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Savings and Retirement: How might saving be encouraged for low- and middle-income households?

In 2007 the tax code contained $108.6 billion in tax expenditures that subsidized retirement saving, but only a small fraction is aimed at low- and middle-income households. Several reforms would help to encourage saving among these households. One would be a reform of the savers’ credit. A second would be to encourage automatic enrollment in 401(k) plans and Individual Retirement Accounts (IRAs). Taken together, these two changes would make saving easier and more rewarding.

  • Current retirement saving incentives are inefficient and poorly targeted. They are worth the least to lower-income families and thus provide minimal encouragement to those households who most need to save more to provide for basic needs in retirement. Also, as a strategy for promoting aggregate national saving, the subsidies are poorly targeted. Higher-income households are disproportionately likely to respond to the incentives by shifting existing assets from taxable to tax-preferred accounts. Because low- and middle-income households are much less likely to have other assets to shift in this way, any deposits they make to tax-preferred accounts are more likely to represent new saving.
  • The saver’s credit is a credit to low- and middle-income households for contributions to retirement savings plans. The credit rate is not fixed but declines as income rises. For married couples filing jointly, the credit rate is 50 percent for adjusted gross incomes (AGI) below $31,000, 20 percent for AGI between $31,000 and $34,000, and 10 percent for AGI between $34,000 and $52,000. For single filers, the credit rate is 50 percent for AGI below $15,500, 20 percent for AGI between $15,500 and $17,000, and 10 percent for AGI between $17,000 and $26,000.
  • The saver’s credit could be improved in several ways. First, if it were made refundable, it would benefit the millions of low-income families who face no net federal income tax liability but do pay other taxes. Second, if it were simplified by setting a fixed credit rate, with the contribution limit phasing down as income rises, it would be easier for taxpayers to understand. Third, if the credit were converted to a match (a 50 percent credit is equivalent to a 100 percent match) and deposited directly into the account rather than refunded as a tax reduction, it would make the credit operate more like a standard 401(k) match and help improve account balances.
  • Reform of the saver’s credit would make saving more rewarding; other options would make saving easier. The automatic 401(k) proposal would automatically enroll eligible workers in their employer’s 401(k) or other retirement savings plan, if the employer has one. Saving for retirement would thus become the default option: employees taking no action would automatically be on the path to better saving for retirement; employees not wising to participate could still opt out. Similarly, the automatic IRA proposal would automatically enroll employees in an IRA if their employer does not offer a retirement plan. When automatic enrollment has been instituted on a company level, it has shown to be an effective method of raising the participation rates of low- and middle-income workers in company retirement plans.
  • These incentives to make saving more rewarding and efforts to make saving easier could be mutually reinforcing: the saver’s credit will reach more people if automatic enrollment is expanded, and the value of automatic enrollment is enhanced if the saver’s credit is reformed.
  • Some provisions of current policy actually discourage retirement saving. For example, outdated asset tests in means-tested public assistance programs penalize low- and moderate-income households that respond by saving. Applicants for public assistance programs generally must meet both an asset test and an income test, and any retirement savings they hold in defined-contribution plans are often counted in their assets. This has the effect of a steep implicit tax on 401(k) and IRA saving, producing a disincentive for these families to save. Changing the rules of asset tests to exclude the value of retirement savings accounts would generate stronger incentives for low-income families to save.
 
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