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The American retirement system is built for the rich

Mark Allen Miller for the Washington Post
Mark Allen Miller for the Washington Post

Lawmakers proclaim they want to help the middle class save. But that’s not who benefits most from IRAs and 401(k) plans.

Democrats and Republicans in Congress don’t typically agree on tax policy. But late last month, 216 House Democrats joined with 198 of their GOP colleagues to pass legislation advancing a cause that both parties have championed in recent years: ensuring that high-income individuals can stuff even more money into their tax-advantaged retirement accounts. Only five House members — all Republicans — voted no.

Overwhelming Republican support for the bill — known as the Securing a Strong Retirement Act of 2022, or Secure 2.0 — comes as no shock: Tax-cutting has long been a central plank of the GOP platform. What’s more surprising is that every Democrat in attendance backed the measure, too. Even Rep. Alexandria Ocasio-Cortez (D-N.Y.) — a pillar of the party’s left wing who at a gala last September sported a gown with the slogan “TAX THE RICH” — voted to bestow billions of dollars in benefits on the very taxpayers whom she says should pay more.

Bipartisan support for Secure 2.0 is part of a decades-long pattern: While loudly and proudly proclaiming that their goal is to nurture nest eggs for the working class, lawmakers have constructed a complex of tax shelters for the well-to-do. The lopsided result is that as of 2019, nearly 29,000 taxpayers had amassed “mega-IRAs” — individual retirement accounts with balances of $5 million or more — while half of American households had no retirement accounts at all. Overall, according to the Congressional Budget Office, the top 10th of households reap a larger share of the income tax subsidy for retirement savings than the bottom 80 percent.

It’s working out just fine for the financial institutions that manage assets in IRAs and 401(k)s. The combined amount in those vehicles reached $21.6 trillion at the end of 2021 — up fivefold since 2000 — and the more money that pours in, the more that managers collect in fees. A small sliver makes it back to lawmakers in the form of campaign contributions: The largest asset managers — BlackRock, Vanguard, Fidelity and State Street — gave almost $1.2 million through their political action committees to House and Senate candidates in the last election cycle. But that’s a pittance compared with what these firms stand to gain from Secure 2.0.

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University of Virginia law professor Michael Doran — who held tax policy roles at the Treasury Department under Presidents Bill Clinton and George W. Bush — calls the current state of affairs “the great American retirement fraud.” It’s hard to argue with that description. And Secure 2.0 would take the fraud to a new level: Its congressional supporters have engaged in Enron-style accounting gimmicks to mask the bill’s effects on deficits — tricks that, if used by corporate executives, might well land them in jail. (Sen. Ben Cardin (D-Md.) has introduced a broadly similar bill in the upper chamber, though without some of the House’s most egregious accounting shenanigans.)

One reason the deception has succeeded thus far is that the details are complicated, allowing Congress to funnel benefits to the donor class without ordinary voters having any idea of what’s going on. Even some lawmakers might have been hoodwinked, though if so, they bear blame for not making an effort to understand the legislation they voted to pass.

The boondoggle began from humble origins. In 1974, Congress passed a provision allowing workers who weren’t covered by employer pension plans to contribute up to $1,500 per year to new “individual retirement accounts.” Workers could claim tax deductions for their contributions — and assets in IRAs would grow tax-free — but distributions would be subject to ordinary income tax (plus an additional 10 percent tax on withdrawals before age 59½).

All that might seem innocuous, but from the outset, IRAs were a generous gift to the upper class. At the time, very few low- and middle-income individuals could afford to stash $1,500 in a retirement account each year — median income for U.S. households was $11,100 in 1974 — so the people taking full advantage of the new IRAs tended to be relatively rich. And since the benefit was structured as a deduction, it was worth more to taxpayers in higher income brackets.

In any event, the $1,500 IRA in 1974 was just a start. In the nearly half-century since, Congress has continually expanded the amount that individuals can pour into tax-deferred savings accounts. The advent of employer-based 401(k) plans in 1978 accelerated the process. At the time, the Joint Committee on Taxation, which advises Congress on tax legislation, said that the new 401(k) provision would have a “negligible effect upon budget receipts.” Now, the JCT estimates that 401(k)s and other similar defined-contribution plans cost the federal government $200 billion per year.

Today, individuals can contribute up to $6,000 per year to an IRA ($7,000 if age 50 or older), plus $20,500 to a 401(k) ($27,000 for 50-year-olds and up), with their employers potentially chipping in to bring the 401(k) total to $61,000 ($67,500 for the over-50 set). For most Americans, those limits are meaningless. In 2018, the most recent year for which data is available, 58 percent of taxpayers with wage income made no contribution to 401(k)-style plans, and less than 4 percent bumped up against the contribution cap. The data on IRAs tells a similar story: As of 2020, approximately 63 percent of U.S. households had no such accounts.

For the select few who can afford to contribute up to the IRA and 401(k) caps, the potential rewards are tremendous. Steve Rosenthal of the Urban-Brookings Tax Policy Center and I calculated that an individual who made the maximum 401(k) contributions since 1990, investing exclusively in an S&P 500 index fund, would have more than $7 million in her account today.

When JCT released data last summer showing that 28,615 taxpayers had accumulated $5 million or more in IRAs, lawmakers cried foul. Rep. Richard Neal (D-Mass.), who as chairman of the Ways and Means Committee is the top tax writer in the House, lamented the “exploitation” of IRAs. “IRAs are intended to help Americans achieve long-term financial security, not to enable those who already have extraordinary wealth to avoid paying their fair share in taxes,” Neal said. But mega-IRAs are an entirely predictable consequence of Congress’s policy choices.

