Insights Blog

Republican Plan to Cut 401(k) Tax Breaks Fuels Inequality

October 28, 2017

Teresa Ghilarducci, labor economist and director of SCEPA's Retirement Equity Lab (ReLab), made the following statement regarding Congressional Republicans' proposal to cut contribution limits for 401(k) retirement savings contributions:

"The Republicans are right about one thing - 401k and IRA tax incentives probably don't help encourage retirement savings overall. People shift funds they would have saved anyway to a tax-sheltered account and low-income people don't get much of a tax break.

The Republicans are also correct that the current tax treatment of 401ks and IRAs disproportionately helps the well off at the expense of low-income workers. The problem is the Republican proposal - which turns the current system into more of a Roth system -- will favor wealthy people even more.

Current tax law allows people to contribute up to $18,000 to a 401(k) account free of federal income tax (and most state income tax) until people withdraw the funds from their 401(k) or IRA. The Republicans propose to reduce the cap on tax-free contributions to $2,400 and tax additional contributions when they are made, rather than when they are withdrawn. This is how Roth IRAs are taxed.

This proposed Roth structure favors high-income workers for two reasons: 1) Roths can be inherited - the more wealthy you are, the more likely you will leave material amounts of money to your kids; and 2) Since under the Roth IRA structure, retirement savings grows tax-free and comes out tax-free, the sooner someone saves a lot and the more time they can let the fund grow, the bigger the tax benefits. The affluent can save early, often, and over time. Lower-income people, not so much.

This proposal makes the retirement crisis worse and retirement income security more unequal. It is a gimmick that pushes tax breaks into the future to bring more tax revenue to the government now and saves the government nothing. All it does is make the Republican tax cuts appear smaller.

The plan exacerbates retirement insecurity through lowering taxes on the rich, increasing the cost of saving for the middle class, and doing nothing to solve the real problem of regressive tax breaks.

Republicans are going in the wrong direction on retirement security. In the United States, the median retirement account balance for near-retirees is just $15,000. These older workers will likely face downward mobility or even poverty in old age. Yet, Republicans
during the Trump Administration have worked to halt the fiduciary rule, discourage state retirement plans, and kill the myRA savings program. We need a fair tax system that provides a refundable tax credit that is the same for everyone who saves for retirement."

About SCEPA

SCEPA works to focus the public economics debate on the role government can and should play in the real productive economy - that of business, management, and labor - to raise living standards, create economic security, and attain full employment.