Keith Mack
Tax incentives for retirement savings are ripe for reform. The current system primarily benefits high-income households, who are likely to save substantial amounts anyway, while low-income households, who are the least likely to have savings, receive little to no benefit. This has resulted in a substantial loss of tax revenue for the federal budget. To address these issues, reforms have been proposed, such as the SECURE Act 2.0, which seeks to boost retirement savings by expanding automatic enrollment in savings plans and strengthening protections for part-time workers. However, critics argue that it does not address the fundamental flaws in the current system. An alternative proposal suggests replacing the current deduction for contributions with a flat-rate refundable credit deposited directly into the saver's account, which could improve incentives for most households to save for retirement.
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What You'll Learn
Reforming public policies toward retirement savings
The current system of retirement savings incentives has been criticised for favouring high-income households over those most in need of assistance. In 2013, 66% of the benefits of retirement tax incentives went to the top 20% of taxpayers with the highest incomes. Meanwhile, the bottom 20% of households received just 2% of the benefits.
The current system is also criticised for failing to encourage overall savings. Higher-income households are more likely to respond to retirement tax incentives by shifting existing assets into tax-preferred accounts, rather than by saving additional funds.
A proposal by William Gale, discussed before the United States Senate Committee on Finance, suggests replacing the current deduction for contributions to retirement savings accounts with a flat-rate refundable credit that would be deposited directly into the saver's account. This proposal would improve incentives for most households to participate in retirement savings accounts and raise national savings. It would also help close the fiscal gap by raising $450 billion over the next decade through tax reform.
Another proposal suggests restructuring the saver's credit, which is the one retirement savings incentive designed to assist lower-income households. The saver's credit provides a modest credit to households with incomes of up to $66,000 for married tax filers who contribute to a retirement savings plan. However, the credit's design means that very few eligible taxpayers claim it, and even fewer receive the full amount.
Other approaches to reform include a universal thrift savings plan and overhauling the structure of tax-based incentives.
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Improving incentives for most households to participate
The current retirement savings incentives have been criticised for benefiting high-income households disproportionately. In 2013, 66% of the benefits of retirement tax incentives went to the top 20% of taxpayers, while the bottom 20% of households received just 2% of the benefits. High-income households are likely to save substantial amounts for retirement anyway, and they respond to retirement tax incentives by shifting existing assets into tax-preferred accounts, rather than by saving more.
The Saver's Credit, or the retirement savings contributions credit, is the one retirement savings incentive designed to assist lower-income households. It provides individuals and families with modest incomes a tax break on top of any deductions they may receive from contributions to their individual retirement accounts (IRAs) or employer-sponsored plans. However, the credit's design means that very few eligible taxpayers claim it, and even fewer receive the full amount.
To improve incentives for most households to participate in retirement savings, the current deduction for contributions to retirement savings accounts could be replaced with a flat-rate refundable credit that would be deposited directly into the saver's account. This would improve incentives for most households to participate and raise national savings. Another proposal is a universal thrift savings plan, which would overhaul the structure of tax-based incentives.
Another way to improve incentives is to expand automatic enrolment in retirement savings plans and strengthen protections for part-time workers. This would particularly benefit low- and middle-income families. Additionally, the saver's credit could be restructured to make it more accessible to eligible taxpayers, as currently, few eligible taxpayers claim it, and even fewer receive the full amount.
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Raising national savings
However, current tax incentives tend to benefit higher-income households, who are likely to save substantial amounts for retirement regardless of the incentives. In contrast, low-income households, who are the most in need of assistance, receive fewer benefits from these incentives. To address this issue, reforms should focus on prioritising low- and middle-income taxpayers who are at risk of financial insecurity in retirement. For example, restructuring the Saver's Credit to make it more accessible and beneficial to eligible taxpayers could encourage greater savings among those who need it most.
Another proposal suggests replacing the current deduction for contributions to retirement savings accounts with a flat-rate refundable credit deposited directly into the saver's account. This would improve incentives for most households to participate in retirement savings and raise national savings. Additionally, it would help close the fiscal gap by raising a significant amount of revenue through tax reform.
