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Tax breaks designed to boost retirement savings may benefit high-income earners, leaving mainly middle-class workers behind a report From the National Institute on Retirement Security.
With most Americans receiving less than half of their pre-retirement income from Social Security, many rely on employer-sponsored savings plans and individual retirement accounts to fund their golden years.
Although Congress created tax incentives to encourage savings, the structure of the US tax code and uneven planning participation have skewed those benefits toward higher income earners.
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“Our country spends a lot on encouraging retirement savings,” said Dan Doonan, executive director of the National Institute on Retirement Security and a co-author of the report. “But workers across the income spectrum are affected differently in terms of access to workplace plans and the value they get from tax benefits.”
Indeed, more than half the tax breaks for company retirement plans, such as 401(k) or 403(b) plans and IRAs, go to the top 10% of earners — those earning $117,224 or more, according to the report. Based on data from 2019.
It will be important to drill down to really understand which policy levers can make a difference to the millions of middle-class Americans who are not accumulating enough retirement savings.
Dan Doonan
Executive Director of the National Institute on Retirement Security
tax structure
One of the reasons for the uneven tax benefits for retirement savings is our tax structure, explained Tyler Bond, research manager at the National Institute on Retirement Security and report co-author.
Tax brackets show the levies you pay on each dollar of income. But families don’t have to pay taxes until income exceeds the standard deduction, which is $12,950 for single taxpayers and $25,900 for married couples in 2022.
For example, if a married couple earning $25,000 a year together contributes 3% of earnings ($750) to their 41(k) plan, there is no advance tax break because their income is 25,900 for 2022. less than the standard deduction.
However, as families start earning and contributing more, the benefit increases. If a family earning $150,000 contributes 12% to their 401(k), or 18,000, they may qualify for $3,960 of tax savings.
More than half of married couples filing together have an adjusted gross income of less than $100,000, Bond said, meaning these families are seeing “relatively small” tax savings.
According to the report, another issue is that employees are not participating on the same level in employer-sponsored schemes.
The findings suggest that, unexpectedly, top earners are more likely to contribute a higher percentage of earnings sooner, giving more time to compound growth and greater tax benefits over time.
Potential solutions for middle-class savers could include promoting Social Security or changing tax benefits to retirement savings, the report suggests. One option might be to switch the write-off from a deduction-based incentive to a refundable credit.
“It’s encouraging that policymakers are examining the nation’s lack of retirement savings,” Doonan said. “But it will be important to really drill down to understand which policy levers can make a difference to the millions of middle-class Americans who are not accumulating enough retirement savings.”