By Cyril Tuohy
Does tax policy have the power to change investor behavior when it comes to saving for retirement?
Favorable tax treatment is essential to encourage people to save through their defined contribution programs, the ACLI said in a policy position document delivered to the Senate Finance Committee.
Surrender on the tax-benefits front isn’t an option, ACLI and ICI lobbyists insist. Even household surveys indicate that people value the tax-deferred treatment of retirement account contributions as a major incentive to contribute toward their retirement.
Congress should “do no harm to the existing retirement savings system in the context of tax reform,” the ACLI said in testimony delivered to the Senate panel. In the retirement sphere, tax deferrals are as entrenched an entitlement as Social Security and Medicare.
But wait! As those pronouncements about the virtues of tax incentives were aired at the Senate committee's hearing on retirement savings, researcher Brigitte Madrian was casting doubt on an axiom of public retirement policy.
Madrian, the Aetna professor of public policy and corporate management at the Harvard Kennedy School, said that behavioral response to the changes in financial incentives to save isn’t “particularly large.”
Procrastination, lack of financial literacy and the complexity of the tax code are more important barriers to incentivizing savings than adjusting employer matching contribution levels or tweaking contribution rates, she said.
"In many cases, countering these frictions leads to increases in savings plan participation and asset accumulation that surpass the effects of financial incentives," Madrian said in remarks delivered to the Senate panel.
In any case, the tax code is “particularly ill-suited to generating financial incentives to save,” she said.
The tax code is too complicated and delays financial incentives when people are more likely to respond to immediate incentives, she said.
Lawmakers are looking to reform the nation’s retirement savings system to encourage more people to save through individual or employer-sponsored retirement plans.
Much of the nation’s public policy promoting private savings for retirement has used tax exemptions on retirement-savings-plan contributions. These exclusions cost the government about $127.2 billion annually, a report by the Joint Committee on Taxation has found.
If the exclusions cost taxpayers billions every year, yet such incentives have only minimal impact on retirement-plan-savings rates, isn’t there a better way to incentivize workers to improve their savings behavior?
Senate Finance Committee Chairman Ron Wyden, D-Ore., said the fact that taxpayers deliver billions of dollars in subsidies each year even as millions of individual retirement plans remain underfunded, shows that “something is out of whack.”
“The incentives for savings in the tax code are not getting to the people who need them,” Wyden said.
Federal Reserve data published in August found that the average worker has saved only $59,000 for retirement, yet as many as 9,000 taxpayers have IRA accounts each worth more than $5 million. In effect, the accounts have become “tax shelters for millionaires,” which IRAs were never intended to be, Wyden said.
Madrian said the most effective method to increase savings plan participation is through automatic enrollment. Indeed, the Pension Protection Act of 2006, which encouraged more employers to use automatic enrollment, has generated big increases in savings plan participation rates.
But such incentives satisfy only half of the equation, she said, asserting that rule changes are needed to make it difficult or prohibitively costly for workers to spend their retirement savings before they reach their golden years.
“If you want employers to help their workers save, make it easy,” Madrian said. “And if you want individuals to spend less, make it hard!”
Bills in Congress designed to improve retirement savings rates include the use of auto-enrollment features, but none of the bills proposes significant changes in tax incentives associated with retirement savings accounts.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].</p>
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