'Talk about robbing Peter to pay Paul': Economists propose axing 401(k), IRA tax benefits to help fund Social Security — but some retirement experts are lashing back (2024)
A new brief from the Center for Retirement Research at Boston College makes the case for scrapping tax benefits on retirement plans like 401(k)s and IRAs, potentially adding billions of dollars in U.S. tax revenue each year.
Economists Alicia Munnell and Andrew Biggs argue how subsidies for these retirement plans, which they say fail to “significantly boost national saving,” could be diverted to fund Social Security instead — which is set to run short of cash by 2033.
“It makes little sense to throw more and more taxpayer money at employer plans and IRAs,” the duo wrote in the brief. “In fact, the case is strong for eliminating the current tax expenditures on retirement plans and using the increase in tax revenue to address Social Security’s long-term financing shortfall.”
The price of deferred taxes
Americans saving up for their golden years get to defer taxes on contributions to retirement plans, like 401(k)s and IRAs, which they only pay on withdrawals in retirement. But deferring their taxes not only squeezes the future savings they get to enjoy in retirement, it also leaves potential tax revenue on the table.
The brief points to Treasury estimates that the tax preference for employer-sponsored retirement plans and IRAs reduced federal income taxes by about $185 billion in 2020 — equivalent to about 0.9% of gross domestic product.
What’s more, the tax expenditures for retirement savings plans are actually more likely to benefit higher earners. The Tax Policy Center estimates nearly 60% of those benefits went to taxpayers earning at least $167,000 annually, while more than 38% went to those making $245,000 or more in 2020.
Why? Higher earners are more likely to have access to employer-sponsored retirement plans, are more likely to participate in them and contribute more when they do participate, the brief states.
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The researchers also calculated, based on Federal Reserve data, that between 1989 and 2022, the share of workers aged 25 to 64 who participate in employer-sponsored retirement plans rose by a meager two percentage points, from 51% to 53%.
Meanwhile, Social Security benefits are a major source of income for low-income seniors, many of whom rely on these checks to cover the cost of essentials. Additional financing would allow the program to continue paying beneficiaries in full for an extended period of time.
Some retirement experts oppose nixing tax incentives
Not everyone is convinced by Munnell and Biggs’s proposal to reduce or eliminate tax preferences for retirement plans.
“Talk about robbing Peter to pay Paul,” Brian Graff, CEO of the American Retirement Association, told the National Association of Plan Advisors (NAPA). “It’s absurd to take away the incentives from a system that’s actually working to give money to a system that has fundamental challenges.”
Some experts challenge whether retirees indeed face major financial headwinds with Social Security checks in the future. However, The Center on Budget and Policy Priorities says that without their benefits, a stunning 38.7% of older adults would have incomes below the poverty line.
In fact, even with a 3.2% cost-of-living bump to Social Security benefits in 2024, a survey from The Senior Citizens League (TSCL) found over half of respondents worry their retirement income won’t cover the cost of essentials.
“The Social Security benefits are modest, only replacing about 30% of one's earnings during working years,” Mary Johnson, Social Security and Medicare policy analyst at TSCL, told Moneywise in an email.
Contributions to a traditional 401(k) are always tax-deductible. Your contributions to a traditional 401(k) are always tax-deductible, regardless of income. In contrast, contributions to a traditional IRA may or may not be tax-deductible, depending on income and whether you're already covered by a 401(k) plan at work.
The tax advantages of a 401(k) begin with the fact that you make contributions on a pre-tax basis. That means you can deduct your contributions in the year you make them, which lowers your taxable income for the year. Note that this benefit applies to traditional 401(k) plans, not Roth 401(k) plans.
The Bottom Line. A 401(k) plan is a workplace retirement plan that allows you to make annual contributions up to a specific limit and invest that money for your later years after your working days are over.
IRA and 401(k) accounts let you save for retirement with tax benefits. Employers may match your contributions but limit your investment choices. IRAs offer more control, flexibility, and potentially lower fees.
The main difference between 401(k)s and IRAs is that 401(k)s are offered through employers, whereas IRAs are opened by individuals through a broker or a bank. IRAs typically offer more investment options, but 401(k)s allow higher annual contributions.
Generally, from a tax perspective, it is more favorable for participants to roll over their retirement plan assets to an IRA or new employer-sponsored plan rather than take a lump-sum distribution.
Contributions to a traditional 401(k) are taken directly out of your paycheck before federal income taxes are withheld. Because the contributions are pre-tax, it lowers your total taxable income which means you might owe less in income taxes, regardless of whether you itemize or take the standard deduction.
The main appeal of the after-tax 401(k) plan is that those contributions grow tax-free, similar to a Roth IRA or a Roth 401(k). And like those plans, qualified withdrawals are tax- and penalty-free. The catch is that not all 401(k) plans allow after-tax contributions.
You can set your contribution to have a specific amount of each paycheck added to your 401(k) account, or you can have a certain percentage of your paycheck taken out. Since 401(k) contributions are pre-tax, the more money you put into your 401(k), the more you can reduce your taxable income.
By age 35, aim to save one to one-and-a-half times your current salary for retirement. By age 50, that goal is three-and-a-half to six times your salary. By age 60, your retirement savings goal may be six to 11-times your salary. Ranges increase with age to account for a wide variety of incomes and situations.
Generally, you have 4 options for what to do with your savings: keep it with your previous employer, roll it into an IRA, roll it into a new employer's plan, or cash it out. How much money you have vested in your retirement account may impact what decision you make.
By age 40, you should have accumulated three times your current income for retirement.By retirement age, it should be 10 to 12 times your income at that time to be reasonably confident that you'll have enough funds. Seamless transition — roughly 80% of your pre-retirement income.
If you're saving exclusively in a Roth 401(k), your options to access that money are limited before the age of 59 1/2. While you can withdraw any amount you contributed to a Roth 401(k) at any time without taxes or penalties, the earnings typically cannot come out penalty-free before you reach age 59 1/2.
Fortunately, there's a rule of thumb for optimizing two kinds of accounts—a 401(k) and a Roth IRA or Roth 401(k)—that makes sense for most people. Start by contributing enough to your 401(k) to get the full employer match, then direct any additional savings to a Roth IRA up to the annual contribution limit.
Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.
Instead, the money is taken out of your paycheck before federal taxes on your income are figured. This is how you save on taxes today. Your 401(k) pretax contribution comes out of your paycheck first thing, lowering your taxable income. Then, your taxes are taken out of your paycheck based on the smaller income number.
The money deposited into a traditional IRA reduces your adjusted gross income (AGI) for that tax year on a dollar-for-dollar basis, assuming it is within the annual contribution limits (see below). So a qualifying contribution of, say, $2,000 could reduce your AGI by $2,000, giving you a tax break for that year.
Contributions to a 401(k) are tax-deductible and reduce your taxable income before taxes are withheld from your paycheck. There is no tax deduction for contributions to a Roth IRA, but contributions and earnings can be withdrawn tax-free in retirement.
Introduction: My name is Errol Quitzon, I am a fair, cute, fancy, clean, attractive, sparkling, kind person who loves writing and wants to share my knowledge and understanding with you.
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