I
took one semester of economics as a senior in high school. And though I enjoyed it, I am glad I never
took an economics class in college or pursued a career in that field because
some of the zaniest ideas about personal finance seem to originate with
economists. I wrote about one a year ago
(see “Spend Now, Save Later? What?!?!”),
but now I’ve got a new one to share with you.
As
reported by USA Today, two economists wrote a “research brief” last
month arguing that the federal government should no longer allow pre-tax
contributions to retirement accounts.
(Pre-tax means the money deposited is not taxed before it goes into the
account. If you earn, for example, $1000
but put $200 of that into a pre-tax account 401(k) plan you would only pay tax
on $800 of your earnings.)
The
rationale for their proposal: the current policy favors the rich, has not
substantially increased retirement savings, and the savings reaped by changing
the policy should be redistributed to others.
They cited statistics that show households in the top 10% by income have
a median amount of $559,000 in retirement accounts in 2022. By contrast, those in the 40th to
60th percentile by income had just $39,000 in such accounts.
By
not allowing the tax deduction for contributions to retirement accounts, these
two economists figure the government would increase its income by $185 billion
per year, and that could go to shore up the Social Security system and increase
benefits for those receiving checks from Social Security.
Let
me set aside my gut reaction to what amounts to a redistribution of wealth and
the fact that I and millions of other middle-Americans DO (and did) benefit
from the retirement account tax benefits and would suffer harm to our
retirement planning and living if they were abolished. Let’s look at some other statistics and facts,
keeping in mind that there can be sizable variations in individual cases; these
are averages.
According
to the U.S. Bureau of Labor Statistics, workers at the 40th
percentile of income in 2022 made $54,945 per year. Interestingly, with wage inflation being what
it is, the average income that year for someone aged 25-34 was about the same,
at $52,936. So we can reasonably deduce
that many or most of the people at the 40th percentile are younger
workers. And how much should someone
aged 30 have saved for retirement?
According to investment firm Fidelity, a 30-year-old should have saved
one times his annual salary. Okay, at
the $39,000 figure cited by the economists, they are a little behind—but not
that much, really.
In
short, the disparity between “rich and poor” as cited by these two economists does
not take into account age differences.
Obviously, older workers will for the most part be making more money
(i.e. be at the higher end of the household income scale and be in the middle
of their peak earning years) and would have also had more time to build up
their retirement savings.
And
that $185 billion in savings? That is
about 12% of what Social Security doles out each year in benefits. Can retirees use that additional money? Absolutely.
But increasing the monthly check by 12% would hardly replace the income
that would be lost from having even a modest balance in a 401(k) or IRA. Moreover, it is disingenuous to claim that
the $185 billion per year would “shore up” the Social Security system,
certainly not if the money is used to increase benefits, which is what these
economists advocate. The whole problem
with the system is that it lacks the income long-term to pay the benefits it already
promises. And now we’re going to promise
beneficiaries MORE money?
The
research paper also ignores the benefits that retirement accounts offer lower
income workers. For example, there is
the Retirement Savings Contribution Credit on the federal tax return. This credit gives low- and middle-income
workers a credit of up to 50% of the first $2000 (or $4000 for a joint return)
deposited to a retirement account. That
is a credit, not a deduction; it comes directly off the bottom line of what is
owed Uncle Sam. And while many financial
planners decried the fact that workers were raiding their 401(k)’s during the
recent runup in inflation (and in past recessions, too) just to cover living
expenses, what would have happened if there were no 401(k)’s to raid? Instead, that $185 billion would be waiting
for the hapless 30-year-old victims of inflation thirty-seven years down the
road when they finally qualify for Social Security. Small comfort now. Retirement accounts for many people living on
the edge are a lifeline when they face a financial crisis many years before
retirement. Disincentivizing saving in
those accounts would do a disservice to the very people that policy purports to
help.
I
could go on, but let me close by pointing out that the federal government does
get its share of taxes from these pre-tax retirement accounts. They may not tax the money when it goes into
the account, but they tax that money—and
all the interest and appreciation it accrued over the years—when it is
withdrawn. And retirement savers DO have
to withdraw it eventually. Required
minimum distributions begin at age 73 now.
Those withdrawals increase many retirees’ income to the point that it
makes their Social Security benefits taxable, too. And those taxes DO go to shore up the Social Security
system.
The
exception, of course, is Roth accounts which are post-tax. In other words, money deposited into Roth
retirement accounts is taxed before it goes in but is NOT taxed when it is
withdrawn after age 59 and a half—nor is any of the years of interest and
appreciation it accrued taxed. It’s a
bargain for people saving for their golden years. But frankly, I hardly put any money into a
Roth account over the years. In the back
of my head I always thought that it was such good deal that one day the feds
would wake up and take away the benefit; and I would end up getting taxed on
the money when I put it in and taxed again when I took it out. And if Congress listens to bird brains like
these two economists, it might just happen.
Until
next time,
Roger
“Suppose one of you wants to build a tower. What is the first thing you will do? Won’t you first sit down and figure out how much it will cost and if you have enough money to pay for it? Otherwise, you will start building the tower but not be able to finish. Then everyone will laugh at you.” Luke 14:28, 29 CEV
