Millions of Americans don’t save enough for retirement, not because they don’t want to, but because they face systematic obstacles to doing so. One of those hurdles is a rigged tax code to benefit top earners. Congress took a small step (among other ineffective steps) to fix this by creating a federal Saver’s Match beginning in 2027 that will later replace the current Saver’s Credit, in the general spending package that was approved in December 2022. It now falls to financial services companies, as well as state governments, to ensure that, like many LMI savers targeted by this new mix, they will have low-cost, low-risk retirement savings accounts when the new mix takes effect.
Much of Americans are not ready for retirement. The Center for Retirement Research at Boston College estimates that, in 2019 – before the pandemic – 49% of working-age households were at risk of severe and painful spending cuts once they reach retirement. This was close to the highest levels of 51% recorded in the aftermath of the Great Recession in 2010 and 2013.
Similar proportions of people felt insecure about their retirement before and during the pandemic. Calculations based on annual Federal Reserve data Household Economics and Decision Making Survey show that only 50.0% of people 25 and older who were not retired said their retirement plans were on track in 2021. Percentage recorded in the years 2017 to 2019, it is surprising that half of the Americans clearly recognize their lack of preparation for their future lives in old age.
The obstacles people face in saving for their future are myriad, all contributing to widespread retirement insecurity. He complex maze of savings optionsoften inducesanalysis paralysis”, preventing people from signing up for retirement savings accounts. In addition, the tax benefits of the retirement account are heavily biased towards wealthier households, which means that those with low or moderate income (LMI) have less incentive to save. The US government gave up an estimated $230 billion in tax revenue in 2022 related to retirement incentives, but a estimated 60% of this generosity went to the top 20% of wage earners that year. The total amount spent on these inefficient tax breaks is more than five times what the federal government spent on science, technology and space exploration, more than four times what it spent on natural resources and the environment and still nearly $28 billion more than it spent on food aid. This unequal distribution of retirement tax benefits is not just the result of an unequal distribution of income. homes in the bottom fifth of the income distribution received 4% of pre-tax income, but only 0.4% of retirement tax benefits. The fact that the vast majority low- and moderate-income households receive little or no help from the tax code to save for retirement is counterproductive, as these are the people who need help the most.
Congress established the Savings Credit, formally known as the Retirement Savings Contribution Credit in 2001, to boost savings incentives for LMI Americans. Taxpayers, those with adjusted gross income of less than $68,000, can get up to 50% “back” on their contributions to a qualified retirement account in the form of a tax credit. Taxpayers can get up to a $1,000 tax credit one year later if they contributed $2,000 to a retirement account during the applicable tax year. However, the credit rate drops rapidly with income. For example, married taxpayers filing jointly with income greater than $41,000 but less than $44,000 get a credit rate of only 20% of their retirement account contributions and those with income greater than $44,000 get a credit rate of only 10%. Taxpayers can only receive the full value of the credit if they owe at least that amount in federal income taxes, which means it is a non-refundable tax credit. This effectively excludes large swaths of low-income taxpayers from getting any benefit from the Savings Credit, that is, those who owe less than $1,000 in federal income taxes. Conversely, this means that many people, who actually qualify for the credit, only get 20% or 10% of what they put into a retirement account. Unsurprisingly, saver’s credit plays a relatively small role in the world of retirement savings. The total value of the credit was just $1.3 billion in 2022, a drop in the bucket compared to the $230 billion the Treasury spent overall to subsidize retirement savings. In 2019, only 15.5% of taxpayers with adjusted gross income between $25,000 and $50,000 took this credit with an average credit amount of $200. Furthermore, this rather low acceptance rate was the highest among any low-income group.
In the December general spending bill, Congress took several important steps, long overdue to improve the retirement prospects of Americans. It required that all employers must automatically enroll their employees in a retirement plan if they offer one, for example. They also changed retirement plan rules so more part-time employees can be eligible for their employers’ 401(k) plans. These provisions could increase the number of people who participate in employer-based plans.
After years of law by groups concerned with building wealth among low- and moderate-income people, Congress also replaced the Saver’s Credit with a redesigned and renamed “Saver’s Match,” beginning in 2027. Qualifying taxpayers will get a “match” (of fact, a tax credit) to your retirement account during the tax year, rather than a credit applied to your tax return a year later, which can be deposited directly into your retirement account. The new design of this combination/credit is likely to serve as a greater incentive for people to save money in a retirement account and keep it there. After all, parties can be powerful savings incentives. Additionally, qualifying savers can still receive a match/credit of 50% of their savings into a retirement account of up to $1,000 per year, but that match is phased out instead of falling off cliffs. This could possibly mean higher matches for people of moderate income. Third, and perhaps most important, the new credit/match is separate from what people owe in federal income taxes, meaning the new credit will now be refundable, so more low-income people can benefit. These improvements are substantial and could significantly change savings for low- and moderate-income Americans.
But many households will only see the full benefits of the new Saver’s Match if they can access low-cost, low-risk retirement accounts. Claiming the Saver’s Match requires that the money be saved in qualified accounts such as 401(k)s and IRAs. In a bombastic tone, Roth IRAs will not be eligible. But these are often the type of plans offered by state-sponsored retirement plans. However, many low- and moderate-income workers do not work for employers that offer retirement benefits, and few Americans across the income spectrum use IRAs to save for retirement. So the biggest hurdle for people to take advantage of the new adjustment is that they simply don’t have a qualifying retirement account. Also, too many IRAs on the market come with high fees I excessive risks. There is also no justification for the tax code to subsidize, as excessive costs and/or risks will erode people’s savings and leave them with less money for their own future. This goes exactly against the public policy goals behind Saver’s Match.
The challenge now is to maximize the benefits of Saver’s Match by increasing the retirement plan participation of low- and moderate-income savers. Some state governments such as California, Oregon, and Illinois have begun offering low-cost, low-risk retirement savings accounts to employees who do not have such plans at work. However, many savers across the country do not have this option. This places a responsibility on financial services companies to help people establish accounts that do not deplete their savings with inappropriate fees, other costs or risks.
Financial services companies must now step up and develop and promote savings products tailored to the needs of LMI households. The Saver’s Match tax changes take effect in 2027. That gives financial services companies, many of which claim to want to help LMI Americans save more, four years to show they’re serious. They need to enroll more of these households in retirement accounts, keeping fees to a minimum, and offering investments that avoid excessive risk—for example, by not investing in highly leveraged private equity, virtual currencies, or other unregistered and underregulated assets. Congress has done its part to help low-income Americans save more. Now it’s up to the financial services industry to do its part.
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