{{ Dr. Munnell and the co-authors of her study, including Andrew Biggs, a conservative economist and senior fellow at the American Enterprise Institute, conclude by offering this bold proposal: End tax deferral on savings — or at least cap it. Then use that tax revenue to help fund Social Security. This shift could close a substantial portion of the shortfall that Social Security currently faces.
“If we have scarce resources, I would like to see those dollars go to the people in the bottom half of the income distribution,” Dr. Munnell said. }}
And I’ll note that the one big thing that no one is talking about is limiting fees & commissions and doing a better job at disclosing them. Give every American access to the Federal Gov’t employees’ Thrift Savings Plan (TSP) as an option to whatever slop their employer provides.
The quality of your life in retirement is inversely proportional to the amount you lost to fees & commissions over your investing lifetime.
The proposal is to end the tax deduction (or limit it to a small amount) for IRA and 401k contributions. They amounted to $300 Billion in 2022. Then put that $300 Billion into shoring up Social Security. You would then just save for retirement in a taxable account. If you’re worried about current capital gains and dividends, you’d save for retirement in a vehicle like Berkshire Hathaway.
The tax deduction mostly goes to upper income workers who would be saving for retirement anyway.
In my own case, I needed “X” dollars to retire early. I would have saved “X” whether there was a tax deduction or not. The tax deduction just meant that I moved money I would have been saving anyway to an IRA and 401k. No additional retirement savings resulted by gifting me a big tax deduction.
Most of us find that ira contributions are not deductible–especially if your employer offers any retirement plans. Then after tax contributions are better directed to a Roth which does have an income cap. Claims that the wealthy benefit are dubious.
Your target is pretax contributions to 401k. And most upper income participants find their contributions capped by total employee participation. These are middle income programs. Again claims they serve the wealthy are dubious.
You can make a non-deductible IRA contribution and then immediately convert it into a Roth, which gives you tax free gains forever. No additional ability to save is gained by this tax free treatment.
This is only true if you do not have other assets in the IRA. IOW, a new or empty IRA.
And keep in mind that IRA is not a single account. It is one or more accounts at one or more financial institutions that are all in a single name.
If you have an existing IRA and make a non-deductible contribution, you establish basis to the IRA. Every withdrawal/conversion made after that will be a mix of tax-paid and pre-tax money. IOW, some tax will be due.
This is a clever trick. I’ve always thought that there are no advantages to rolling over an IRA into a 401k, and there were only disadvantages (fewer investment choices, etc). But this is really quite clever. Even more clever would be, let’s say someone has a 300k tIRA and they want to convert 50k of it to a Roth IRA (and pay the taxes), but they want to contribute to a backdoor Roth IRA each year thereafter. Couldn’t really be done. BUT, using this technique, they could roll over $250k of the tIRA to their 401k, convert the remaining 50k to Roth IRA (and pay the taxes), and then each year thereafter contribute to their non-deductible tIRA and then convert it to Roth IRA with no additional taxes due. That’s a good way to grow a Roth IRA!
They are great programs for high income earners! But the original point of both the IRA and 401(k) programs is to help middle and low income earners save for retirement.
The backdoor Roth method I described above is only available to high income earners. Similarly, you can’t get the full 401(k) benefit unless you have sufficient income and the higher your tax bracket the more tax savings you realize.
The IRA/401k system favors those in the Top 10% of the income distribution since it’s a tax deduction (i.e., the higher your tax bracket, the larger your tax deduction.) It’s just arithmetic. Most of that $300 Billion per year in IRA/401k tax benefits are going to folks in the upper tax brackets.
If you wanted to make the system fairer, take that $300 Billion year and instead give every one of the 150 million US wage and salary earners a $2,000 refundable tax credit to a low-fee retirement account like the Thrift Savings Plan for Federal Gov’t workers. The biggest problem with retirement savings is that relatively few workers find their way to a low-fee index fund. If you’re paying the 2% of assets per year in fees and costs that Wall Street’s business model is based on, your going to lose have the value of your account over your lifetime. Again, it’s just arithmetic.
They are only proposing to end (or cap) the tax deduction (i.e deferring taxes), not all of the incentives. They didn’t say anything about ending Roth accounts, nor did they suggest that the saver’s credit be ended.
There has already been a step toward doing that by requiring catch-up contributions to be Roth for higher income participants, rather than giving them the choice to take the deduction and defer the taxes.
For 401(k)s, I would agree with this. But for IRAs, deductibility is limited to low income taxpayers or those who have no retirement benefits through employment. So eliminating deductibility of IRA contributions could actually be a disincentive to low income taxpayers. Which is why I think a cap on the deduction might be a better idea.
If you take away the features of a retirement account, you will effectively kill it. The only way that program works is by both tax deferral and by having restrictions on the middle class and poor pulling out their funds early. If it is a taxable account, then it becomes liquid and the ONLY people that would save for retirement would be the rich.
The Middle class and poor would ABSOLUTELY raid their taxable savings at the earliest opportunity.
A lot of 401k plans now have a pass through brokerage option. When my former company moved our 401k to Fidelity, that option was added at some point. So while I was able to choose from the usual 10-15 funds available in the 401k plan, I was also able to move 95% of the money to the pass through brokerage option. And indeed I did so, and I can invest in almost anything I want to in that brokerage subaccount inside the 401k. They call it brokeragelink.
If you were able to go back in TMF to 2006(?) when they first came out with the rule that got rid of the $100k income limit for Roth conversions, you could see where I suggested that the way to get around the pro-rata rule for Roth conversions would be to roll your IRA over into an employer plan. It wasn’t as easy back then, because not as many employer plans allowed rollovers from IRAs, but more plans do so now. You can actually use it to get around the pro-rata rule even for after-tax contributions already in your IRA, because employer plans don’t accept after tax contributions. So if you have $25k in your TIRA, including $5k of after-tax basis, you would just roll $20k into your employer plan and you have a $5k TIRA that is all basis (after-tax). You can immediately convert that to a Roth IRA and don’t have to pay any taxes. Then, in future years, you can make a non-deductible contribution to the TIRA, and again, immediately convert that, again with no additional taxes due.