Another retirement rescue ensues in Washington this week. This time, Congress hopes not only to help the appalling savings gap, but relieve part of the nation's debt crisis in the process. Kind of a two-for-one deal.
The Senate Finance Committee on Thursday will hear testimony on tax reform options to promote retirement security.
As William Gale notes, the tax structure for retirement plans such as 401(k)s is inherently flawed by an economic loophole that, I agree, is much more likely to serve the wealthiest.
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"By providing incentives for contributions through tax provisions linked to the marginal tax rates people owe, current incentives deliver their largest immediate benefits to higher-income individuals in the highest tax brackets," Gale, a senior fellow at the Brookings Institution and one of the speakers testifying before the committee, writes in a recent research paper.
Essentially, Gale argues, the tax incentive is really just prompting high-income people to shuffle existing assets into tax-sheltered accounts and doesn't actually increase overall savings.
Gale's proposal is to swap tax deductions for immediate tax credits, a plan that would ultimately result in exposing worker and employer contributions to taxation, but because the credit is directly deposited into their retirement account, it's a distinct incentive for lower-income savers to contribute more. And the money that's no longer tax exempt could produce $450 billion in tax revenues over the next decade.
Legislative initiatives, particularly tax reforms, to improve retirement security were also offered at the beginning of 2010, though some elements were not so much "debt-friendly." Nor were they breakthrough.
For example, Vice President Joe Biden, who heads up the Middle-Class Task Force, insisted the Saver's Credit – a tax credit designed to entice low-income workers to contribute more to their savings plan – needed to be expanded. According to the IRS, if you make eligible contributions to a qualified IRA, 401(k) and certain other retirement plans, you might be able to take a Saver's Credit of up to $1,000 or up to $2,000 if filing jointly. The credit is a percentage of the qualifying contribution amount, with the highest rate for taxpayers with the least income.
Biden's task force wanted to provide a 50 percent match on the first $1,000 of retirement savings for families making up to $65,000, plus a partial credit for families making up to $85,000.
But studies show few taxpayers take advantage of the credit, even in its current form. In fact, according to the Transamerica Center for Retirement Studies, only 12 percent of workers eligible for the credit even know it exists. Unless low-income workers were actively seeking the credit on their tax return form, or were given a tip from their plan sponsor, they unknowingly missed that opportunity to bump up their contributions this year.
So while lawmakers can rally on fixing the system, a little more help at the ground level, through education and outreach, is still a fundamental necessity.
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