It's never too early to be saving for retirement. Making sure that you have enough saved in your accounts once you stop working is important because it means you can take care of yourself in old age. One way people save up for retirement is through an IRS provision known as the 401(k). Essentially, the 401(k) is an employer-sponsored pension account that a) can be pre-tax or post-tax, and b) allows for employers to make matching or non-elective contributions. I discussed the 401(k) last year in a blog entry. I thought it was an improvement over status quo because it allowed for more people to save.
At the same, time it was hardly a perfect retirement account. One of the flaws that it suffers from is leakage. In this context, leakage is when an individual makes a pre-retirement withdrawal from the 401(k), and incurs taxes and penalties as a result. Researchers at Boston University estimate that leakage has caused 401(k) savings to be 20 percent lower, on aggregate, than without the current leakage rules (Munnell and Webb, 2015). A study from Deloitte Consulting was released earlier this week saying that over the next decade, Americans are going to lose nearly $2.5 trillion as a result of leakage.
That is a huge number there! Over $2T lost because of some tax code inefficiencies? That's a lot! Fortunately, the Republicans in Congress proposed a solution to the issue: the Universal Savings Account (USA). Under the House Republican proposal, individuals can place up to $2,500 in the USA. These dollars would be post-tax, but the earnings on the funds would be tax-free. The USA differs from a Roth IRA in two ways. One, an individual can withdraw funds at any time for any reason. Two, there are no income limits on participation, whereas the Roth IRA has a limit of $200,000. The libertarian Cato Institute thinks that this is a wonderful idea, whereas the Left-leaning Center on Budget and Policy Priorities (CBPP) dislikes it. Who is right in this public policy battle? Let us go through the arguments in Cato's and CBPP's policy briefs to see who is right.
How much will USAs cost the American economy? According to the Joint Committee on Taxation, these USAs are going to cost $8.5 billion in government revenue over the next ten years. The CBPP opines that the JTC cost estimate is too low because the JTC is supposedly underestimating the shift towards the USAs. Let us assume that the JTC is understating the cost by tenfold (i.e., it's actually $85B). And let's say that the USAs only reduce leakage by 10 percent ($250B). Keep in mind these are two very generous assumptions in favor of CBPP. That would still mean that the USAs are creating a net benefit of $165 billion over 10 years.
Will USAs boost savings? CBPP does not think that USAs will boost savings. CBPP cites a Harvard University study showing that 85 percent do not respond to such savings, and that the remaining 15 percent shift the savings from taxable to tax-preferred accounts (Chetty et al., 2013). I would contend the findings since the study was conducted in Denmark, which means different tax and regulatory structure than that of the United States. If we take Chetty's findings at face value, it would mean that USAs would increase savings by 1¢ for every dollar of tax-cut benefit. The CBPP is also concerned that USAs could actually decrease savings because households would be too incentivized to withdraw funds pre-retirement, thereby leaving less for retirement.
Do USAs help out the rich only or all income levels? The CBPP argues that the wealthy are in the best position to rearrange their portfolios and shift over to the tax-preferred USAs. The Right-leaning Heritage Foundation supported CBPP's argument with its analysis from two decades ago: if most households had to choose between paying major bills and saving for retirement 30-40 years down the road, which would they be inclined to do? Pay bills now. Even with that being the case, Cato counters the argument by saying that low- and middle-income earners tend to avoid special-purpose savings accounts because of liquidity issues. Cato then uses the Canadian and U.K. success stories to show how lower-income households are incentivized to save when liquidity is no longer an issue with the savings accounts.
Conclusion: I'm on a bit of a time crunch, but I approve of USAs. If I have a major criticism about the Republicans' plan, it's that the $2,500 limit is too low. I love how some portray this as a subsidy for the rich when it is in fact reducing taxes on savings. The default assumption for critics is that the money belongs to the government, not the people who worked to earn their money. More to the point, there should be as much neutrality between savings and consumption since a given household knows its own financial sate and needs better than the IRS. Plus, the USA can stop the double taxation that occurs on savings. Given how low the U.S. personal savings rate has been, this should be passed through Congress. If the government cannot make the Social Security reform necessary to make Social Security solvent, it should at least get out of the way and allow people more freedom over their finances with USAs.
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