Retirement Savings Crisis Continues to Take a Back Seat on Capitol Hill

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Representative Kevin Brady speaks as Senate and House Republicans announce their new tax plan at the Capitol

The recently-released tax plan did not include the proposed changes to 401(k) contribution limits discussed in this article, likely due to the backlash against the initial idea. Yet as Thomhave explains here, most Americans do not use 401(k)s as a vehicle for their retirement savings. Earlier this year, the Trump administration and the Republican Congress began eliminating measures that could have bolstered Americans' abilities to save for retirement beyond inadequate 401(k) plans.

One of the many dubious particulars of the Republicans’ new tax proposal is the way they’re considering paying for it: reducing Americans’ ability to save for their retirements through 401(k)s. The GOP’s plan is to offset the huge cost of tax cuts for the wealthy by limiting tax-deferred contributions into traditional 401(k)s, whittling down a benefit that already does too little to help most Americans prepare for retirement.

401(k) plans are the most popular retirement vehicle offered by private employers, but they came about mostly by accident. Four decades ago, a retirement consultant realized that Section 401(k) of the Revenue Act of 1978 could be used to offer employees a tax-deferred retirement savings vessel. The idea was that 401(k) plans would pair well with traditional pension plans—after all, a diversified retirement savings portfolio is best, right?

That’s not what happened.

Intended as a supplement to pension plans, 401(k) plans quickly began to replace pensions. With pensions, it was up to employers to dole out the promised benefits to retired employees—and if an employer’s investments went awry, the employer would have to make up the difference. The introduction of 401(k) plans allowed companies to shift the risk from their profits to their employees, who are ultimately responsible for their (401)k investment decisions. And while some employers will “match” a certain amount of contributions, they can also ensure that there’s little to no skin in the game for them: To make up for the matching funds, corresponding salaries typically fall.

With this passing of the buck, 401(k) plans themselves are reminiscent of trickle-down economics. Before the rise of the 401(k), pensions dominated. By March 2017, just 15 percent of private-sector workers participated in traditional pension (“defined-benefit”) plans (the rate is much higher in the public sector).

But most Americans don’t actually benefit from 401(k)s. According to the Census Bureau, only one-third of Americans actually contribute to a 401(k), perhaps because they aren’t signing up for the plan or because they aren’t eligible—or because their employer doesn’t offer a 401(k) plan or any retirement savings plan at all.

As a result, the retirement inequality gap is even greater than the income inequality gap. Approximately half of the tax benefits from traditional 401(k) plans go to the richest 10 percent; just 3.5 percent of those benefits go to those in the bottom half of the wealth distribution.

Higher-income workers are more likely to benefit from 401(k) plans, not only because they are more likely to work for a company that offers them, and are better able to withstand investment risk, but also because most companies require that employees contribute to their 401(k) plans before receiving an employer match. Higher-income individuals, of course, are in better financial shape to contribute. Pension plans don’t require employee contributions, and are therefore more accessible to traditionally-marginalized groups.

Today, according to a 2016 Economic Policy Institute report, “For many groups—lower-income, black, Hispanic, non-college-educated, and unmarried Americans—the typical working-age family or individual has no savings at all in retirement accounts, and for those that do have savings, the median balances in retirement accounts are very low.” In the absence of 401(k) plan access and usage, Social Security is the most important benefit for Americans during their retirement years, the report indicates.

In short, 401(k)s are geared toward eliminating risk for companies and those at the top … and still mostly only benefit those at the top.

And yet, the Republicans are considering a plan to pay for their tax proposal that would make this unfair system even more unfair. To raise revenue to offset their proposed tax cuts, Republicans would limit the amount of money that could be tax-deferred under 401(k)s. The maximum annual contribution to traditional 401(k)s (currently $18,000) would be reduced to $2,400. This would likely discourage saving for retirement, when such savings are desperately needed.

Contributions beyond $2,400 could go to Roth 401(k) plans, which unlike traditional 401(k) plans are taxed now instead of when funds are withdrawn. Roth plans are best for individuals who believe that they will be in a higher tax bracket when they retire—not those individuals whose incomes will fall as they get older. 401(k) plans already disproportionately benefit higher-income people—and the possible changes would make this imbalance even more lopsided, hurting those who have lower incomes by the time they retire.

Reducing the limit to $2,400—still a large chunk of change for many Americans—would likely not greatly affect low-income earners, who often don’t make a wage high enough to save anything at all, forcing them to continue working during traditional retirement years. But the hit to 401(k)s would be just one of many ways that Trump and the Republican Congress have hurt low-income people’s prospects for retirement saving.

The Obama administration actually attempted to make retirement savings plans more accessible, particularly to low-income families, through a program called “myRA.” Announced in 2014, myRA was meant to be an introduction of sorts to retirement savings, a starter account for people without employer-based retirement options to begin saving a portion of their paychecks. In July, like many Obama-era initiatives, the Trump administration ended the program, stating it was too expensive.

In May, Trump also signed into a law a repeal of an Obama-era rule that made it easier for states to establish “auto-IRAs.” In such a program, workers are automatically enrolled into Individual Retirement Account plans (with corresponding payroll deductions) to save for retirement if their employer does not offer a retirement savings option; auto-enrollment is a research-backed way to encourage retirement saving. (Some states that already had plans developed and approved, such as Oregon, are still moving ahead with their plans. For other states that planned to enact the auto-enrollment programs, the future is uncertain.)

And with 401(k)s, the Republican Congress is considering reducing the benefits of a system that’s flawed to begin with. Welcome to the Trump Era, where we’re compelled to defend one bad trickle-down-inspired policy so Congress doesn’t enact an even worse one.

This article has been updated. 

Tax Cuts for the rich. Deregulation for the powerful. Wage suppression for everyone else. These are the tenets of trickle-down economics, the conservatives’ age-old strategy for advantaging the interests of the rich and powerful over those of the middle class and poor. The articles in Trickle-Downers are devoted, first, to exposing and refuting these lies, but equally, to reminding Americans that these claims aren’t made because they are true. Rather, they are made because they are the most effective way elites have found to bully, confuse and intimidate middle- and working-class voters. Trickle-down claims are not real economics. They are negotiating strategies. Here at the Prospect, we hope to help you win that negotiation.

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