Chris A. Middleton, CTFA

Executive Vice President, Director of Retirement Plan Division

Eliminating Tax Incentives for Retirement Plans

Late last year, the Setting Every Community Up for Retirement Enhancement (SECURE) Act made significant improvements in the U.S. retirement system. Along with certain provisions of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in early 2020, we have welcomed many retirement plan legislative changes over the last 12 months. But it’s election time, so a lot more ideas are being thrown around. Retirement policy might not seem like the most gripping topic of the moment, but there is one proposal out there that deserves comment.

This lousy idea is the reduction or elimination of tax incentives for retirement saving. Reducing the deductibility of 401(k) and similar plans has been floated for years through various proposals, but has thankfully never developed legs for legislative adoption or approval. The reasoning behind this proposed policy change appears to be twofold.

The first is related to how our federal government approaches budgeting. Since deferred savings into retirement accounts is not subjected to income tax by the federal government, it is viewed as lost “revenue” for the year. It’s as though the money belonged to the government in the first place, and the deductibility was the equivalent of the government “spending” money. Thus, if you want to raise funds in Washington to pay for other programs, this “tax expenditure” can be targeted for reduction or elimination.

The second argument is that the deductibility is unequal amongst varying demographics. A person in the 12% tax bracket who puts $1,000 into a 401(k) avoids $120 in taxes, while a person in the 24% tax bracket defers $240 from taxes. Although this disparity is true, it doesn’t seem to be a concern for policy makers when collecting the funds on the flip side under the same tax schedule. That said, a smart case could be made to look for additional ways to increase the incentive for a lower wage earner to save for retirement. Programs like the current savers credit for lower income earners make a lot of sense. But why in the world would we want to decrease the incentive for higher or middle class wage earners? Are they saving too much and abusing the current retirement plan system?

It is informative to look at how well middle class earners are doing in their savings for retirement. Baby Boomers have an average of $152,000 saved for retirement, according to an Annual Retirement Survey of Workers conducted by the TransAmerica Center for Retirement Studies. That sounds like a decent amount of money until one realizes that the average adult between ages 65 and 74 spends $48,885. Based on these numbers, it could be difficult to make $152,000 work for 30 years or longer in retirement, even when augmenting retirement spending with Social Security. In fact, restricting retirement savings through punitive retirement policy will actually trigger the need for more government and social welfare spending to care for people who had the ability to prepare for retirement but were not incentivized to do so. In addition, undersaving leads to less spending, which is key driver of the country’s economic engine.

The ultimate problem with this proposed retirement policy change is that it appears to have little to do with retirement policy and a lot to do with politics, especially in this election year. Washington is often dysfunctional, so most proposed ideas do not get the traction needed for legislative adoption. Hopefully this concept is yet another idea that gets put out to pasture.

We should be encouraging both low-income earners as well as the higher and middle class earners to save for retirement. Increasing savings incentives for lower wage earners is sound retirement policy. Decreasing saving incentives for higher or middle class wage earners is not. Even during a contentious election year, hopefully everybody can agree that we should not allow politics to get in the way of sound retirement policy for all citizens.

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As of January 24

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