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Making the Tax System Work for Low-Income SaversThe Saver's CreditPublished: July 07, 2005 || Availability: Brief #13 from the series Tax Policy Issues and Options The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders. Note: This report is available in its entirety in the Portable Document Format (PDF). For decades, the U.S. private pension system has provided preferential tax treatment to employer-provided pensions, 401(k) plans, and Individual Retirement Accounts over other forms of saving. The effectiveness of this system of subsidies is controversial. Despite the accumulation of vast amounts of wealth in pension accounts, concerns persist about the ability of the pension system to raise private and national saving, and in particular to improve saving outcomes among households most in danger of inadequately preparing for retirement. The saver's credit, enacted in 2001 as part of the Bush administration's tax cut legislation, was designed to help low-income individuals and households save for retirement. The credit in effect provides a government matching contribution for voluntary individual contributions to 401(k) plans, Individual Retirement Accounts (IRAs), and similar retirement savings arrangements. The saver's credit is an improvement, but its current status as both temporary—it is scheduled to expire in 2006—and nonrefundable hinders its ability to really help low- and middle-income families. This policy brief outlines several ways to improve the credit. Many of the major concerns about the nation's pension system stem, at least in part, from the traditional form of the tax subsidy to pensions. Pension contributions and earnings on those contributions are treated more favorably for tax purposes than other compensation. But pension tax preferences are worth the least to lower-income families, and thus provide minimal incentives to the households that, on average, most need to save for their basic needs in retirement. The tax preferences instead give the strongest incentives to higher-income households, which least need to save more to achieve an adequate retirement living standard. These higher-income households are also disproportionately likely to respond to pension tax incentives by shifting assets from taxable to tax-preferred accounts, with the net result that pensions serve as a tax shelter, rather than as a vehicle to increase saving. In part reflecting this upside-down set of incentives, the nation's broader pension system betrays several serious shortcomings:
The saver's credit is the first and only major federal legislation directly targeted to promoting tax-qualified retirement saving for moderate- and lower-income workers. The matching rates under the saver's credit reflect a progressive structure—that is, the rate of government contributions per dollar of private contributions falls as household income rises, exactly the opposite of the incentive structure created by traditional pension tax preferences. This is currently a relatively minor exception to the general pattern: the bulk of recent policy changes have expanded retirement savings opportunities for higher-income workers, and the Treasury Department estimates that the tax expenditures associated with retirement saving preferences in 2005 total roughly $150 billion, of which only about $1 billion is attributable to the saver's credit. Leading policymakers on the Ways and Means Committee, including Representatives Rob Portman (R-Ohio) and Benjamin Cardin (D-Md.), are actively exploring possible expansions of the saver's credit.
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