(The very largest IRAs, like PayPal co-founder Peter Thiel’s reported $5 billion account, result from a different loophole: the ability of founders and early-stage investors to stuff IRAs with start-up stock. But Forbes revealed more than a decade ago that Thiel and another PayPal co-founder were using their IRAs to shelter entrepreneurial earnings; the Government Accountability Office flagged the IRA-stuffing phenomenon in 2014; and rather than clamping down, lawmakers from both parties sat on their hands.)

Indeed, lawmakers — including liberal Democrats — have learned virtually nothing from the last half-century. The Secure 2.0 bill, sponsored by Neal, doubles down on the inequities of the status quo. It will inevitably result in even more of the mega-IRAs that Neal and other Democrats decry.

The costliest provision in Secure 2.0 — clocking in at $9.6 billion over the next decade — is an increase in the threshold age for required minimum distributions. Under current law, taxpayers must begin to take withdrawals from their 401(k)s and traditional IRAs at age 72. (It had been 70½ before Secure 1.0, signed into law by President Donald Trump in 2019, raised the age by a year and a half.) Secure 2.0 would bump that up to age 75. The change would mean that taxpayers with supersize IRAs could enjoy three extra years of tax-free growth before they needed to take money out. Lower-income retirees wouldn’t benefit because they don’t have the luxury of holding off on withdrawals, which they need to cover living expenses.

Another provision would lift the cap on 401(k) catch-up contributions at ages 62, 63 and 64 from $6,500 to $10,000. Factoring in employer matching contributions, that would raise the maximum 401(k) inflow to $71,000 per year. In theory, catch-up contributions are supposed to help people who couldn’t save much until later in life. But if lawmakers were genuinely concerned about retirement security for people who need it, they wouldn’t start by aiding taxpayers who can afford to save more each year than most Americans earn. The higher limit on catch-up contributions will simply allow high-income taxpayers to race further ahead.

There are, to be sure, scattered provisions of Secure 2.0 that would modestly boost retirement savings among some low- and middle-income workers. For example, the bill instructs the treasury secretary to “increase public awareness” of the retirement savers’ credit, which offers up to $1,000 to workers who contribute to IRAs and 401(k)s. The bill also tweaks the parameters of the credit so that more middle-income households can claim it.

But Secure 2.0 doesn’t fix the most significant flaw in the savers’ credit: the fact that it’s nonrefundable. Workers can’t claim the full $1,000 unless they have at least $1,000 in tax liability. A head of household with two kids won’t hit that threshold until she has at least $38,505 in income (at which point she would be ineligible for the full credit anyway because her income is too high). The credit is, in this respect, another element of the swindle: On paper it looks like it’s designed to help lower-income individuals, but in practice it’s largely a ruse.

Another provision of Secure 2.0 that ostensibly helps lower-income Americans would require new 401(k) plans to enroll employees automatically. Unless an employee explicitly opts out, employers would have to deduct a steadily rising percentage of the employee’s paycheck — topping out between 10 and 15 percent — for contributions to the employee’s 401(k) account. That’s a questionable financial decision for many low-income taxpayers: Should, for example, a single parent with two young kids who is earning $15 per hour be putting 10 to 15 percent of her earnings into an account that she won’t be able to access until age 59½? But it’s catnip for asset management firms, which now would hold even more savings on which they could draw fees.

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The top-weighted benefits of Secure 2.0 might be tolerable if they were offset by other tax increases on the rich — if this were all just moving money from one deep pocket to another. But the items audaciously labeled as “revenue provisions” in the bill generate revenue as real as Monopoly money.

One of these “revenue provisions” would give employers the option to make Roth contributions to employee 401(k) plans. Roths — named for the late senator William Roth (R-Del.) — offer a variation on traditional IRAs and 401(k)s. In the traditional arrangement, contributions are deductible but distributions are taxed at ordinary rates. In a Roth, there is no deduction for contributions, but money in the account (including gains) can be withdrawn tax-free after the taxpayer reaches age 59½.

As long as tax rates remain constant, Roth and traditional accounts produce the same amount of revenue in present value terms, a result known as the Cary Brown theorem in honor of the MIT economist who demonstrated it. But there’s a twist: The Joint Committee on Taxation, which produces official revenue estimates for tax bills, publishes projections for only a 10-year budget window. Through that lens, Roth contributions look better because the upfront taxes appear within the 10-year window, while the revenue losses from tax-free withdrawals do not. The Rothification provisions in Secure 2.0 bring $35 billion of revenue into the 10-year window — ostensibly offsetting the cost of the bill’s giveaways — but the $35 billion is pure make-believe: It comes at the expense of an equivalent amount of revenue down the road.

Nonetheless, Rep. Vern Buchanan (R-Fla.), one of Secure 2.0’s promoters, praised the bill as “completely budget neutral” — either because he thought he could play voters for fools or, perhaps, because he was fooled himself. The question now is whether Buchanan’s fellow Republicans can fool fiscal conservatives into thinking that they really care about the deficit — and whether Democratic lawmakers can fool their base into thinking that they genuinely care about wealth inequality. If lawmakers from either party were truly concerned about the plight of low-income retirees, they would focus on strengthening Social Security, which actually provides a safety net for older people, rather than adding more deficit-financed bells and whistles to retirement accounts for the rich.

The era of tax-incentivized saving for retirement is nearly half a century old, and for all that time, Congress has showered high-income savers with generous benefits while paying lip service to the working class. The old adage says you can’t fool all of the people all of the time. Bipartisan retirement “reform” puts that to the test.

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