The U.S. is facing a retirement savings crisis of its own making. Not only are people not saving enough to live on in retirement (36% of people recently surveyed think they’ll run out of money in their later years), over half the workforce doesn’t even have access to a workplace retirement plan, and 25% of U.S. working adults have zero retirement savings or pensions. If nothing changes, if we don’t provide people with greater access to retirement savings vehicles, we, as a society, are going to be paying for it later. Both in the form of social services needed and lost productivity and lower spending (the fuel of our economy) due to children caring for their parents.
How Did We Get Here?
The nature of work has been steadily changing over the past 20 years but our approach to retirement savings has not. The 401k was created in the 1970’s when people worked for big companies for decades and was meant to replace the pension system. It was never meant to be portable or easily changed. It was meant to be set up once and most of the control over investments remained with the employer.
Now, people work for an average of 12 companies as a full time employee over the course of their career. If they’re offered a 401k at every job (and that’s a big “if” since 61 million people work for SMBs, most of which don’t offer retirement plans), that means they will either have to manage 12 retirement accounts, complete 11 rollovers, or cash out which comes with onerous tax penalties. Many people just end up abandoning their account.
People are also more likely to not work as a full time employee at all. As of January 2021, there were roughly 57.3 million independent contractors in the U.S. and that number is expected to grow to half the workforce over the next five years and none of these people are even eligible to contribute to a 401k.
So the 401k isn’t user-friendly for those who have access to one, and it won’t even be available to over half the population (if you count the millions of people who work for small and medium businesses who can’t afford to offer a 401k to their employees), and yet current regulations favor it as the preferred retirement savings vehicle.
The Problem: Annual Contribution Limits
If you either don’t have access to a 401k or aren’t eligible for one, an Individual Retirement Account (IRA) is your only retirement savings vehicle. This would be fine since IRAs are portable, tend to charge lower rates and are otherwise better suited to the modern work environment. Except for one thing: the annual contribution limit.
Current regulations state that IRA participants can only contribute up to $6,000 a year to their account (an extra $1,000 is allowed if you’re 50 or older), and part of your contributions might not be tax-deductible, depending on your income, filing status and whether or not you or your spouse have a 401k. Compare this to the $20,500 in annual tax-deductible contributions allowed to a 401k (an additional $6,500 allowed for those aged 50 or older), and you see the current regulations are setting up a two-tiered retirement system.
Why do we have these laws? Outdated thinking. There is an assumption that contract workers are more likely to be women and can thus, “fall back on their husband’s 401k,” is both factually untrue (men outnumber women as full time independent contractors 3:2), and sexist. No one should be dependent on having a spouse with a 401k to retire with dignity.
Another assumption is that 1099 workers are low-wage earners and thus wouldn’t be able to save more than $6,000 a year. This is also factually untrue. In fact, 1099 workers are most likely to be in the high paying fields of technology and professional services.
The Solution: Level the Playing Field
Independent contractors are already treated unfavorably in the tax system. They must pay higher taxes because IRS rules state they must pay Social Security and Medicare taxes as both an employer and employee (full time employees split these taxes with their employer) and business taxes. On top of this, they don’t qualify to receive workman’s comp, unemployment benefits or FMLA.
By keeping the contribution limit for IRAs at $6,000, regulators are further hamstringing the ability of these workers to create financial stability for themselves and their families. The solution is to raise the annual IRA contribution to match what’s allowed for 401ks so that all workers have a shot at creating the nest egg they’ll need when they eventually retire. This is not only the right thing to do morally for our aging population, but it’s the right thing to do for our economy.