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This week the federal government announced new dollar limits for contributions towards retirement plans and certain deferred compensation plans for 2020 People over 50 can now elect to contribute $26,000 in their 401(k)-type plan. That is $26,000 of earned income.
This boost is good news for whom, exactly? It is likely irrelevant for the vast majority of people because most people over age 50 earn less than $53,000 per year. The median income for all ages is even lower. Since it is not likely that people will save up to the maximum, who benefits from these tax breaks?
According to the independent Tax Policy Center at the Urban Institute, the 87 million taxpayers in the bottom 40% of the income distribution get an average of $105 per year from the retirement contribution tax breaks. Compare that $105 to what those at the top get. The 1.1 million richest taxpayers (income of about $3 million) get an average benefit of $10,120 per year from the tax breaks.
Really, these millionaires are fine for retirement. They don’t need $10,000-plus from the federal government as an incentive to protect themselves in retirement. I propose that every worker get a flat amount of $200 to $600 for their retirement savings, which would cost the government very little, if anything, compared to the current top-heavy subsidies.
During the election of 2012 it was revealed that Mitt Romney had as much as $100 million in his tax-preferred Individual Retirement Account (IRA). These legal Romney-style IRAs benefit mostly the 120,000 people in the top 0.1% of the income distribution. The very wealthy can put in assets that look like they don’t have any value and then when deals are made they balloon, accumulating no tax liability.
There is no good reason why people should be able to stuff under-valued “founders stock” of a tech startup into a Roth account. The IRS could boost enforcement of these multimillion IRAs but Congress would have to move, and this House and Senate don’t want to redistribute tax breaks away from the very rich.
As NYU Professor David Kamin writes, although millions of Americans are under-saving for retirement, the tax code is hardly helping the working and middle class save more. Right now the U.S. uses tools that only help the very top earners. These tools are mainly tax incentives that benefit complex tax-preferred retirement saving accounts. All federal and tax dollars directed at retirement accounts—and taxes not collected are just as expensive as a dollar spent by the government—should be rejiggered to help middle class and lower income workers.
What is the role of tax incentives for the higher earners anyway? The first thought is that the incentives (tax breaks) encourage additional saving. But we know now that tax incentives do not increase saving for the top. Instead, the highest earners shift money from taxed accounts to tax-preferred accounts.
A study conducted on savings data from Denmark found that a reduction in the subsidy rate for certain accounts resulted very few of those affected changing how much they saved in those accounts—the vast majority reacted “passively.” Overall, the Denmark study implies that each dollar spent on retirement savings incentives led to only one cent in additional savings.
In fact, most studies conclude that tax incentives have little effect, other than increasing net worth of the top earners (especially for households with sophisticated tax advice).
The bottom line is that, as Monique Morrissey at the Economic Policy Institute has written: “The biggest problem with the tax system is that it encourages sheltering not saving.” This is not a call to eliminate federal help. There remains a role for tax incentives in increasing retirement savings, especially for low- and middle-income households. But I am calling for a major overall, specifically a refundable retirement credit.
Refocusing the current tax incentives on low- and middle-income Americans would help prevent the coming retirement crisis. We need everyone to benefit from subsidies. One way to make sure that happens is to put all workers into guaranteed retirement accounts, just like we are all in Social Security.