We previously wrote about shortcomings in Social Security and why it should be reimagined. Today, we examine some issues with personal retirement savings that people can use to help prepare for retirement.
Social Security was never intended to be a comprehensive retirement plan; it was intended to supplement private savings and pensions. If our mechanisms for private savings and pensions have issues, that compounds the problems we have with retirement. If we want to address the shortcomings of Social Security, we really should be looking at problems in other retirement mechanisms we have and see how a holisitic approach to the problem of retirement might work.
Types of Personal Retirement Savings Plans
To begin our discussion of retirement shortcoming, we need to look at some of the retirement programs that are available currently. Note that in our discussion of types of retirement plans below, the general information provided is for informational purposes and is not specific to anyone’s particular situation. Readers should not base any retirement decisions solely on the information presented here.
Defined Benefit Plans
Defined benefit plans provide employees with a pension. These programs used to be quite common. Some, typically larger, companies may offer pensions to at least some of their employees. Pensions are also fairly common for government employees. Unions may administer pension programs for some workers.
Defined contribution plans provide employees with a known benefit. For example, an employee may offer a plan that pays 60% of the employee’s last salary before retirement. The plan would pay an employee who retired earning $100,000 per year at the time of retirement a pension of $60,000 for life.
To qualify for a pension, the employee typically has to work a certain amount of time, called a vesting period. Pensions may require 20 years of service or more for the employee to be fully vested. The calculations for determining employee benefits may be much more complex than the example here and may include cost of living adjustments to keep pace with inflation.
Employers are required to adequately fund these plans, to make sure funds are available to make payments to retirees. Major problems occur with harsh economic factors at times. A period of high inflation might make a plan that was well funded now be underfunded, as inflation impacts the amounts to be paid out. A downturn in business for the employer also can jeopardize the employer’s ability to make needed deposits to pension funds. For some companies, pension fund woes have forced bankruptcy.
While these are significant issues for the employer, we will discuss problems with traditional pensions from the employee perspective below. Given the complications of managing a pension plan, many companies offer their employees defined contribution plans instead of. Some employers, such as government entities may offer both defined benefit and defined contribution plans.
Defined Contribution Plans
While defined benefit plans provide a guaranteed benefit, defined contribution plans have no guaranteed benefit. As the name suggests, these plans focus on how money goes into the plans. Money invested in these plans, like the money invested in pension plans, is used to buy assets like stocks, bonds, certificates of deposit, etc. to build wealth and income potential over time. You don’t know, though, exactly how much you will have for retirement.
Individual Retirement Accounts
One of the most popular types of retirement accounts is the Individual Retirement Account (IRA).
Traditional IRA
IRAs were first created by the Employment Retirement Income Security Act (ERISA) of 1974. The objective was to create a personal retirement savings account with tax advantages. This would help people who did not have pensions save for retirement.
Basically, an IRA works like this. A worker opens an IRA with an authorized financial institution. Each year, the employee can make deposits into the account. These deposits are usually tax deductible, meaning they are subtracted from the worker’s income prior to calculating taxes. Workers are limited in how much they can contribute per year. In 2025, the limit is $7,000. For workers over age 50, an additional $1,000 per year “catch-up contribution” may be deposited.
These contribution limits apply to all Roth and Traditional IRAs the worker owns. A worker may have four IRA accounts, but not fund them each with $7,000. The total combined contribution cannot exceed the $7,000 or $8,000 limit.
Funds deposited in the account may be invested in savings type accounts, certificates of deposits, and financial securities (like stocks, bonds, and mutual funds). Some other types of investments are allowed, but we have noted the most common ones. Investment income and capital gains are not taxed as long as the funds remain in the account.
At age 59½, the employee may begin making withdrawals to live in retirement. These withdrawals are taxed as regular income. In general, withdrawals made prior to age 59½ are subject not only to taxation as regular income, but also to a 10% penalty. There are some exceptions to this early withdrawal penalty.
At age 73 (depending on when you were born), the law imposes required minimum distributions which must be withdrawn each year. Steep penalties apply if you do not take your RMD for the year.
Roth IRA
Roth IRAs were created in 1997. In most respects, they are like traditional IRAs and have the same contribution and investment limits, but there are a few key differences.
Contributions to a Roth IRA are not tax deductible, so there is no immediate tax benefit to contributing. When you retire, however, the distributions are federal income tax free.
Your income must be lower than a certain threshold to make contributions to a Roth IRA. If your income is above that limit, the amount you can contribute is reduced – or even eliminated. In 2025, you cannot contribute the full amount ($7,000, or $8,000 if over age 50) if you are a single filer and your Modified Adjusted Gross Income (MAGI) exceeds $150,000 or if you file jointly with your spouse and your combined MAGI exceeds $236,000.
Roth IRAs have no required minimum distribution. Since you have already paid taxes on the contributions to a Roth IRA, you may withdraw your contributions, at any time, but not any growth or earnings on those contributions.
