At the 2014 State of the Union address, U.S. President Barack Obama announced that he would push for a new type of retirement plan, coined the "myRA plan," which would presumably stand for "My Retirement Account."
Currently the U.S. allows retirement incentives via IRA plans, which promote savings and investment for those of working age. The Obama myRA plan announced would be geared to help middle- and lower-income workers who don't have access to retirement plans through their employer, such as a pension or a 401K plan.
The idea would be to offer a type of savings plan that would only offer investment in U.S. treasury bonds. While this would limit risk, it would also imply that the working class that would seek such an investment solution would also have very limited rewards.
For example, an 35 year-old, middle-income worker who saves $1,000 in 2014 that is invested in treasuries would earn a rate of 3.66% at today's 30-year treasury yield, which would equate to $2,940 in savings after 30 years.
Accounting for 3% annual inflation, the nominal return is muted to a smaller gain of just over 20%, which equates to a paltry 0.64% compound annual capital growth rate over a 30-year time period.
While the inflation numbers will not be 3% and the 30-year bond yield will continually move, this assumptions showcase how the workers who are middle- and low-wage earners will not benefit much from the myRA plan.
Instead of investing in the myRA, workers who contribute $1,000 in a low-cost, S&P 500 index fund that is expected to have a total return of 8% annually, as a conservative estimate to the 10% normal expectation, will benefit much more over the 30-year horizon.
With a 3% annual inflation rate estimate, the real return would be 315%, or 4.85% annually.
The nominal return on this investment would be much higher and by disregarding inflation, the total amount of savings the $1,000 initial 2014 contribution would lead to in the S&P 500 is $10,063.
The question that remains is very simple. Do workers that make under $50,000 per year have incentive to open a myRA account, if it existed, versus a traditional or Roth IRA?
Without further information, the answer is no. While capital contributions to the myRA could be considered risk-free, the return on investment is much weaker versus a low-cost index fund approach to owning corporate America.
The Double Tax-Free Incentive
Obama could give further incentive by stipulating that individual myRA contributions could be given with pre-tax dollars and cashed-in with no tax penalties. This would allow tax-free growth as well as tax-free income down the road, sort of like a Traditional/Roth IRA hybrid.
This stipulation would likely be have the corporate and individual advisors, as well as the financial media and pundits, interested in promoting the myRA agenda.
Let's assume we have the same 35 year-old worker with a 30-year investment horizon that has $1,000 in after-tax dollars to invest in 2014. The myRA investment would be raised to pre-tax levels, where the effective tax rate of 16.7125% it taken into consideration using 2014 single-taxpayer U.S. income tax rates. This would increase the contribution amount available to $1,200.66.
An astute financial adviser may then question the benefits of the myRA invested in treasuries versus an IRA account. These questions would ask which of the two options would be better for the investor. While combining a maxed-out Roth IRA with a $1,000 myRA would be the ideal option, we are also assuming that this worker can only afford $1,000 to invest in 2014.
The remaining question is which investment is better? While treasury rates of 3.66% and an after-expense stock index return of 8% annually is not guaranteed, plugging in these numbers for the nominal returns on $1,200.66 for the myRA and $1,000 for the IRA with treasury and stock index returns, respectively, will give an idea of the value moving forward.
The nominal return, although risk-free in investment terms, would be 252.8% over 30-years.
Versus index investing, the amount of tax-free income dollars is much lower and in this regard, the best option would still be to open a Roth IRA with $1,000 and invest in a low-cost S&P 500 index fund.
To the investor who wants a sure thing however, the lower return would still be a better option. As such, advisors would have incentive to offer both options to this investor.
When the government offers incentives for savings, several benefits arise. Under the current understanding of the myRA proposal, there would be not be a net-benefit to aggregate U.S. savings as alternate investment opportunities, such as the Roth IRA, offer more of a reward for savers. It does not seem that myRA demand would really take off any better than Obamacare.
If the myRA had a sense of purpose that could offer a closer return to those of the general stock market however, the economy would be affected in a positive way by those earning under $50,000 per year. The clearest way to jump over this hurdle is to offer a triple tax-free incentive.
The Triple Tax-Free myRA Incentive Program
The third tax-free incentive would involve employers matching contributions, to the tune of which the government could offer an incentive such as a complete tax-write off. This final solution, coupled with the pre-tax in dollars and tax-free out dollars, would further enhance the demand here.
In this regard, we start with $2,401 (employer-matched, pre-tax income) rather than $1,000 (post-tax income) or $1,200 (pre-tax income).
Under this triple-tax free program, where pre-tax earnings, tax-free withdrawals and an employer tax write-off incentive to match contributions, the return on a 30-year horizon with the $1,200.66 matched would be $7,059, keeping in mind all of our previous assumptions.
This return would be 605.9% on the $1,000 after-tax dollars (opportunity cost), as $1,200.66 is pre-tax earnings is equal to the $1,000 in post-tax income and the employer match is in place (with tax incentives). This is much closer to the risk-on 906.3% return on the S&P 500 index with after-tax earnings of $1,000 invested.
This risk-free return is enough to have any financial advisor and employer keen on recommending this investment solution to our 35 year-old who makes $50,000 per year and can afford to save $1,000 in after-tax income per year.
Bonus: High-Net Worth Individuals Help Even More
Offering an added tax-free account would be great for high-income earners, as well as those making over $50,000 that already are maxing out their IRA contributions. This would help the U.S. economy, as these types of savers would be given incentive to invest in an area they may not already have interest in.
By taking the clause out of the myRA that only workers who do not have a 401k can invest, the 401k employees would also be keen on investing in a new myRA account, even at minimal levels, if there was such a triple tax-free incentive.
Conclusion
The benefits to the U.S. economy in the myRA plan, if done with the triple tax-free incentives as stipulated above, would cause an immediate and continued increase in demand for U.S. treasuries. This would help offset the effects of the current foreign demand decline as well as the Fed's tapering program.
From this bond demand increase perspective, the U.S. debt cost would be reduced, which would naturally be a boon to GDP growth. Current U.S. debt holders would be rewarded with higher bond prices, the lower cost on U.S. debt interest would lower government costs and both corporations and individual borrowers would have lower financing costs in the debt and mortgage markets.
When financing costs are lower for the government, corporations and individuals, there is an increase in available funds for government expenditures, personal consumption, personal investment, business investment and corporate dividends.
Such an exciting way to encourage risk-free retirement savings would be a natural boon to the domestic economy and lift U.S. GDP growth accordingly. The increase in U.S. GDP growth would be felt on a global scale, thus offering a higher world GDP growth as both developed, developing and frontier markets are lifted.
The only net-loss to such a plan would be the cost to investors who are short the U.S. stock and debt markets. Obama's myRA, if done correctly with a triple tax-free incentive, would help domestic earners as well as the U.S. economy in one fell swoop.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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