The average 401(k) contribution rate of Black and Hispanic workers is roughly 40% lower than that of White workers, according to a new paper from MIT Sloan School of Management.
Tax and employer matching subsidies further amplify these saving differences by channeling more resources to those who save more, the MIT researchers found. They estimate that breaking the link between contribution choices and saving subsidies, through revenue-neutral reforms, would significantly reduce racial gaps and intergenerational persistence in wealth.
The findings are particularly interesting given the current debate about the tax preferences of workplace retirement plans spurred by a controversial proposal by Alicia Munnell and Andrew Biggs advocating for ending those tax benefits and using the savings to bolster Social Security’s troubled finances.
The MIT working paper, “Who Benefits from Retirement Saving Incentives in the U.S.? Evidence on Racial Gaps in Retirement Wealth Accumulation,” starts out by saying U.S. employers and the federal government devote more than 1.5% of GDP annually towards promoting Defined Contribution retirement saving. The paper studies the distributional and lifetime impact of these savings incentives across racial groups using a new employer-employee linked data set covering millions of Americans.
The data show large gaps in retirement saving across the three largest racial and ethnic groups in the U.S.
The researchers set out to better understand the extent to which retirement accounts and the strong incentives attached to them might exacerbate existing wealth inequality that has persisted for decades.
The data show large gaps in retirement saving across the three largest racial and ethnic groups in the U.S.: non-Hispanic White, non-Hispanic Black, and Hispanic employees.
A Feb. 1 MIT Sloan School of Management article by Betsy Vereckey quotes Lawrence Schmidt, one of the paper’s authors and an assistant professor of finance at MIT Sloan, mentioning how the researchers know that Black and Hispanic workers in the U.S. typically are going to be entering their careers and living their lives in a position with fewer liquid resources available.
“Because there are tax penalties for taking out retirement money early, Black and Hispanic workers often face a dilemma: ‘Do I save for retirement, or do I save to help protect myself against a rainy day?’” Schmidt said.
Not utilizing tax-advantaged retirement plans leads to falling behind those who do. From the paper:
“At an average match of approximately 50 cents per dollar contributed, saving in a tax-favored employer-sponsored account is one of the best, if not the best, financial investment opportunities available to build wealth. This institutional design, therefore, rewards those who can, and do, save more for retirement. Employees who do not contribute receive neither tax benefits nor employer-matching contributions.”
Vereckey’s article also quotes another of the paper’s authors, Taha Choukhmane, an assistant professor at MIT Sloan, talking about how retirement accounts are unique from the perspective of getting massive support from employers, massive support from the government, and benefiting from compound interest through stock appreciation.
“When we study retirement, there’s been a lot of interest in whether these tax subsidies work and increase saving but a lot less on how those benefits are distributed,” Choukhmane said. “Being able to systematically document how it’s distributed and who’s getting left out from this system was a question that really interested us.”
Flagging the penalties
The research found that people are less likely to save if their household demand for liquidity is high, as employees who are short on cash are reluctant to contribute to a retirement fund, knowing they’ll be penalized if they need to withdraw money in an emergency.
“Our findings suggest that there can actually be a deterrent effect in making these accounts illiquid,” Schmidt said in the Vereckey article. The penalty was intended to keep people from spending their retirement money on other things, but an unintended consequence is that it might make retirement accounts less desirable and reduce participation in the first place.
The article notes that the emergency savings account provisions in SECURE 2.0 expanded the situations when savers can take penalty-free distributions to include disaster relief, terminal illness, or other personal or family emergency expenses.
The researchers’ overarching conclusion? We’ll take it from their conclusion on page 33 of the 130-page paper:
We find that the current system channels more tax and employer resources toward workers who are White, possess a college degree, and have richer parents or spouses than it channels toward their similar-income coworkers who are Black or Hispanic, are single parents, and have lower-income relatives. The consequent effects on wealth are large and are not directly addressed by other aspects of the retirement system. The Social Security formula does not vary by race, education, or parental background, and employer nondiscrimination tests consider only current compensation. Our results thus suggest that future research on the optimal design and distributional impact of retirement systems should look beyond differences along the income distribution to better understand the interplay between retirement saving policies and inequality.
• Read the complete working paper here
• Read Betsy Vereckey’s article here
SEE ALSO:
• Economists Refute Biggs-Munnell Plan to Repeal 401(k) Tax Preferences to Boost Social Security
• New Brief Argues for Reallocating 401(k) Tax Expenditures to Social Security
• Retirement Preparation Without Tax Preferences? Part 2
• Despite Financial Optimism, Black Americans Report Retirement Fears