Workers may convert all or part of a traditional IRA to a Roth IRA by moving the funds from a traditional IRA account to a Roth IRA account and paying regular income tax on the amount moved to a Roth IRA account.
Simplified Employee Pension (SEP) IRAs
SEP IRAs were created in 1978. Under a SEP IRA plan, a self-employed worker or a small business may create a plan. The general tax rules are similar to a traditional IRA. Contributions, however, are limited to 25% of the worker’s income, or a maximum contribution of $70,000 in 2025.
If a small business owner sets up SEP IRA accounts for employees, only the employer may contribute funds.
A Roth version of the SEP IRA was created in 2023 by the SECURE Act 2.0.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
SIMPLE IRAs were created in 1996. Like SEP IRAs, these accounts aim at providing personal retirement savings options for self-employed people and for small businesses. The employer makes contributions, and employees may make contributions to these plans. Employee contributions are limited to $16,500 ($20,000 if over age 50) in 2025.
401(k) Plans
In 1978, the Revenue Act created 401(k) plans, named for the section of the Internal Revenue Code that defines them. 401(k) retirement plans are established by employers.
These plans are salary reduction plans, so employee contributions are deducted from employee pay and transferred to the 401(k) plan. Typically, the employee specifies a percentage of his paycheck to contribute to the 401(k). Some plans may allow the employee to specify an exact dollar amount instead of a percentage.
There is a fair amount of flexibility in how a 401(k) plan can be set up. There are, however, also rules that must be followed to assure the plan is fair in getting the participation of the employer’s workforce.
Funding
Employers typically contribute to a 401(k) plan on behalf of their employees. Employees also usually contribute to 401(k) plans. Often employer contributions are match employee contributions. For example, an employer might do a 100% match the first 2% that the employee puts in, plus 50% on the next 4% that the employee puts in. In this case, if the employee sets aside 2% of his income into the 401(k), the employer contributes the same amount for that employee. If the employee contributed 3%, the employer would contribute 2.5%. To get the maximum employer match, the employee would contribute 6%, with a 4% match from the employer. Matching rules vary by employer plan.
When an employee enrolls in a 401(k) plan, he selects the investments (typically mutual funds) his contributions will buy. In some cases, the plan may specify a default investment portfolio if the employee does not choose. Some employers also automatically enroll employees and may automatically increase employee contributions each year up to a cap (like 10%). Employees may opt-out of these automatic enrollments and contribution increases.
Portability and Employee Separation
Like traditional pensions above, 401(k) plans may have vesting schedules. An employee’s contributions are always 100% vested. An employer may have a vesting schedule of up to six years. If an employee leaves before the employer contributions are fully vested, the employer can take back a portion of their contributions, including the earnings and growth on those contributions.
When employees leave an employer, they have several options about what to do with their funds. If the plan allows, their funds could be left in the employer’s 401(k) plan. They could roll the funds into a new employer’s plan, or roll it into their own IRA accounts. Finally, an employee could withdraw the funds, but would then be subject to taxes and penalties if the withdrawal is an early withdrawal.
Traditional 401(k)
A traditional 401(k) plan is taxed similar to a traditional IRA. The employee contributions are deducted from income prior to calculating the employee’s taxes. Withdrawals are taxable as regular income after age 59 ½. Early withdrawals are subject to penalties, though some 401(k) plans allow the employee to borrow against the IRA.
Like IRAs, 401(k) plans have annual contribution limits. In 2025, most employees are limited to $23,500 in contributions. Employees aged 50 and older can add an additional $7,500. Employees aged 60-63 can add an additional $11,250. Total (employer + employee) contributions for a worker cannot exceed $70,000.
Traditional 401(k) plans have required minimum distributions, similar to traditional IRA plans.
Roth 401(k)
Roth 401(k) plans are similar to traditional 401(k) plans, but are taxed like Roth IRA accounts. An employer’s 401(k) plan may allow employees to make both traditional and Roth contributions.
Roth 401(k) contributions have no minimum required distributions.
Solo 401(k)
A solo 401(k) is a plan for a business with no employees other than the owner. These plans may be traditional or Roth plans and may include the business owner’s spouse.
457(b) Plans
Like 401(k) plans in the private sector, 457(b) plans provide a way for employees of government entities and some non-profits to save for retirement. Also like 401(k) plans, 457(b) plans are offered in traditional and Roth versions, with the taxing differences we have seen for IRAs and 401(k)s. 457(b) plans, because they are not governed by ERISA, do not include penalties for early withdrawals.
Contributions have the same limits as 401(k) plans, except that 457(b) plans have an option for accelerated contributions in the last three years prior to retirement.
The Need to Reimagine Personal Retirement Savings
From the quick survey above, we can see that there are many types of retirement savings options available. Each comes with its own rules and limits. We believe that this disjointed nature of retirement funding plans produces inequities that cannot be justified from a policy standpoint. Further, some of the common rules we see throughout these plans seem to undermine the policy objective of maximizing employee savings.