Furthermore, contributing to different types of accounts, such as Roth 401(k)s and Roth IRAs, can provide individuals with more control over their taxes in retirement. These accounts offer federally tax-free income when certain conditions are met and do not impose required minimum distributions, allowing for better management of tax obligations.
Overall, by implementing targeted tax incentives and providing education on tax-efficient ways to save for retirement, national savings can be raised, and retirement security can be improved, particularly for those most in need.
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Prioritising low- and middle-income taxpayers
The current retirement savings incentives favour higher-income households, who are likely to save substantial amounts anyway, and they are likely to respond to retirement tax incentives by shifting existing assets into tax-preferred accounts rather than by undertaking additional saving. In 2013, 66% of the benefits of the retirement tax incentives went to the 20% of taxpayers with the highest incomes, while the bottom 20% of households received just 2% of the benefits.
Low-income households face the greatest need for additional retirement savings. However, current incentives are poorly targeted and inefficient. For example, the saver's credit, which is the one retirement savings incentive designed to assist lower-income households, provides a modest credit to households with incomes of up to $66,000 for married tax filers who contribute to a retirement savings plan. However, because of the credit's design, very few potentially eligible taxpayers claim it, and when they do, few receive the full amount. From 2006 through 2014, only 3.25% to 5.33% of eligible filers claimed credits averaging $156 to $174.
Reforms should prioritize low- and middle-income taxpayers most at risk of financial insecurity in retirement. A more equitable approach to reform would be to restructure the saver's credit. Another proposal is to replace the current deduction for contributions to retirement savings accounts with a flat-rate refundable credit that would be deposited directly into the saver's account. This proposal would improve incentives for most households to participate in retirement savings and raise national savings. It would also help close the fiscal gap by raising $450 billion over the next decade through tax reform.
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Overhauling the structure of tax-based incentives
The current retirement savings incentives have been criticised for disproportionately benefiting high-income households, who are likely to save substantial amounts anyway, while failing to improve the retirement security of those most in need of assistance. In light of this, there have been calls to overhaul the structure of tax-based incentives to better serve low- and middle-income taxpayers who are at risk of financial insecurity in retirement.
One proposal is to replace the current deduction for contributions to retirement savings accounts with a flat-rate refundable credit that would be deposited directly into the saver's account. This would improve incentives for most households to participate in retirement savings and raise national savings. It would also help close the fiscal gap, raising $450 billion over the next decade through tax reform.
Another suggestion is to reform the saver's credit, which is the only retirement savings incentive designed to assist lower-income households. The current saver's credit provides a modest credit to households with incomes of up to $66,000 for married tax filers who contribute to a retirement savings plan. However, the design of the credit means that very few eligible taxpayers claim it, and even fewer receive the full amount. By restructuring the saver's credit, more low-income households could be incentivised to save for retirement.
Additionally, it has been suggested that tax breaks for retirement contributions should be prioritised for low- and middle-income families. This could be achieved through policies such as expanding automatic enrolment in retirement savings plans and strengthening protections for part-time workers.
Overall, there is a consensus that reforms to the structure of tax-based incentives should focus on improving retirement security for those who need it most, rather than simply providing benefits to those who would have saved regardless.
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Frequently asked questions
Tax laws can be changed to incentivize retirement savings by converting the system of income tax deductions for retirement savings contributions to a system of flat-rate refundable credits that are deposited directly into the saver's account.
The Saver's Credit, or retirement savings contributions credit, is a nonrefundable tax credit that provides individuals and families with modest incomes a tax break on top of any deductions they may receive from contributions to their individual retirement accounts (IRAs) or employer-sponsored plans. The Saver's Credit reduces the amount of taxes owed dollar for dollar.
Current retirement savings incentives favor higher-income households because they allow individuals to shift existing assets into tax-preferred accounts, rather than increasing overall savings. Higher-income households are also more likely to save substantial amounts for retirement and other purposes, even without incentives.
