2014
In his State of the Union Speech, the president mentioned in the context of retirement saving “an upside-down tax code that gives big tax breaks to help the wealthy save, but does little to nothing for middle-class Americans.”
More class warfare nonsense. Of course the value of a tax break will be proportionate to your tax rate. If you are paying little or no taxes, then something pre-tax has no value. If you are paying 25% of your income in taxes, you have the same value in savings if you participate in something like a 401k plan, but of course, you again pay the 25% tax rate (or perhaps even higher) when the savings and earnings are withdrawn as ordinary income whereas the low-income person may still pay little or no taxes.
The standard 401(k) provides no ultimate tax break for the higher income. In fact, lower taxes are available outside such plans in the form of dividend and capital gains taxes both of which are designed to encourage investment. Super wealthy rarely fully use 401k plans. In my corporate experience the highest income people typically contribute only to the point of the company match.
The president institutes a new retirement program that allows post-tax contributions and tax-free withdrawals. How does that benefit low-income people any more than current options (Roth 401k or IRAs)? In fact, the tax-free withdrawals still benefit those who pay the highest income taxes. The one benefit is the $5.00 minimum contribution, but today one could do that with regular savings bonds. The problem is not always saving, but the initiative to save. Given his proposal does not have auto enrollment, it’s unlikely much beyond rhetoric has been accomplished.
The Employee Benefits Research Institute (EBRI) has conducted analysis of the tax preferences for 401(k) plans, and concluded that, after controlling for age and tenure, “actual 401(k) account balances are found to be, in large part, proportionate with compensation levels.”
The Obama Administration has proposed new limits on 401(k) account balances on the basis of its populist fairness doctrine designed to appeal to the uninformed. There are already many limits on what higher income people can save on a tax-favored basis. The amount of compensation to be counted is limited, contribution percentages are limited, total contributions are limited and benefits provided in both defined contribution and defined benefit plans are limited. Discrimination tests limited higher paid employee plan contributions to a ratio of lower paid employee contributions.
Consider this from an Employee Benefit Research Institute research paper:
At least part of the Obama administration’s rationale for proposing these new constraints appears to stem from, among other things, a desire to increase the “fairness” of the current retirement savings system. This “lack of fairness” hypothesis is often mentioned in conjunction with the so-called “upside-down incentives” provided by the current tax system with respect to the tax treatment of contributions in the 401(k) system.
From a financial economics perspective, the current federal tax treatment for 401(k) plans has advantages for workers with higher marginal tax rates (those who pay taxes at higher rates are seen as receiving a greater benefit from the deferral of those taxes) if other elements of the tax code are ignored.
However, and as previous EBRI publications have explained, the constraints contained in IRC Secs. 402(g) and 415(c), combined with nondiscrimination requirements for the actual deferral percentage (ADP) and actual compensation percentage (ACP) have resulted in a relatively flat multiple of final earnings at retirement as a function of salary across the income range.
The ratio of 401(k) account-balance-to-salary for participants in their 60s, by tenure categories, for the year-end 2011are relatively flat for salaries between $30,000–$100,000, before dropping substantially for those with salaries in excess of $100,000.
Another consideration that should be weighed carefully in setting public policy is the potential impact on retirement income adequacy for those who are still working. Since 2003, the EBRI Retirement Security Projection Model® (RSPM) has shown the impact of several alternative factors to assess the probability that households will not run short of money in retirement (i.e., a “successful” retirement) and has repeatedly found that years of future eligibility in a defined contribution plan (such as a 401(k)) is one of the most (if not the most) relevant factor in predicting retirement success for households not already on the verge of retirement.
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