Tax breaks meant to increase retirement savings are expensive for the federal budget, disproportionately benefit upper-income households, and do nothing to help people at risk of poverty in retirement.
Most of these incentives’ advantages accrue to high-income households, who would save even without them and have the lowest risk of retirement insecurity. In 2019, 60% of the income tax incentives for retirement savings accounts went to the highest-income 20% of households and 1.5% to the lowest-income 20%. Social Security offers a necessary foundation, but research reveals that financial security in retirement depends on numerous income streams.
The Secure Act 2.0 expands and alters retirement tax incentives. The proposed law, which recently passed the U.S. House of Representatives, expands automatic enrollment in retirement savings plans and strengthens protections for part-time workers, but it doesn’t address the flaws in the current incentives that make them useless to low- and middle-income families.
This research explores failed retirement savings incentives and Secure Act 2.0 limitations. It then presents policy proposals to promote retirement security for individuals who gain little from the bill.
Costly, ineffective retirement incentives
The capacity to exempt pension contributions from income and payroll taxes is the second-largest federal tax expenditure, costing $276 billion in lost federal revenues in 2019.
Currently, there are two main forms of tax preferences for retirement savings. First, 401(k) and regular IRA contributions reduce a person’s taxable income. Both contributions and investment earnings aren’t taxed until withdrawn. In a Roth IRA, contributions are made with taxed income and withdrawals are tax-free. Complex rules regulate tax-favored retirement plan contributions and early withdrawals. The saver’s credit, explained below, is a modest incentive accessible to fewer taxpayers.
Higher-income households are more likely to use retirement tax breaks. In 2019, 77% of top-income quintile households received a benefit, compared to 19% of bottom-income quintile households and fewer than 50% of middle-income quintile households. In 2018, the most recent year for which data is available, 41.7% of wage earners contributed to a DC account.
High-income households have more retirement accounts and have bigger average balances than lower-income savers. Families in the top 10% of the income distribution had average accounts worth $692,800, while those in the poorest 50% had average accounts worth $57,400. While federal spending on savings incentives doubled between 2004 and 2020, retirement insecurity rose. The percentage of households in danger of not having enough retirement income climbed from 41% in 2004 to 49% in 2019.
Policies to promote retirement security should target persons with modest wages who are at risk of financial instability in old age. The current system of incentives gives high-income households huge tax breaks relative to middle-income households and little or no help to low-income families. This upside-down structure derives from factors that benefit high-income households, including:
- In 2020, incentives allowed tax-sheltered savings of up to $57,000 per year in an employer-sponsored retirement plan.
- That’s more than the average full-time worker’s $56,287 salary, but it helps higher-income households save more.
- The greatest incentives are tax deductions or exclusions that benefit high-income savers. A $1 deduction saves a family in the highest tax bracket 37 cents, but just 10 cents in the lowest. People whose incomes are so low that they owe no tax before refundable credits like the EITC are considered will receive no tax benefits from a retirement savings plan.
- Complex incentives and penalties for early withdrawals can discourage participation among low-income households without other emergency resources.
- The saver’s credit, the one retirement tax incentive allegedly geared at helping lower-income households, is nonrefundable and hence delivers no or a very limited benefit to lower-income households that owe little or no tax to offset with the credit.
Despite their high and growing cost, existing retirement savings incentives have done little to reduce retirement insecurity. Current incentives cause higher-income people to move savings from non-tax-privileged to tax-advantaged accounts, but do nothing to boost total savings. The federal budget forgoes a large tax income amount each year to offer benefits to households that would have saved without an incentive, while failing to improve the retirement security of those who need it most. In recent decades, policymakers have increased the maximum amount that may be contributed to an account and delayed the age when minimum payouts must begin, along with other adjustments that generally benefit higher-income households.
Incentives worsen the racial wealth disparity
Existing incentives and retirement savings discrepancies aggravate the racial wealth disparity. Workers of color are disproportionately concentrated in positions and sectors with poor retirement plans. This, along with things like low intergenerational wealth transfers, makes it hard for families of color to save for retirement.
Two-thirds of Hispanic and half of black families lack a retirement plan in 2019. In comparison, one-quarter of white households and one-tenth of high-income families have no retirement savings account. White Americans have more retirement accounts and greater balances, thus they benefit disproportionately from current incentives. White households with IRAs and 401(k)s had average balances almost triple those of black and Hispanic families.
The Secure Act 2.0 has various costly downsides
Secure Act 2.0 would increase access to employment-linked retirement savings programs over time. Changes like mandating companies to automatically enroll workers in 401(k) plans and enabling employers to include student loan payments for matching contributions will certainly enhance participation, especially among low-takeup workers. Likewise, requiring companies to expand coverage for part-time workers would help many people get 401(k) plans.
However, these adjustments don’t solve the system’s fundamental faults, and other provisions would bias benefits toward the rich. It’s important noting that many workers don’t save since they need every dollar to survive. So, diverting earnings to limited savings accounts can diminish a family’s living standard and make it harder to take on costs that could eventually lead to better earnings or a higher standard of living before retirement.
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Bio:
Mike was born in Chicago, Illinois on August 13, 1946. He was brought up in the
suburb of Skokie on Chicago’s northwest side and graduated from Niles Township (
East ) high school In 1964. Two years later he joined the US Air Force in November of
1966. After 2 years of Intense training he volunteered for Viet Nam and was sent to
Bien Hoa Airbase, which was 25 miles from Saigon, the nation’s capital. He
volunteered for a number of especially dangerous missions on his days off, such as
flying as a door gunner on a US Army helicopter and as a technical assistant on a
psychological operation on an Air Force O-1E observation aircraft. Capping off his
impressive accomplishments was winning the coveted Base Airman of the Month for
March 1969, a feat which was featured in the Pacific Stars And Stripes newspaper
read by every service man stationed in the Pacific theater of operations. After his
Viet Nam tour of duty he was stationed at Luke Air Force Base in Glendale, Arizona
where he met and married his wife, Lequita.
He graduated from Arizona State University in May, 1973, and after a 30-plus year
career as a financial advisor he joined a number of service organizations including
Easter Seals and Valley Forward, sponsor of EarthFest. He was also involved with the
National Federation of Independent Business and became the longest-serving
chairman of the Leadership Committee ever. He spoke before the ( AZ ) House Ways
and Means & Senate Finance committees. He then joined Disabled American
Veterans ( DAV ) in September of 2015. He rose quickly through the ranks and
became Chapter 8 Commander in May of 2019 where he served with Distinction for 3
years before being “ termed out”. The next year, as Vice Commander, he won the
title of National Champion Recruiter!
