Retirement tax breaks leave middle-class savers behind, report says

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According to a report by the National Institute for Retirement Security, tax breaks designed to boost retirement savings could primarily benefit high earners, leaving middle-class workers behind.

With most Americans receiving less than half pre-retirement income from Social Security, many rely on employer-sponsored savings plans and Individual Retirement Accounts to fund their golden years.

Although Congress has created tax incentives to encourage savings, the structure of the US tax code and unequal participation in the plan have skewed these benefits toward high earners.

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“Our country is spending heavily to encourage retirement savings,” said Dan Doonan, executive director of the National Institute on Retirement Security and co-author of the report. “But workers at all income levels are affected differently in terms of access to company schemes and the value they get from tax benefits.”

Indeed, more than half of the tax breaks for company retirement plans, such as 401(k) or 403(b) plans and IRAs, go to the top 10% — those earning $117,224. or more, according to the report, based on 2019 data.

It will be important to really dig to understand what policy levers can make a difference for the millions of middle-class Americans who are not accumulating adequate retirement savings.

Dan Doonan

executive director of the National Institute on Retirement Security

Tax structure

One of the reasons for the unequal tax advantages for retirement savings is our tax structure, explained Tyler Bond, research director of the National Institute on Retirement Security and co-author of the report.

The tax brackets show the deductions you will owe on each dollar of income. But families don’t owe taxes until income exceeds the standard deduction, which is $12,950 for single taxpayers and $25,900 for married couples filing together in 2022.

For example, if a married couple earning $25,000 a year together contributes 3% of their earnings ($750) to their 401(k) plan, there is no initial tax relief since their earnings are lower than the standard deduction of $25,900 for 2022.

However, benefits increase as families begin to earn and contribute more. If a family earning $150,000 contributes 12% or $18,000 to their 401(k), they can benefit from a tax savings of $3,960.

More than half of married couples who file together have adjusted gross incomes of less than $100,000, Bond said, meaning those families enjoy “relatively small” tax savings.

Another problem is that workers are not participating in employer-sponsored plans at the same level, according to the report.

Not surprisingly, higher earners are more likely to contribute to higher percentages of earnings sooner, allowing more time for compound growth and greater tax benefits over time, according to the results.

Possible solutions for middle-class savers may include increases in Social Security or changing tax benefits for retirement savings, the report suggests. One option could be to replace deduction-based incentive write-offs with refundable credits.

“It’s encouraging that policymakers are looking at the nation’s retirement savings gap,” Doonan said. “But it will be important to really dig to understand what policy levers can make a difference for the millions of middle-class Americans who aren’t accumulating adequate retirement savings.”

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