Updating retirement savings policy for the modern economy

Just days before adjourning to return to their home states to campaign for the November mid-term elections, the Senate Finance Committee held a hearing on retirement savings and tax reform. The meeting comes on the heels of a Joint Committee on Taxation (JCT) report that found that retirement tax incentives are set to cost the Treasury nearly $700 billion over the next five years, second only to the cost of the exclusion for employer-provided health insurance.

In his opening remarks, Finance Committee Chairman Ron Wyden (D-OR) noted that taxpayers are spending $140 billion each year subsidizing retirement accounts, and the current savings incentives in the tax code are not getting to the people who need them, mainly low- and middle-income taxpayers. Chairman Wyden cited a recent study from the Federal Reserve that found that an employee with middle-of-the-pack savings has $59,000 set aside for retirement, while according to the Government Accounting Office, some 9,000 taxpayers have IRAs worth more than $5 million. The Federal Reserve study also found that nearly a third of workers have no pension and nothing set aside for retirement. Chairman Wyden noted that as the Finance Committee continues to work on modernizing the tax code, it is important for the committee to consider how to improve current retirement savings incentives and ensure they are helping middle-class Americans prepare for retirement.

Ranking Member Orrin Hatch (R-UT), in his opening remarks, cited the long history of bipartisanship among members of the Finance Committee, as they have worked to craft good policy to help Americans save more of their hard-earned money. He noted that retirement savings is a very important topic and he hoped to hear facts from the witnesses that would inform the committee on retirement policy considerations.

The witness list consisted of people from academia, business, public policy research, and the media, all with very different views on the current state of retirement savings and how to improve the system’s effectiveness. A number of witnesses told the committee that the current retirement savings incentives are working well and are helping the middle-class prepare for retirement.

Scott Betts, an executive with a third party administrator of employer-sponsored retirement plans, cited IRS statistics that show 80 percent of participants in 401(k) plans make less than $100,000 per year, and 43 percent of participants make less than $50,000 per year. Betts also cited data from the Employee Benefits Research Institute that shows over 70 percent of workers earning $30,000 to $50,000 per year participated in an employer-sponsored retirement plan when one was available through their employer.

Brian Reid, Chief Economist at the Investment Company Institute, the national association of U.S. investment companies, cited data from the Current Population Survey showing that retirees receiving private-sector pension income increased by more than 60 percent between 1975 and 1991, and that among those receiving income from private-sector pensions, the median amount of inflation-adjusted income increased nearly 40 percent between 1991 and 2012. He also cited data showing that poverty rates for people aged 65 and older have fallen over time—from nearly 30 percent in 1966 to 9 percent in 2012—with the elderly having the lowest poverty rate among all age groups.

Both Betts and Reid argued that the current incentives for retirement savings are working well, and any changes in policy should build on the current system, rather than dismantle it. They also argued that the current methodology of calculating the cost of retirement savings incentives overstates the true cost. Unlike the mortgage interest tax deduction or the exclusion of employer-paid health insurance premiums from taxable compensation—which reduce taxes paid in the year taken—retirement savings incentives simply defer taxes until a later date, and do not result in a permanent loss of revenue to the Treasury. Taxes will eventually be paid on retirement plan assets when participants withdraw the funds in retirement and that will result in additional revenue for the Treasury.

Auto enrollment was cited by a number of witnesses as a way to increase participation. Brigitte Madrian, Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School, cited auto enrollment as the most promising public policy step that can be taken to increase the percentage of Americans saving for retirement. Ms. Madrian also noted that steps should be taken to discourage pre-retirement distributions, including reducing the amount that individuals can withdraw before retirement and increasing early withdrawal penalties.

Andrew G. Biggs, Resident Scholar at the American Enterprise Institute, echoed Ms. Madrian’s comments on auto enrollment, stating that auto enrollment is probably the single most effective step we can take to increase retirement saving. Dr. Biggs also cited investment costs as an important factor in achieving retirement security, noting that focusing pension plan offerings on low-cost index funds—as the federal Thrift Savings Plan does—could be of great benefit to savers.

John C. Bogle, founder of the Vanguard Group, agreed, stating that it is “absolutely essential” to reduce the cost of investing for retirement savers, both in employer-sponsored retirement plans and IRAs. He cited the benefits of low-cost index funds as a way to reduce the cost of investing and increase retirement savings. Mr. Bogle also recommended changes to the early withdrawal rules and plan loan provisions to make it more difficult to take pre-retirement distributions.

The final witness, Ellen Schultz, a former reporter and editor at The Wall Street Journal, was unable to attend the hearing, but submitted a written statement. Ms. Schultz stated that using tax breaks to encourage savings is potentially a good thing, but more scrutiny is needed to determine how to structure them to work more efficiently. She noted that based on her 25 years of reporting, she has found that the retirement savings tax incentives flow largely to the highest-paid Americans. Ms. Schultz noted that a rollback of contribution levels, or freezing them at the current level might be an option, and stated that it would be “illuminating” to measure the revenue loss attributable to highly paid employees setting aside billions of dollars in deferred compensation plans and supplemental executive pension plans.

The hearing ended with the committee taking no action, but it is unlikely that this is the end of the discussion. Once a new Congress is sworn in, we can expect further scrutiny of the cost and effectiveness of current retirement savings incentives. Millions of retirement savers can only hope that the Latin maxim primum non nocere—do no harm—guides Congress as it considers changes.