed, the health savings account allows for tax and penalty-free distributions on qualified medical expenses prior to retirement, and some health savings accounts also include an employer match.

Vesting Requirements:

Most companies that match employee contributions to 401(k) plans require workers stay at a company for some time prior to receiving full ownership of the employer match. The length of time a worker must stay at a company to receive full ownership of employer matching contributions is called a vesting requirement.  Around 28 percent of companies have no vesting requirement.  Vesting requirements range from one to six years with around 13 percent of companies vesting at one year and 10 percent of companies vesting at six years.

Vesting requirements are irrelevant for workers who have stayed at the company longer than the vesting periods.  

A recent poll found that one in four workers is considering changing jobs in 2021 and the number of potential job changers is higher for younger adults.   Many people who will lose their employer matching contributions because they will not meet the vesting requirement might be better off contributing to an IRA instead of the firm-sponsored retirement plan.

New workers who have not reached the vesting period should consider the likelihood they will leave for a new job and not receive the employer match.  Many of these new workers may choose to contribute to an IRA instead of a 401(k) plan, depending on the vesting requirements, their long-term plans, their job satisfaction, and other features of the retirement plan.

Allowable contributions by employees:

The tax code allows for generous employee contributions to 401(k) plans. The maximum allowable employee contribution to 401(k) plans in 2021 is $19,500 or $26,000 for workers 50 and up. However, most companies limit the amount their employees can contribute to a 401(k) plan to a certain percent of salary because non-discrimination rules limit contributions to highly compensated employees.

Some higher-compensated employees at firms with a relatively low employee contribution limit may choose to use IRAs once the contribution limit is met.  This is a relatively nice problem to have.

Retirement Plan Fees: 

A report by the Center for American Progress revealed that annual 401(k) fees are a substantial drain on retirement income for many workers.  

The level and impact of fees documented in the report differed substantially across plans.

The average annual fee for all workers was 1.0 percent of assets.  The average fee at firms with fewer than 100 401(k) participants was 1.32 percent of assets.  A well-managed retirement account at a larger firm could have a fee as low as 0.25 percent of assets. 

The report calculates lifetime 401(k) fees for a median age worker at three different annual fee rates – 0.25%, 1.0%, and 1.3%.   The scenarios assumed the worker contributes 5% of salary and receives a 5% employer match. 

The lifetime 401(k) fees for a median-wage worker under these conditions are $42,000 at a 0.25% annual fee, $138,000 at a 1.0% annual fee, and $166,000 at 1.30% annual fee.  

Higher retirement fees were associated with a higher likelihood of ending up with insufficient retirement income.  An increase in retirement plan fees from 0.5% of assets to 1.0% of assets will reduce the likelihood a worker will have sufficient retirement income from 57% to 69%.

High retirement fees are an especially important issue when interest rates are low, as with the current macroeconomic environment.  The de-facto interest rate on investments in bonds inside high-fee 401(k) plans is currently negative.

Workers are often unaware of retirement plan fees and their impact because the fee is an indirect charge.  Workers need to be aware of the fees at their retirement plan and seek alternatives if their plan has high fees. 

Some investment managers argue for the use of high-fee actively managed funds.  However, Warren Buffet, arguably the best active stock picker of all time, argues sticking with the S&P 500 will lead to better returns than active management for most investors.

Workers at firms charging high 401(k) fees that do not match employee contributions could likely do better with a low-cost IRA, at a firm like Vanguard or Fidelity, than through a higher-cost retirement plan. 

Workers at firms matching employee contributions could participate in the firm-sponsored retirement plan, take full advantage of the 401(k) match, and immediately roll over funds to a low-cost IRA when switching employers.   Some firms allow in-service roll overs for older employees, another difference in 401(k) features.

Workers at firms with high-cost 401(k) plans could increase returns by shifting investments in bonds to Treasury Direct, where there are no transaction fees.   This approach would leave the 401(k) plan more fully invested in equities and subject to losses during market downturns.  However, the entire portfolio including both equity investments inside the 401(k) plan and bond investments through the Treasury would be in balance.

The main beneficiary of a system that provides matching funds to high-cost funds is Wall Street.  Congress should consider rules allowing employers to match employee contributions to IRAs combined with automatic enrollment in low-cost IRAs.

Such rules don’t exist.  401(k) fees can have a major impact on resources available during retirement.  It is up to the worker/investor to maximize the use of low-cost funds either by selecting a low-cost IRA over a high-cost 401(K) or by rolling over funds to a low-cost plan when switching positions.

Availability of a Roth 401(k) option:

Workers have a choice between contributing to a traditional pretax retirement plan or an after-tax retirement plan, also called a Roth account.   Roth 401(k) plans became available January 1, 2006. Prior to that date after-tax or Roth retirement options were only available through IRAs.

Seven in ten firms now offer a Roth 401(k) option. However, only around 18 percent of workers contributed after-tax dollars to their 401(k) plan in 2016.

Contributions to a traditional retirement plan are not taxed in the year they are made but are fully taxed when disbursed.  

