A Biden campaign pledge to make employer-sponsored plans more equitable is driving the conversation. While Biden’s team hasn’t offered many details, some observers believe a Biden administration would favor changing retirement plan tax benefits to the benefit of lower-income workers.
Skeptics worry this would depress retirement savings overall and lead to higher taxes for upper middle-class Americans (although this would also break a separate Biden campaign pledge).
But the argument’s fervency belies its import. Even if a Biden administration redistributes the tax benefits of retirement savings away from higher earners to lower ones, your retirement savings are unlikely to change radically. And this pales in comparison to larger issues, such as getting more Americans to actually enroll in retirement savings plans in the first place.
“The language used makes it seem like a hot button issue,” said Alicia Munnell, director of retirement research at Boston College. “But it’s not going to upend the 401(k) system.”
Biden’s Pledge to “Equalize Benefits” Sparks Debate
Tucked away on the Biden campaign website is an extended list of proposals to improve the lives of older Americans. One bullet point states that if Biden were elected president, he would “equalize benefits across the income scale, so that low- and middle-income workers will also get a tax break when they put away money for retirement.”
As it stands, a raft of tax deductions incentivize Americans to contribute money to their employer-sponsored retirement plans. Let’s say you’re in the 24% marginal tax bracket and save $5,000 annually in your company’s 401(k) plan. That money goes into your 401(k) account before income taxes are assessed, saving you around $1,200 a year in taxes.
This incentive structure gives high earners a bigger tax break. Someone in the 37% bracket saves more tax dollars than someone in the 12% bracket. That same $5,000 401(k) contribution saves $1850 in federal income tax for someone in the 37% bracket, but just $600 for someone in the 12% bracket.
Observers Guesstimate Biden’s 401(k) Plan
Since the Biden campaign hasn’t fleshed out its cryptic pledge, policy wonks presume it means his administration would build on past proposals and replace the current tax deduction with a flat tax credit. Some have already made back-of-the-envelope calculations to guesstimate the size of a tax credit needed to actually “equalize benefits.”
Both the Tax Foundation and the Tax Policy Center estimate that any new tax credit would need to be about 26% to satisfy Biden’s desire to change the system without adding to or subtracting from how much the government spends on retirement savings tax incentives—to be “revenue neutral” in Washington speak.
Another way to look at the 26% tax credit is how it would equalize the value of a tax deduction. Instead of getting to deduct that $5,000 401(k) contribution against their personal marginal tax rate—be it 12%, 24% or 37%—everyone would get to deduct their 401(k) contribution at the same 20.5% marginal tax rate, calculates Garrett Watson, a senior policy analyst at the Tax Foundation. So a $5,000 401(k) contribution would save all workers the same $1,025 in taxes.
That means workers whose annual income push them into higher brackets—more than approximately $80,000 for married families filing jointly—would potentially face higher taxes, while those earning less than this amount would save more in taxes. Moreover, the tax credit would be refundable, so lower income workers who owed less in taxes than the value of the credit would actually get money back from the IRS.
“By and large, it would help lower- and middle-income people save more,” said Eric Toder, co-director of the Tax Policy Center. “And its effects on the decision to save would not be significant for those on the upper end.”
Getting more people to save for retirement would go a long way toward improving retirement security for millions of Americans. More than three quarters of taxpayers who earn more than $100,000 have contributed to a retirement plan, per the Tax Foundation, compared to about 60% of those making between $50,000 and $75,000.
And the vast majority of retirement holdings belong to the richest Americans. As of 2016, for those middle-income earners who had retirement accounts, the median value of those accounts was $25,000, according to the Federal Reserve’s Survey of Consumer Finances. That compares to more than $400,000 for the top 10% of earners with retirement accounts.
Biden’s Campaign Promise on Taxes
While redistributing the tax benefits of retirement savings may seem in line with Biden’s aims, it might run afoul of another campaign promise: No new taxes on families earning less than $400,000.
“The prospect of reducing benefits for people who are higher earners is going to be hard,” said Watson. “This would not just be on the 1%—people in the middle class might see a slight reduction in their retirement (tax) benefits.”
Using the current tax bracket, married households filing jointly in the 22%, 24% and 32% brackets—most of whom earn less than $400,000—might receive lower tax savings when they contribute to their 401(k), thus increasing their tax bill.
Still, Biden’s official plan is vague on details. A Biden adviser told the Washington Post, “…[i]n our retirement proposal, we would hold harmless those below $400,000.” To achieve that, though, Biden would likely have to move away from a revenue neutral plan, either adding to the deficit, or increasing taxes elsewhere.
These trade-offs and complications are why Lance Schoening, director of government relations at the financial investment management company Principal, would prefer a Biden administration focus on tweaking the retirement savings tax incentives, rather than overhauling the system.
“The focus should be on how to make the existing system better,” Schoening said.
Biden’s Retirement Policy Platform in Context
In the context of recent history, Shoening’s skepticism makes sense. Former President Obama abandoned his plans to limit the tax breaks for college savings 529 plans, which tend to go to higher earning families, in order to pay for more generous tax credits for poorer Americans.
The initial deduction-to-credit proposal went nowhere when it was introduced almost a decade ago, and even an idea floated by House Republicans to limit how much you can save in a 401(k) tax free was ultimately abandoned.
A new Biden administration may simply want to avoid a narrow fight on who gets what tax benefits, and redouble efforts instead on policies that would have a bigger impact .
“It’s a relatively small deal,” said Munnell, who thinks policies that mandate employers enroll workers in a retirement savings account would be more impactful.
To his credit, Biden supports such a requirement. He also wants to increase Social Security benefits, lower the Medicare eligibility age, and to raise taxes to help pay for it.
Biden will likely spend his political capital on those policies, rather than picking a bitter fight with the investment industry that’ll ultimately alienate small businesses and upper middle class voters all for a proposal that won’t make Americans retirement prospects that much more secure.