The latest brief by the Center for Retirement Research at Boston College looks at how taxpayer resources could be utilized more productively, and possibly reallocated to Social Security.
In traditional defined contribution (DC) plans, participants are not taxed on the money they or their employers add to their retirement accounts, nor on the investment balances they accumulate. Instead, participants are taxed on their contributions and investment earnings later in life during retirement, when they receive their benefits. This process generally allows for participants to see lower tax revenues.
According to the U.S. Treasury, tax preferences for employer-sponsored retirement plans and individual retirement accounts (IRAs) decrease federal income taxes by somewhere between $185 billion to $189 billion. Yet, this process actually does little to grow retirement savings, and instead, costs the Federal Treasury, Social Security, and Medicare more money, the CRR argues in its brief.
“Revenue losses also extend to the payroll tax for Social Security and Medicare. In the case of DC retirement plans, employee contributions are taxed as earnings, but employer contributions are not. Thus, calculating the revenue loss involves applying only the employer portion of the payroll tax – 7.65% – to employer contributions,” the CRR writes.
Regarding defined benefit (DB) plans, a fixed benefit plan provided by employers, the total estimate of the payroll tax revenue loss was $68 billion in 2020.
Reducing expenditures for DC plans
The Center for Retirement Research goes on to argue against tax expenditures on traditional DC plans, which the brief notes accounts for close to two-thirds of retirement-related revenue loss.
If the Federal Treasury chose to remove tax expenditures and instead have the Internal Revenue Service (IRS) require employers to report earnings and realized capital gains from contributions, revenues would increase by $121 billion, adds the CRR.
Another alternative, the brief finds, would be to limit total employer and employee retirement contributions to anywhere between $10,000 and $20,000, or cap total accumulations in tax-favored retirement plans to $500,000 or $1 million.
Rollbacks of the retirement savings tax preferences could help Social Security’s long-term funding gap, which is expected to exhaust itself by the early to mid-2030s, notes the CRR.
It also provides a solution to the decades-long divide between Republicans and Democrats over how to maintain the government program’s solvency, without increasing the retirement age or raising taxes, the CRR says.
“Redirecting the tax expenditure to Social Security would reallocate existing funds that do not significantly improve retirement income security to a program that indisputably does,” the CRR writes. “The front-loaded nature of savings from reducing the tax expenditure also could provide time for other changes to Social Security to be phased in. Finally, linking reductions to the tax expenditure to maintaining Social Security’s solvency could overcome the legislative inertia that has for years delayed action on Social Security reform.”
SEE ALSO:
- Haley Doubles Down on Raising Social Security Retirement Age for Younger Americans
- 7 Key Social Security Metrics for 2024
- 9 States Still Taxing Social Security Benefits in 2024
Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with over six years of experience and a passion for telling stories and reporting news. Amanda received her degree in journalism and government and politics at St. John’s University. She is originally from Queens, New York, but now resides in Denver, Colorado with her partner. In her free time, Amanda enjoys running, cooking, and watching the latest drama show.