By contrast, funds placed in a Roth retirement plan are fully taxed in the contribution year but are not taxed at disbursement after age 59 ½.  In addition, distributions from Roth accounts, unlike distributions from traditional retirement accounts, do not increase the amount of Social Security benefits subject to federal income tax.

Another advantage of the Roth account is that workers can disburse contributions from the account prior to age 59 ½ without penalty or tax.   However, funds disbursed from investment returns in the Roth disbursed prior to age 59 ½ are subject to penalty and are fully taxed.

In general, workers with a low marginal tax rate at a firm that does not match employee contributions to a 401(k) plan should use a Roth 401(k) or IRA instead of a traditional retirement vehicle.  This worker should use a Roth IRA when the firm does not offer a Roth 401(k) plan.

A worker that does contribute to the traditional 401(k) plan, perhaps because of the employer match, can in the future rollover the 401(k) assets to an IRA and convert the IRA to a Roth.   The conversion is economically desirable in a year the person has a low marginal tax rate.

Availability of hardship distributions and 401(k) loans:

The tax code allows but does not require 401(k) plans to take hardship withdrawals from a 401(k) plan or to borrow funds from their 401(k) plan.  Most firms with 401(k) plans do allow hardship distributions and 401(k) loans.  Also, the tax code allows all employees to distribute 401(k) funds early and pay both a 10 percent penalty and tax on the withdrawal. 

Research has shown that 401(k) savings is being used to finance current consumption. One recent paper has shown that leakages from 401(k) plans are primarily from highly leveraged households.  The early use of 401(k) funds may leave many households with insufficient income in retirement.

A person using retirement funds prior to retirement may be better off contributing to a Roth retirement account than a traditional retirement account because the amount contributed to a Roth IRA is not subject to tax or penalty at any time.  The funds from investment returns prior to age 59 ½ are subject to tax and penalty.

The use of the Roth can be done inside the firm’s plan if the firm has a Roth option or through an IRA if the firm plan does not have a Roth option.

Investment Options

Most 401(k) plans offer a range of stock and bond funds to invest in.  A core issue shaping 401(k) investments is the ratio of assets in stock funds to assets in bond funds.   Younger investors generally have most of their assets in stock funds while older investors move assets to bond funds as they near or enter retirement.  

The core fund is usually a broad low-cost passively invested stock fund, often covering the S&P 500, however, funds investing in stocks of small companies or international stocks are also usually offered. 

The bond funds hold either government bonds, corporate bonds, or a mix of both.

Target-date funds are a way to automatically move funds from stocks to bonds as a person nears retirement age.   Around 77 percent of 401(k) investors have at least some of their retirement savings in a target-date fund. 

There are some limitations with 401(k) options which can lead to adverse impacts for investors.

Some 401(k) plans might not offer a low-cost option.  As previously noted, the solution to this problem is to use IRAs instead of 401(k) plans when the employer does not match contributions and to eventually roll over the assets to a low-cost IRA.

Most 401(k) bonds do not offer bonds or bond funds that will rise in value with inflation.  This is a major potential risk for 401(k) investors in the current low interest rate macroeconomic environment.

A person looking for an inflation hedge should consider purchasing I-Bonds or EE-bonds directly through the Treasury.  There are no fees on purchases of bonds through Treasury Direct.    

The advantages associated with investments in I-Bonds are discussed here. The interest rate on EE-Bonds is currently very low but all EE-bonds double in value after 20 years.

Other ways to hedge against inflation risk and interest rate hikes is purchase Treasury inflation protection (TIPs) or to purchase funds specializing in TIPS like VTIP, STIP, or VIPSX.  These funds are generally not offered inside 401(k) plans.  Investors can purchase them inside an IRA or with funds outside of a retirement account.

In general, fund managers of 401(k) plans do not invest in individual stocks.  IRAs do offer this option.  Stock picking is challenging, and most investors should seek to achieve broad diversification through low-cost funds before attempting to create their own portfolio.

Use of Annuities:

During working years, the financial focus of 401(k) investors is on the accumulation of wealth.  After retirement, the focus turns to assuring that people have sufficient income going forward.

One way to lock in sufficient income in retirement is through the purchase of an annuity, an insurance contract that provides regular payments to investors some point in the future. 

Around, 10 percent of 401(k) plans offer an annuity inside their 401(k) plan. It is also possible to use funds in an IRA to purchase an annuity.

There are costs and risk associated with the use of annuities to fund consumption in retirement.

  • Annuities are not guaranteed by the FDIC.
  • A recent law, the Secure Act, reduced liability to plan sponsors if the insurance company offering the annuity were to fail.   This Act basically transfers risks from firms to workers.
  • The use of annuities often reduces inheritances from retirement wealth because with many annuities payments stop once the recipient dies.
  • Annuities can be expensive because people with long life expectancy are more likely to purchase an annuity than people with short life expectancy.

Annuities can reduce the risk of outliving retirement resources, but the products are expensive and difficult to evaluate.  One proposal designed to reduce the likelihood of a person outliving a retirement option, discussed here  involves automatic use of a portion of 401(k) funds for the purchase of an annuity.  This approach is not widely available, if at all, and most people entering retirement cannot easily convert their retirement wealth to a stable income stream.

