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

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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.

  • Authors

    Peter R. Orszag

    Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - Lazard

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