A new report finds that the tax breaks designed to encourage
Americans’ retirement savings disproportionately benefit high-income households
and do little to assist middle-class families.
More than half of the tax breaks for defined-contribution
plans, such as 401(k)s and individual retirement accounts, go to those whose
income puts them in the top 10%, according to new research from the National
Institute on Retirement Security, a nonprofit, nonpartisan organization
established to contribute to informed policymaking. NIRS’ membership includes
financial services firms, employee benefit plans, trade associations and other
retirement service providers.
The report documents how current tax incentives fail to
promote adequate retirement security for the middle class. It considers the
impact of factors including marginal tax rates, retirement plan participation
and income distribution on retirement savings levels. The research also offers
potential solutions that could enhance retirement security for middle-class
families.
“It is clear that there are many people approaching
retirement with a Social Security benefit that will replace less than half of
their current income, meager savings, and who are less likely to be accruing a
pension benefit than middle-class workers in the past,” the report found.
More than 40 years ago, when the 401(k) was created by the
Revenue Act of 1978, saving for retirement through a 401(k) offered more
benefits for a typical middle-class worker. However, recent changes to the tax
code, the economy and life expectancy have made saving for a secure retirement
through a 401(k) more challenging for middle-class families, who are also
struggling to pay for health insurance and high housing costs, and to save for
college for their kids.
Saving for retirement remains a good idea, but tax changes
have altered the arithmetic regarding retirement savings. For one thing, top
marginal income tax rates are much lower now than they were 40 years ago, so
there is generally less advantage to be gained by lowering taxable income
through contributions to a 401(k) or other retirement plan, the report noted.
Second, the standard deduction on federal income tax returns
is much larger now, thanks to the Tax Cuts and Jobs Act of 2017. Those who are
married and filing jointly need household income above $109,000 in 2022 to move
beyond the 12% marginal tax bracket. Thus, the tax match available through
saving for retirement is only 12% or less for many middle-class families, which
is a weak, illiquid premium offer for locking up money for decades.
Finally, current interest rates are much lower than rates
were 40 years ago. Investors must either take more risk or plan for lower
returns on their investments by saving more.
Taken together, these changes mean that a typical
middle-class family receives a smaller tax break through saving for retirement
in a tax-advantaged plan like a 401(k) than a similar family did 40 years ago,
while they’re also expected to need more resources to achieve for a secure
retirement.
Because of Social Security’s progressive benefit structure
and capped benefit amount, high-income earners need to save more for retirement
through private means because they will receive a smaller replacement ratio
from Social Security than low-income workers. While it’s true that Social
Security is generous to those with very low incomes, replacement rates drop off
quickly for those in the middle class. But tax incentives aren’t filling that
gap until a taxpayer reaches significantly higher income levels, leaving a
gaping hole into which much of the middle class falls, the report said.
Another major factor contributing to retirement incentives
being skewed toward higher-income earners has nothing to do with tax policy,
but is simply a function of the fact that there is a strong correlation between
participating in an employer-based plan and income level. Participation in a
workplace retirement plan rises as income levels increase, and workers are 15
times more likely to participate in a retirement saving plan if they’re offered
a plan through their employer, according to the AARP.
“Saving for retirement is one of the biggest financial
challenges facing middle-class families,” said Dan Doonan, NIRS executive
director. “But the middle class is left behind by the retirement savings system
in key ways, including tax incentives.”
Doonan suggested that policymakers should look at ways to
strengthen Social Security, increase access to and participation in retirement
plans, which some states are already doing for workers who lack workplace
plans, and reform the deduction-based tax system that favors high-income
workers and replace it with a refundable tax credit that would benefit all.
One of the report’s suggested Social Security reforms as the
system grapples with long-term financing problems would be to eliminate the
maximum taxable wage base — currently $147,000 per year — on which workers and
their employers pay FICA taxes to fund Social Security benefits.
“While the percentage of workers with earnings above the tax
max has held relatively steady for years, the percentage of earnings above the
tax max has increased due to the increased amount of income inequality in the
U.S.,” the report said. “Eliminating the tax max completely would bring more
revenue into the program.”
Click here for the
original article.