Conclusion:

The focus of retirement planners is to automatically enroll workers in 401(k) plans and to maximize lifetime 401(k) contributions.  However, not all 401(k) plans have the same level of quality.  Many workers will be better off by diverting some investments inside their 401(k) plan to an IRA or other investment vehicle.

  • Workers at firms that do not match employee contributions are often better off in a low-cost IRA than a high-cost 401(k) plan. 
  • Workers that contribute to the high-cost plan because of the employer match can move funds to lower cost plans either through an in-service roll over or when switching positions.
  • Low-marginal tax rate workers at firms that do not offer a Roth 401(k) are often better off using a Roth IRA than the traditional firm-sponsored retirement plan.
  • Workers who are likely to disburse funds prior to retirement may be better off with a Roth IRA than a firm-sponsored plan.   
  • Most 401(k) plans do not offer adequate investment options that adequately insulate workers from an increase in inflation or interest rates.  These risks can be better addressed by investments outside of a 401(k) plan.

The analysis presented here suggests whether a worker is ready for a financially secure retirement cannot be summed up with a single number like the value of assets inside a 401(k) plan or even net worth. 

Childcare & Employment Outcomes


  • Recent research likely understates the impact of children and lack of childcare on the economic recovery.
  • Many people with children may be underemployed and hours worked should be a key economic variable in a study of the impact of children on employment outcomes.
  • The impact of children and childcare on employment outcomes is concentrated on the part of the workforce that is of child-rearing age.  An analysis including people who are older and retiring will understate the impact of childcare on employment outcomes.
  • Additional research should consider multivariate models based on repeated cross sections and on longitudinal datasets.  The research should consider multiple existence of children definitions and educational attainment groups.

In a recent article, Jason Furman and coauthors argue that lack of childcare had only a small impact on the U.S. jobs recovery at the end of the COVID pandemic.    

Furman’s focus is on the change in the employed to population ratio for people with children under 13 and for people with no children over 13.  He finds a small decrease in labor force participation for women without a bachelor’s degree but no impact for any other group.

The research paper is narrowly focused on labor force participation and on a single definition of households with children.   Several additional tests are needed.

  • Many people without childcare are employed part time and would like to work additional hours.  It would be useful to examine how the pandemic impacted hours worked and underemployment for people with and without small children. My hypothesis is the existence of children of certain ages has a larger impact on underemployment than on labor force participation or unemployment.
  • The article does not document a pre-pandemic baseline on the impact of children and childcare on employment patterns.  It is likely that in normal times many people with children were already out of or marginally attached to the workforce.
  • Furman and coauthors consider only one classification of people with children — at least one child under 13.  Other existence of children variables including a child not yet in school, a school-age child, and multiple children in certain age groups should be considered.     
  • Furman and coauthors consider the impact of two education groups – no bachelor’s degree and bachelors or above on the impact of childcare on labor market outcomes.  It would be useful to consider three groups – less than bachelor’s degree, bachelor’s degree, and above bachelor’s degree.   I suspect this partition will show a significant impact of children on labor force outcomes for the large cohort of people ending their educational career with a bachelor’s degree.  Additional education beyond a four-year degree may reduce the impact of children on labor force outcomes.
  • The bivariate results presented by Furman and coauthors can be misleading because of omitted variables.   The bivariate framework does not allow for consideration of multiple child-existence variables or multiple education groups.  (See two comments above.). The bivariate framework also does not account for the impact of age on workforce outcomes and the interaction of an age and children on work outcomes.  
  • An analysis of the population in peak working years age 26 to 50 is likely to show a larger impact than an analysis of the entire population.  Older workers who are retiring may be out of the workforce regardless of whether they have children.  Furman’s finding that the impact of children on employment outcomes is small may be the result of the existence of a large number of older workers who are leaving the workforce.  The pertinent population for this question is workers of child-rearing age only.
  • The speed of the recovery and the impact of childcare on the labor market is likely to differ across industries.  Labor shortages have been most pronounced in restaurant and hospitality industry.  It would be useful to determine if the impact of childcare on employment and the labor market recovery is larger in some industries than other industries, especially since certain industries have a more pronounced labor shortage and are more highly dependent on female workers with young children.
  • The CPS can be used to track individuals over a period of time.  It would be highly useful to use longitudinal CPS data to compare month to month changes in labor market outcomes – fully employed, unemployed, underemployed, non-participant, from month to month.

Concluding Thoughts:  The analysis by Furman and coauthors likely substantially understates the impact of childcare on the economic recovery.  Much more analysis on this topic is needed.

Jason Furman, Kearney, M., and Powell, W. How much have childcare challenges slowed the US jobs market recovery.

https://www.piie.com/blogs/realtime-economic-issues-watch/how-much-have-childcare-challenges-slowed-us-jobs-market

Julia A. Rivera Drew, Flood, S, and Warren J.R. Making Full Use of the Longitudinal Design of the Current Population Survey:  Methods for Linking Records Across 16 Months

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4477847/

IPUMS CPS https://cps.ipums.org/cps/