October 16, 2012
The U.S. foregoes nearly $200 billion a year in tax revenue to encourage people to save for retirement. That’s well over $1,000 a year for every person who draws a paycheck.
On the surface, it appears to be working. By 2010, the percentage of families that had at least one person enrolled in some form of retirement savings plan including pensions had surged to 63.8 percent, up from just 31.6 percent in 1992. Just 37.9 percent of households currently have someone with a traditional pension plan, which have been on the decline for years.
Yet the median value of all retirement accounts – half of the 63.8 percent of families had less, half had more – was just $43,900 in 2010, not including defined pensions accounts. Even among those on the cusp of retirement between ages 55 and 64, the median savings were just $100,000. And for those in the first decade of retirement, the median retirement account was also just $100,000, according to the Employee Benefit Research Institute. That’s enough for about a $700-a-month annuity – about half the minimum Social Security benefit.
The averages, of course are much higher since they incorporate the larger savings put aside by high earners. The national average for retirement savings (not including pensions) is $173,232, according to EBRI. And for those between the ages of 65 and 74, the average was $324,199, skewed upward by including people like former Massachusetts Gov. Mitt Romney, whose IRA held anywhere from $21 million to $102 million, according to his latest tax filings.
The bottom line assessment universally shared by experts is that retirement security for most rapidly aging baby boomers, who are now crossing the 65-year-old threshold at the rate of 10,000 persons a day, is far more precarious than previous generations. And the prospects for retirement security for succeeding generations – those now in the heart of their working careers – is worse.
“Many Americans are facing the likelihood of not having sufficient income in retirement unless they increase their savings, work longer, or significantly decrease their expenditures in retirement if they hope to make ends meet,” Craig Copeland, an analyst at EBRI, wrote last month.
“Our current pension policy is a failure,” said Eugene Steuerle, an institute fellow at the Urban Institute. “There have been many years where the net savings is zero – we’re not even getting as much savings as the government is putting into it.”
Most people aren’t aware of the many ways the tax code encourages retirement savings. First and foremost is an employee’s ability to exclude from taxable income most money funneled into a defined contribution individual retirement plan. Any employer match is also excluded. These account for an estimated $109 billion of the overall retirement tax expenditure, according to a recent analysis by the Tax Policy Center.
But that is only the most visible tax break. Employer contributions to traditional pension plans also are excluded from taxable income as are the earnings generated by the assets in those pension plans.
Other breaks include exemption for capital gains built up inside a Roth IRA, which is financed with after-tax income and can be withdrawn tax free – in essence establishing a “zero tax” zone. Capital gains built up inside 401(k)-style plans, inside annuities, inside life insurance policies and inside non-deductible IRAs also aren’t taxed until withdrawn, which effectively lowers their overall tax rate.
There’s also a tax credit for lower-income retirement savers, but that barely exceeds a billion dollars a year because few low-income people take advantage of it. When they work for employers that offer retirement savings plans – and many low-wage workers don’t – they usually don’t enroll because they need the money to pay the bills. They also are in families most likely to deplete the accounts when laid off or faced with financial emergencies.
When the Tax Policy Center analyzed who took advantage of the various retirement tax incentives, it found that 79.6 percent of the benefits went to families in the top 20 percent of the income distribution. That’s probably because the top 25 percent pay 85 percent of the taxes according to the IRS. On the other hand, just 7.3 percent of its estimate of $198.8 billion in retirement tax expenditures went to the bottom 60 percent of the population.
The assumption by most economists is that higher income earners will continue to save substantial sums for retirement without the tax break. The coming retirement crisis will be centered in the lower half of the population.
That’s why Steuerle of the Urban Institute said an overhaul of the retirement savings system through tax reform should be part of dealing with Social Security’s long-term financial shortfall. The most likely Social Security change beyond raising new taxes – which can be achieved by lifting the income cap on the payroll tax or applying the Social Security tax to non-wage income like capital gains and dividends – will be limiting future cost-of-living increases. That could be applied only to people with substantial income from other sources.
“Are we doing too much for the top,” he asked. “Low income people don’t get much in the way of benefits. Social Security should do a better job for people at the bottom and the tax benefits should be better targeted.”