Catch-up
contributions won't save it.
As someone who should have saved more for retirement when I
was younger, I’ve often taken solace in the existence of “catch-up
contributions” — the additional amount above the usual limit that the IRS lets
people 50 and older sock away in a 401(k) or other employer retirement fund to
shield the funds from pre-tax earnings.
Catch-up contributions were enacted by Congress in 2002 to
encourage more saving by older workers, many of whom had just seen their
portfolios deflate following the dotcom bubble. The theory, notes a report by
the Investment Company Institute, was that older people would be able to defer
more because they would no longer have the expenses of children or buying a
first home.
In practice, however, catch-ups don’t seem to have provided
anything like a catch-all solution. According to Matthew Rutledge of the Center
for Retirement Research, who analyzed data from 1999 to 2005, the people most
likely to use catch-ups were the tiny fraction of workers — only 9%
of the total group — who were already contributing close to the maximum.
One might hope that, over time, participants would try
increase their contributions, eventually maxing out and thus becoming more
likely to use catch-ups. But the nominal deferral limits have also continued to
increase, so employees may have been struggling just to keep up.
Tax Policy Failure?
One problem, identified by researchers at the 2015
Retirement Research Consortium last month, centers around the tax advantages of
catch-ups. Tax incentives rise in value with income — along with one’s marginal
tax rate — so they wind up encouraging the wealthiest, who already have more to
save, to use catch-ups. By contrast, lower-income households are less sensitive
to tax incentives to begin with as they have lower tax rates and may have no
tax liability after deductions and exemptions.
Another limitation to catch-ups: Since they are only
available to people over 50, they apply to a demographic that already saves
more on average. As Patrick Purcell of the Social Security Administration
pointed out at the Retirement Research Consortium, “From the perspective of
younger, lower-earning workers, the catch-up provision might appear to be both
upside down and backward.” Following this reasoning, it would more sense to try
to incentivize people who are under 35 and earning less — as, for example, Roth
IRAs do.
The ‘Crowd-Out
Effect’
Finally, researchers have also discovered something called
a crowd-out effect, in which an increase to one savings vehicle causes a
decrease to another. In other words, an individual’s saving strategies compete
with each other — and so employees who use catch-ups may be simply shifting
assets across savings plans, reallocating contributions from, say, a post-tax
IRA into their pre-tax 401(k). It’s still unclear whether the enactment of
catch-ups have led to a total increase in retirement savings overall.
The crowd-out effect illustrates how hard it is to change
savings rates once they are fixed in one’s mind (and in one’s 401(k) selection
form — a phenomenon I have experienced first-hand).
In order to take full advantage of catch-ups, we savers will
have to make sure that they represent real, incremental savings — however
painful — instead of mere mental accounting.
Click here to access the full
article on CNN Money.