Sunday, February 18, 2024

Another Brilliant Idea from the "Experts"


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,



“Suppose you 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