Are Retirement Savings Tax Incentives Leaving the Middle Class Behind?

A new report by the National Institute on Retirement Security highlights the insufficiencies of current tax incentives in ensuring retirement security for the middle class. It includes marginal tax rates, retirement plan participation and income distribution on retirement savings levels as culpable factors.

The report, “The Missing Middle: How Tax Incentives for Retirement Savings Leave Middle Class Families Behind,” also offers potential solutions that could enhance retirement security for middle-class families.

Saving for retirement is one of the biggest financial challenges most working Americans will face. While the vast majority will participate in Social Security, less than half will have their income replaced, the report says. Many workers will need to save for retirement through other vehicles.

Congress has passed a number of tax incentives to encourage saving for retirement, but due to the structure of the tax code, uneven levels of retirement plan participation and the growth of income inequality, many of the benefits of these tax incentives accrue to high-income earners, the report says.

“The middle class is left behind by the retirement savings system in key ways. Social Security replacement rates are too low for middle-class families to maintain their standard of living in retirement, but many middle-class households don’t reach the level of income and savings needed to truly benefit from the tax incentives for individual savings,” the report says. “This means the middle class too often is missing out in terms of benefiting from various retirement savings programs.”

More than half of the present value of tax benefits for defined contribution plans and individual retirement accounts accrues to those in the top 10% by income, according to the report, and a significant percentage of the present value of defined benefit pension plans also accrues to those in the top 10%. The top 30% of workers by income receive 89% of the present value of DC plans and IRAs, and 83% of the present value of DB plans.

The value of tax incentives for saving is greater for those at higher income levels, who face higher marginal tax rates, the report says. These incentives are weaker for much of the middle class. Additionally, those who are able to invest earlier and at higher levels enjoy a greater advantage from the deferral of taxation on investment gains.

The tax expenditures for retirement saving, focused on the defined contribution system, have led to inequities beyond income and wealth, the report says. Geographic and racial inequities related to retirement are exacerbated by the tax incentives for saving.

Solutions to these inequities should focus on increasing participation in the retirement savings system and ensuring working families also receive adequate incentives to save for retirement, the report says. Some potential solutions could focus on building upon Social Security, either through benefit changes or allowing the program to integrate lifetime income options for savers.

Reforming the tax expenditures themselves, by eliminating the deduction-based system and replacing it with a refundable credit, is another possibility. Other solutions could focus on increasing access and participation in savings plans, which some states are doing for workers who lack workplace plans, thereby making it easier to participate, the report says. Finally, curbing abuses of the existing system would ensure that the significant sums of federal tax revenue dedicated to retirement security are directed at generating retirement income.