Our concern is with the sea of tax-advantaged Defined Contribution Plans. Regulatory requirements to assure that pension funds are solvent are appropriate. Contracts, rather than by government policy, primarily define these pensions. Our belief in free markets leads us to adopt a generally hands off policy toward private pensions otherwise than assuring adequate funding.
Program Complexity
There are many types of tax-advantaged retirement accounts. We have discussed a broad sample, but not all of them. There seems to be little, if any, policy justification to this patchwork of varying accounts and rules. It would seem consolidation and simplification would promote clarity, resolve some inequities, and could improve worker focus on preparing financially for retirement.
Contribution Limits
We first take issue with the system of annual contribution limits. Some form of contribution limits can be justified. The goal of these plans is to provide for retirement of all Americans. It is not to provide a massive tax shelter to the wealthiest Americans. Some sort of limitation, then seems to be in order. Nevertheless, we disagree with the annual limits on multiple grounds.
Equity Concerns
First, the annual contribution limits are not equitable. An employee of a small company that cannot offer retirement benefits has only IRAs as an option for tax-advantaged personal retirement savings. If under 50, they are limited to contributing $7,000 per year. An employee at a larger company with a 401(k) plan can contribute $23,500 to the 401(k) plan, likely receive employer contributions in the 401(k) plan, and then contribute $7,000 to their own IRA plan. When counting employer contributions, the employee at the larger company can theoretically save over $30,500 in tax-advantaged plans, while the small company employee can only contribute $7,000. As a matter of public policy, there can be no justification for such disparities. At the very least, this argues for a consolidated overall limit applicable to each person, as opposed to each plan. We feel more drastic changes are needed.
Timing Concerns
Second, the annual limits ignore the fact that retirement savings are best made as early as possible. We should want people to frontload their personal retirement savings as much as possible. The current limits work against that. If a worker has a spike in income (perhaps due to a lot of overtime) in a year, it really makes no sense to tell him that even though he has additional income available, he must defer investing it for retirement to later years. This is contrary to what the policy goals should be and against the interest of the worker.
A shift to contribution limits based on account value solve both of these problems. For example, a limit could be that contributions may only be made when the account balance is $5,000,000 or less. This limit could then be indexed for inflation, like the annual limits are now. This limits abuse of the accounts, but does so without forcing disadvantageous timing of investments by workers.
Vesting and Portability
One significant disadvantage of the traditional pension is vesting requirements. Vesting is a process whereby the worker earns or qualifies for benefits. Traditional pensions might require 15, 20, or more years to qualify for full pension benefits. If a worker leaves an employer with a traditional pension, he could find he is only eligible for a half pension or even nothing at all.
IRAs have no such problem, since they are not attached to an employer. When 401(k) plans were introduced, some companies wrote long vesting periods into those plans. Now, full vesting must happen within six years when there is partial vesting each year. It must happen within three years for cliff vesting, where the vested amount is zero until it is all vested at once.
Vesting requirements create a portability problem. They make it difficult to take retirement benefits with you.
Imagine if your employer had a three year cliff vesting schedule, meaning you are 0% vested in the employer contributions until you have worked for three full years. You work there for 2½ years, then get an offer for another job. You want to take that offer, but if you do that, you will lose all of the employer contributions in your 401(k) account. This makes it financially harder for you to move. Your current employer likes that, but public policy should be supportive of easy movement of labor.
The fundamental problem here is having retirement funds too closely tied to employment. Further limiting, or even eliminating, vesting in defined contribution retirement accounts would enhance portability and labor mobility.
Unrelated Business Income Taxes
Tax exempt entities, including retirement accounts, can have their tax exempt status jeopardized by something called the Unrelated Business Income Tax (UBIT). A retirement account, if it invests in certain securities, may be subject to UBIT and partially lose its tax advantages.
The IRS explains that
unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption.
A tax exempt organization with more than $1,000 in UBIT is liable for tax on that income. We don’t want a charitable organization, for instance, to own businesses and in essence make those businesses tax exempt because the charity is tax exempt. That would be unfair to competitors and to other taxpayers.
If investing in a local partnership for a restaurant or other business in which the retirement account would be expected to be truly actively involved, UBIT makes sense. It does not make sense if investing in partnership units which are publicly traded on a securities exchange. The typical investor has no more practical influence over the partnership than a typical shareholder has over a corporation.
Why is this important? MLPs often have relatively high distribution yields. This means they are often excellent securities to hold to generate income. The typical investor in exchange-traded MLPs in no meaningful way regularly carries on the business of the MLP.
In general, retirement accounts should be fully exempt from UBIT for income generated from any exchange-traded security. Perhaps UBIT could come into play if the retirement account holds more than 10% of the total outstanding partnership units, but the typical IRA investor should not have to worry about whether any publicly traded security is going to subject her account to UBIT.
Final Thoughts
Our previous article on Social Security found good reason to reimagine Social Security. We also see good reason to reimagine how private retirement savings works. These are two parts of a broader issue of improving retirement opportunities for Americans. In considering one, we should consider them both together.