The Saver’s Credit: Expanding Retirement Savings for Middle- and Lower-Income Americans

J. Mark Iwry, Peter R. Orszag, and
Peter R. Orszag Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - Lazard
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

March 1, 2005

For decades, the U.S. tax code has
provided preferential tax treatment to
employer-provided pensions, 401(k)-type
plans, and Individual Retirement Accounts
(IRAs) relative to other forms of savings.
The effectiveness of this system of
subsidies remains a subject of
controversy. 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 savings, and in
particular to improve savings among
those households most in danger of
inadequately preparing for retirement.

Many of the major concerns stem, at
least in part, from the traditional form of
the tax preference for pensions. Pension
contributions and earnings on those
contributions are treated more favorably
for tax purposes than other
compensation: they are excludible (or
deductible) from income until distributed
from the plan, which typically occurs
years if not decades after the contribution
is made. The value of this favorable tax
treatment depends on the taxpayer’s
marginal tax rate: the subsidies are worth
more to households with higher marginal
tax rates, and less to households with
lower marginal rates. The pension tax
subsidies, therefore, are problematic in
two important respects:

First, they reflect a mismatch between
subsidy and need. The tax preferences
are worth the least to lower-income
families, and thus provide minimal
incentives to those households who
most need to save more to provide for
basic needs in retirement. Instead the
tax preferences give the strongest
incentives to higher-income
households, who, research indicates,
are the least likely to need additional savings to achieve an adequate living
standard in retirement.
Second, as a strategy for promoting
national savings, the subsidies are
poorly targeted. Higher-income
households are disproportionately likely
to respond to the incentives by shifting
existing assets from taxable to taxpreferred
accounts. To the extent such
shifting occurs, the net result is that the
retirement savings plans serve as a tax
shelter, rather than as a vehicle to
increase savings, so the loss of
government revenue does not
correspond to an increase in private
savings. In contrast, middle- and
lower-income households, if they
participate in retirement savings plans,
are most likely to use the accounts to
raise net savings. Because middleincome
households are much less likely
to have other assets to shift into taxpreferred
accounts, any deposits they
make to tax-preferred accounts are
more likely to represent new savings
rather than asset shifting.

The Saver’s Credit, enacted in 2001, was
expressly designed to address these
problems. The Saver’s Credit in effect
provides a government matching
contribution, in the form of a
nonrefundable tax credit, for voluntary
individual contributions to 401(k)-type
plans, IRAs, and similar retirement savings
arrangements. Like traditional retirement
savings plan subsidies, the Saver’s Credit
currently provides no benefit for
households that owe no federal income
tax. However, for households that owe
income tax, the effective match rate in the
Saver’s Credit is higher for those with
lower income, the opposite of the
incentive structure created by traditional
pension tax preferences.