Hedge your tax-friendly bets

Thankfully I am not an economist. I tend to deal in reality more than theory or in my world better known as balderdash. The problem with economists, pundits and assorted experts is they ignore human nature and presume people act according to their assumptions – they don’t.

You can see this relative to both retirement and health care. But when theorists convince policymakers of their musings anything can happen.

That’s how we got high deductible health plans to the financial detriment of millions of Americans. If patients were made to act like consumers with money at risk they would keen shoppers was the theory. Congress was so convinced it eliminated Medigap Plan F and established tax-favored health savings accounts.

According to the CATO Institute tax-free employer-paid health benefits equal $352 billion in lost tax revenue a year. CATO claims that is equal to $1 trillion in earnings and suggests that we would all be better off if workers had the cash to exercise consumerism when buying healthcare coverage.

Do most Americans adequately plan for or enact appropriate actions when it comes to healthcare or retirement? My decades of dealing with both indicates the contrary.

Americans are emotionally driven and simply do not pay attention to or devote the time necessary to make appropriate decisions in the short or long term. That is not going to change. If there is a problem with lack of financial literacy, it pales in comparison with the general ignorance about health care.

I recently stumbled upon a issue brief proposing to eliminate all tax-favored employer-based retirement plans because of the tax revenue loss, they don’t encourage retirement savings and they mostly benefit higher income Americans.

These proposals are unlikely to be enacted, but just such thinking is how we ended up with the complex retirement system we have.

On X January 17, 2024 Andrew Biggs co-author of the brief stated that “Full repeal (of tax-advantaged retirement plans) would fix roughly 3/4 of Social Security’s long-term funding gap.”

Think about that, we scrap the entire private retirement system and still have a 25% funding gap and no increased Social Security benefits to replace lost retirement plans.

Besides, Social Security is not part of the federal budget process. Social Security is not funded from general revenue. Are the economists suggesting that change? There’s a bad idea.

The economist’s big issue is the loss of income tax revenue, but 401k plans are not tax free, rather tax deferred. In addition, proceeds are eventually taxed as ordinary income foregoing the advantages of dividends and long-term capital gains.

The author’s of the brief also attack pension plans claiming the annual increase in the value of accrued DB benefits is excluded from the payroll tax base for both employers and employees.

Annual increase in accrued benefits? Are we assuming that eliminating the defined benefit pension would result in an immediate increase in taxable wages? I’m sure the relatively few workers with a pension will buy that idea.

The brief, as expected, notes that high earners benefit more from 401k plans.  According to the Urban-Brookings Tax Policy Center 59 percent of the current tax expenditures for retirement saving flows to the top quintile of the income.”

When don’t tax breaks flow mostly to those who pay the most taxes? At the same time Social Security favors lower income workers.

Let’s be clear, those upper-income taxpayers are not millionaires and billionaires. The mean household income for the top quintile in the U.S. is around $226,386 according to the BLS – that’s mean and household, not workers using a 401k. As a reminder, there are limits and discrimination tests in both defined benefit and defined contribution plans that restrict the benefits for higher paid participants.

Suggestions in the brief include:

a government mandate to enroll employees in a retirement plan-without tax advantages

eliminate tax deferral and tax the earnings like other savings.

restrict combined employee-employer contributions to, say, $10,000 or $20,000 per year.

limit total accumulations in tax-favored retirement plans to, say, $500,000 or $1 million.

The authors acknowledge that “while reducing these tax incentives could, perhaps, somewhat reduce interest among employers in offering work-based savings plans, alternative arrangements could be made to ensure that all workers have an organized way to save for retirement.”

We already have dozens of alternate arrangements widely criticized as inadequate because they are not employer based?

I wouldn’t put all my investment eggs in tax-qualified investment vehicles.

Don’t base your retirement planning on the musings of academics, but the growing federal debt, the coming crisis for Social Security and the sad state of retirement saving in the US indicate changes must be made.