David John, Senior Senior Strategic Policy Adviser at AARP’s Public Policy Institute - US Tax...
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Transcript of David John, Senior Senior Strategic Policy Adviser at AARP’s Public Policy Institute - US Tax...
Title text here
US Tax Benefits for Retirement Saving: Who Benefits and Why?
January 25, 2016
David C. JohnSenior Strategic Policy AdvisorAARP Public Policy Institute
Coming Attractions
• What is the Purpose of Tax Benefits?• Context: Quick Overview of the US System• Traditional Treatment (EET)• “Roth” Treatment (TEE)• Savers Credit & A Better Savers Credit• Comparing results• Do Tax Benefits Incentivize Saving?
What Is the Purpose of Tax Benefits for Retirement Saving?
• To encourage people to save or save more?
• To increase savings balances (& thus retirement income)?
• Both?
US Tax System
• Extremely complex• 7 marginal tax brackets between 10% and
39.6%. Also capital gains.• Standard deduction + personal exemption +
itemized deductions reduce taxable income• 43% pay no net income tax• Also FICA (Social Security & Medicare) + state
& local income taxes
US Retirement System• Social Security based on wage indexed lifetime earnings
– Benefits increase annually by prices– Average benefit about $16,000 – range $5k to $35k
• Few private sector DB plans• Both EET and TEE retirement savings plans available• About half have employer-sponsored plans• Rest can save in Individual Retirement Accounts (IRAs)
– Only about 1-in-20 actually do• Funds can be accessed early (may be a tax penalty)• No tax-free lump sum and few annuitize
Traditional (EET)
• Reduces taxable income & shows a deduction on paycheck. Assumes lower tax bracket in retirement.
• No income limit in employer or individual plan.
• Withdrawals before age 59½ taxable + 10% penalty.
Traditional (EET) - Benefits
• Easy to understand. Benefit can be seen throughout the year.
• Deduction is an incentive to save for all income levels regardless of actual benefit.
• Deduction especially valuable if no employer plan.
Traditional (EET) - Negatives
• Size of benefit depends on marginal tax rate.• If taxpayer has no tax liability, he or she gets
no real benefit.• Wealthy get much more; low income get no
real value.• Benefit increases consumable income – not
savings.
Traditional (EET) – Government Finance
• Reduces revenue today – extremely visible & quantifiable (both now and in the future).
• Tax deferral, not tax exempt. Most lost income eventually recaptured.
• Taxes on internal buildup are collected.
Roth (TEE)
• Created in 1997. Contributions after tax up to contribution limits. All internal buildup and withdrawals tax free.
• No tax on early withdrawal of contributions.• Roth IRA only available up to annual incomes
of $114,000 (single). Roth employer plans available to all income levels.
• Income limit to keep wealthy from using it as a tax shelter.
Roth (TEE) - Benefits
• Simple to understand.• No tax ever on internal buildup.• Lower income do get a benefit.• Upper incomes get an even greater benefit.• Especially used by upper income and upwardly
mobile younger white collar workers.
Roth (TEE) - Negatives
• Upper income can use loophole for unlimited Roth benefit.
• No immediate savings incentive – especially for lower incomes.
• As contributions reduce consumption income, contributions & participation may decline.
Roth (TEE) – Government Finance
• Appears to produce more immediate government income.
• Tax never collected on internal buildup. Foregone future revenue may be huge & growing.
• Wealthy can use to shelter income & assets.• Tax benefit assumes that government keeps its
word.
Savers Credit
• Special additional benefit for lower income savers regardless of tax treatment.
• Provides 50% of up to $2,000 contribution for incomes below $36k. Much lower matches up to family incomes of $61k.
• Only offsets tax liability. If none, then no benefit is paid. Also, must be claimed on long tax forms.
Problems with the Savers Credit
• Few claim the credit or know about it. • Most eligible have no tax liability & use
shorter forms where Savers Credit is not available.
• Credit comes as consumable payment.• No incentive to save as credit comes long after
decision has been made.
A Better Version
• Simple credit available on short tax forms regardless of tax liability.
• Provides 50% credit for contributions that goes directly into the account. Not available for early withdrawal.
• Deposited into the same investment choice as rest of account.
New Version - Positives
• Actually benefits population it is intended to help.
• Builds savings balances and increases retirement incomes.
• Easy to claim. Can be automatic in tax software.
• Growing balance is an incentive to save.
New Version - Negatives
• Revised savers credit has a high budget cost – up to $20 billion/year.
• Savers may not understand that they cannot use early withdrawal for match.
Do Tax Benefits Increase Saving?
• There is evidence that 85% of retirement savers are passive & only 15% are actively involved.
• Passive savers react to automatic enrollment much more than tax incentives.
• Active savers react to tax incentives, BUT…
– Chetty, Friedman, et al., ACTIVE VS. PASSIVE DECISIONS AND CROWD-OUT IN RETIREMENT SAVINGS ACCOUNTS: EVIDENCE FROM DENMARK
What About the Wealthy?
• Very upper income savers reallocate savings according to tax incentives. They do not change the amount saved, just where it goes.
• Lower income savers are more likely to react to a change in take home income.
• They save due to automatic enrollment, but little data on auto into TEE accounts. May stop if they see a significant drop in income.
Title text hereContact Us:
David C. JohnSenior Strategic Policy Advisor
AARP Public Policy Institute www.aarp.org/ppi
Twitter:@AARPpolicy www.Facebook.com/AARPpolicyBlog: www.aarp.org/policyblog