At the 11th hour, Republicans rejected a sharp reduction in the amount workers can contribute tax-deferred to their 401(k) plans. But retirement saving could still be at risk depending on how the looming fight among various business and special interests evolves in the days ahead.
CHICAGO – U.S. Republican lawmakers came close to staging a damaging raid on retirement savers this week to pay for a massive tax cut for corporations and the wealthy. Their recklessness brings to mind that old saying – “This is no way to run a railroad.” But in this case, using that expression would be grossly unfair to incompetent railroad managers.
We need to have a thoughtful, national conversation about how to improve retirement saving in this country. Instead, Republicans in Congress are throwing ideas at the wall to see what will stick. Worse yet, the 401(k) idea is no more than an accounting gimmick, with an impact on retirement saving that is uncertain at best.
The cap would have been set at $2,400 annually – a dramatic reduction from the 2017 limit of $18,000 (or $24,000 for savers age 50 and higher). Workers would have been encouraged to contribute to Roth accounts, which accept post-tax contributions but generally accumulate tax-free.
The motive behind the envisioned 401(k) grab is clear. Republicans must find very large piles of new revenue – and budget cuts – to offset their proposed tax cuts. The nonpartisan Tax Policy Center estimates the cuts will reduce federal revenue by $2.4 trillion over 10 years, with most of the tax relief going to corporations and the wealthiest households.
Tax-deferred retirement saving offers a juicy target. The contributions to 401(k)s are made with pretax dollars, and withdrawals down the road in retirement are taxed as ordinary income. Deferred taxes on 401(k)s, traditional pensions and IRAs are projected to top $1 trillion from 2015 to 2019, according to the nonpartisan Tax Policy Center. The $2,400 cap would push a large portion of that revenue into the 10-year budget window that matters in Washington.
RUNNING THE NUMBERS
You can have a healthy debate about the relative merits of tax-deferred versus Roth accounts. The big plus with a Roth is that contributions and investment returns are withdrawn tax-free in retirement. Both approaches have merit, and winners and losers vary depending on a saver’s affluence and tax bracket at the time of contribution and withdrawal. But that is not the debate we are having.
”This simply would bring in revenue right away at expense of lost revenue in future”, said Karen Smith, a senior fellow at the Urban Institute. Smith is co-director of the institute’s proprietary microsimulation model, called DYNASIM. It is a unique computer modeling program that lets the organization project characteristics such as financial, health and disability status of the U.S. population for the next 75 years.
Smith has been running numbers to determine what the impact of a major shift toward Roth-style accounts would mean. She finds that taking away the upfront tax incentive would prompt people to save less – so much so that the backend tax benefit of a Roth would not be sufficient to overtake the lower savings.
“You still need to buy groceries and pay rent – and you have to do all that from after-tax income. The argument here is, ‘tax me more and I’ll save more,’ but it’s hard to argue it will work that way.”
A $2,400 cap would impact savers across the income spectrum. The Employee Benefit Retirement Institute (EBRI) reports that even among low wage workers ($10,000 to $25,000) who contribute to a 401(k), 38 percent would be affected by the cap; for higher-income contributors ($75,000 to $99,999), 76 percent would be affected. The impact on near-retirement workers is especially striking. EBRI reports that for workers age 55-64, some 75 percent of contributions now being made would exceed the $2,400 cap. (The numbers are based on an EBRI database that incorporates millions of administrative records from 401(k) plans)
All this against a backdrop of continued unimpressive saving accumulations. The typical workers nearing retirement age (55-64) had a balance of $104,000 in a 401(k) or Individual Retirement account last year, according to recently released Federal Reserve Board data. Contribution rates to 401(k) plans are flat – combined worker and employer contributions stood at 10.9 percent in 2016, compared with 10.7 percent in 2007, according to Vanguard data.
The gap in saving between wealthy and poor households is stunning. The U.S. Government Accountability Office reported recently that the highest quartile households had median defined contribution account balance of $201,500 in 2013, a figure that plunges to $60,900 for the second quartile and down to almost nothing below that. The gaps between racial groups are no less disheartening.(reut.rs/2gLXYTq)
“This plan wouldn’t just kick the can down the road”, said Diane Oakley, executive director of the National Institute on Retirement Policy. “It kicks a snowball downhill with an avalanche at the bottom.”
Better ideas are available. Making the federal Saver’s Credit refundable would be a great start. Ending the attacks on efforts to create automatic IRA programs at the state level – much less the abandoned federal-level plan – also would help. Instead, retirement saving is just getting kicked around as a way to pay for tax breaks for the rich.
The GAO recently released a report outlining the challenges we face in financing retirement, and called on Congress to establish a commission to examine the entire system and make recommendations.
Good luck with that, GAO.
