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We Don't Have to Be Flat Broke in Retirement

Raising contribution ceilings on retirement accounts can help solve the retirement crisis.

By Barry Ritholtz

(Bloomberg View) --Of the many proposed legislative changes that might occur during the presidency of Donald Trump, the one with the highest probability of actually becoming law is a reduction in corporate tax rates. While we are considering making changes to the tax laws, I have a modest, related proposal that won’t cost very much and has enormous potential benefits: Raising the ceiling on contributions to individual retirement accounts (IRAs), 401(k)s and other tax-deferred retirement-savings accounts.

At a minimum the IRA contribution ceiling should be tripled to $15,000 a year, and indexed to inflation, and the 401(k) limit should be doubled to $36,000 a year.

Let’s begin with the basic facts: For this year, IRAs top out at $5,500 a person ($6,500 if you are 50 or older); 401(k)s max out at $18,000 ($24,000 if you're 50-plus).

Those numbers are, to be blunt, absurd. Without any changes, the U.S. will face a retirement crisis in the next 20 years or so. Raising the limits would be the first of several steps the U.S. should take to avoid that fate. (Fixing Social Security and Medicare are subjects for another column.)

Consider a saver who puts away the maximum of $5,500 for 30 years, generating a 6 percent return and ending up with $460,909. That's not bad, but it falls short in several ways. Part of the problem has to do with the 1974 law that allowed creation of IRAs. Taxpayers were allowed to set aside as much as 15 percent of their annual income or $1,500, whichever is less. Simply adjusting for inflation since then, that $1,500 in 1974 should be $7,343 today. In other words, in current dollars the maximum contribution is almost $2,000 short of the original limit.

But raising the IRA ceiling almost 50 percent is only the start. That $460,909 in 2047 is actually only equal to $189,888 in today’s dollars, assuming a 3 percent average inflation rate during the next 30 years. (It's worth even less if inflation turns out to be higher.)

Furthermore, the average IRA account balance in 2014 was slightly more than $100,000 and the average IRA individual balance was $127,583. This is vastly less than what is needed.

Things are better for 401(k) savers, but far from great: Put $18,000 away for 30 years, let it compound at a 6 percent rate and you end up with $1,508,430. That sounds like enough money to retire on today -- but we are talking about 2047. The present value of that savings account in 2017 dollars (again, assuming a 3 percent inflation rate) would be $617,980. That’s probably still not enough.

A few caveats: The IRA and 401(k) ceilings are scheduled to rise a bit over time. My calculations don't reflect further increases. However, as we have seen since the 1970s, these ceiling increases fail to keep up with inflation.

Thus, people in their 60s today who have been stashing money away in 401(k)s for many years only have an average balance of $304,000, according to the Employee Benefit Research Institute and Investment Company Institute.

Why does this pose such a huge problem? There are several issues that the rules failed to take into account when Congress drafted the retirement legislation in the early 1970s. The first is the increasing longevity of Americans. It's no longer uncommon for a person to live for 20 or 30 years in retirement.

The second issue is how the consumer price index measures inflation. It has been said that the prices of the things we want are going down while the prices of the things we need are going up. The elderly tend not to be big buyers of technology, gadgets, durable goods, autos and so on. These have all fallen in price over the years, and that is reflected in part in today's low CPI rate. On the other side of the pricing ledger, health care, housing, food and energy -- the things we can't do without and which the elderly have to consume -- have all seen significant price increases. Thus, the inflation rate for those in retirement is somewhat higher than is reflected in the CPI data.

Troubling as things may be for those approaching the end of their working lives is how difficult saving for retirement might be for young people. Indeed, millennials may need to double how much they sock away, partly because investment returns have been so low.

The present contribution limits all but guarantee insufficient savings for the average American’s golden years. In the face of the looming retirement crisis, this is an issue that should be resolved sooner rather than later. Let's hope that Trump and Congress take the necessary action.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”

To contact the author of this story: Barry Ritholtz at [email protected] To contact the editor responsible for this story: James Greiff at [email protected]

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