Compliance February 14, 2012

401(k) Tax Advantages Cost Government $50B Annually

The current tax treatment of 401(k) plans costs the U.S. Department of Treasury between $50 and $70 billion per year, says a recent analysis.
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In an Issue Brief from the Center for Retirement Research (CRR) at Boston College, researchers said this loss cannot be calculated simply by looking at the numbers on a cash basis, because the 401(k) tax advantage is a deferral, not a permanent exclusion. The correct approach is to calculate the present value of the revenue foregone, net of the present value of future tax payments, with respect to contributions made in a given year. 

The CRR noted that the precise number depends importantly on the assumed rate of return and on whether workers face lower rates in retirement. The value of the tax expenditure is also sensitive to how capital income is taxed outside of 401(k)s. “With realized capital gains and dividends taxed at a maximum of 15%, the relative advan­tage of 401(k)s has declined sharply,” the report said. 

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Recent deficit reduction commissions have pro­posed capping the contribution eligible for favorable tax treatment at $20,000 or 20% of income. Others have proposed replacing the deduction with a government match. Such changes would reduce the attractiveness of 401(k)s for high earners.  

On the other hand, the CRR said, the accompanying proposals to tax divi­dends and capital gains at the rates applied to ordi­nary income would enhance the value of the favorable tax provisions. 

The Issue Brief can be downloaded here.

Data & Research February 14, 2012

Home-Related Costs Top Retirement Expenditures

Americans age 50 and older spend less in retirement than in their working years, and home-related expenses remain their most expensive items.
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Health costs are the second-biggest expense for older Americans, according to a report by the Employee Benefit Research Institute (EBRI).  Healthcare is the only spending category that steadily increases with age.

Data show that demographic sub-groups such as singles, blacks, and high school dropouts are outspending their resources in retirement. The EBRI report notes that before retirement, people pay FICA (Social Security) taxes, incur work-related expenses, and set aside money for retirement. But after retirement, most people have different financial obligations, and, as a result, retirees may be able to maintain their level of preretirement well-being with very different income levels.

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On average, retired households spend about 80% of what working households spend, and their earnings are about 57% that of working households. Household consumption steadily declines with age. Specifically, declining health limits activities and consumption of different goods, which strongly affect the decline in total expenditure.

The full article, “Expenditure Patterns of Older Americans, 2001‒2009,” documents the income and expenditure patterns of Americans who are retired or close to retirement, using data from the Health and Retirement Study (HRS) and its supplement Consumption and Activities Mail Survey (CAMS). Both surveys were conducted by the Institute for Social Research at the University of Michigan.

The EBRI analysis examines income, expenditures, and wealth-holding patterns to provide a more complete idea of how people are doing in terms of being able to afford retirement, compared with arbitrary estimates such as income replacement ratios.

The full article, “Expenditure Patterns of Older Americans, 2001‒2009,” appears in the February 2012 EBRI Issue Brief.
 

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