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Title text here
US Tax Benefits for Retirement Saving:
Who Benefits and Why?
January 25, 2016
David C. John
Senior Strateg...
Coming Attractions
• What is the Purpose of Tax Benefits?
• Context: Quick Overview of the US System
• Traditional Treatme...
What Is the Purpose of Tax Benefits
for Retirement Saving?
• To encourage people to save or save more?
• To increase savin...
US Tax System
• Extremely complex
• 7 marginal tax brackets between 10% and
39.6%. Also capital gains.
• Standard deductio...
US Retirement System
• Social Security based on wage indexed lifetime earnings
– Benefits increase annually by prices
– Av...
Traditional (EET)
• Reduces taxable income & shows a deduction
on paycheck. Assumes lower tax bracket in
retirement.
• No ...
Traditional (EET) - Benefits
• Easy to understand. Benefit can be seen
throughout the year.
• Deduction is an incentive to...
Traditional (EET) - Negatives
• Size of benefit depends on marginal tax rate.
• If taxpayer has no tax liability, he or sh...
Traditional (EET) – Government
Finance
• Reduces revenue today – extremely visible &
quantifiable (both now and in the fut...
Roth (TEE)
• Created in 1997. Contributions after tax up to
contribution limits. All internal buildup and
withdrawals tax ...
Roth (TEE) - Benefits
• Simple to understand.
• No tax ever on internal buildup.
• Lower income do get a benefit.
• Upper ...
Roth (TEE) - Negatives
• Upper income can use loophole for unlimited
Roth benefit.
• No immediate savings incentive – espe...
Roth (TEE) – Government Finance
• Appears to produce more immediate
government income.
• Tax never collected on internal b...
Savers Credit
• Special additional benefit for lower income
savers regardless of tax treatment.
• Provides 50% of up to $2...
Problems with the Savers Credit
• Few claim the credit or know about it.
• Most eligible have no tax liability & use
short...
A Better Version
• Simple credit available on short tax forms
regardless of tax liability.
• Provides 50% credit for contr...
New Version - Positives
• Actually benefits population it is intended to
help.
• Builds savings balances and increases
ret...
New Version - Negatives
• Revised savers credit has a high budget cost –
up to $20 billion/year.
• Savers may not understa...
Do Tax Benefits Increase Saving?
• There is evidence that 85% of retirement
savers are passive & only 15% are actively
inv...
What About the Wealthy?
• Very upper income savers reallocate savings
according to tax incentives. They do not
change the ...
Title text here
Contact Us:
David C. John
Senior Strategic Policy Advisor
djohn@aarp.org
AARP Public Policy Institute
www....
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David John, Senior Senior Strategic Policy Adviser at AARP’s Public Policy Institute - US Tax benefits

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In July 2015, the Government began a consultation on changing how the UK incentivises private pension saving, and the Chancellor is expected to respond to this consultation in the Government’s annual Budget in March 2016.

The Future of Private Pension Saving, kindly supported by Age UK, brought together Parliamentarians, business, academics and industry experts to discuss how best the UK Government can incentivise private pension saving.

The debate was opened by initial remarks from Angela Rayner MP (Shadow Pensions Minister), Jackie Wells (Head of Policy and Research, Pensions and Lifetime Savings Association), Sarah Luheshi (Deputy Director, Pensions Policy Institute), and Yvonne Braun (Director, Long-Term Savings Policy, Association of British Insurers).

On Wednesday 27th January, David John, Senior Strategic Policy Adviser at AARP’s Public Policy Institute, and Deputy Director of the Retirement Security Project at the Brookings institute delivered a presentation on tax incentives for pension saving in the US context at an informal reception hosted by Age UK.

Discussions from this event contributed to a formal representation to the HM Treasury regarding Government policy on pensions tax relief and private pension saving.

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David John, Senior Senior Strategic Policy Adviser at AARP’s Public Policy Institute - US Tax benefits

  1. 1. Title text here US Tax Benefits for Retirement Saving: Who Benefits and Why? January 25, 2016 David C. John Senior Strategic Policy Advisor AARP Public Policy Institute
  2. 2. Coming Attractions • What is the Purpose of Tax Benefits? • Context: Quick Overview of the US System • Traditional Treatment (EET) • “Roth” Treatment (TEE) • Savers Credit & A Better Savers Credit • Comparing results • Do Tax Benefits Incentivize Saving?
  3. 3. What Is the Purpose of Tax Benefits for Retirement Saving? • To encourage people to save or save more? • To increase savings balances (& thus retirement income)? • Both?
  4. 4. US Tax System • Extremely complex • 7 marginal tax brackets between 10% and 39.6%. Also capital gains. • Standard deduction + personal exemption + itemized deductions reduce taxable income • 43% pay no net income tax • Also FICA (Social Security & Medicare) + state & local income taxes
  5. 5. US Retirement System • Social Security based on wage indexed lifetime earnings – Benefits increase annually by prices – Average benefit about $16,000 – range $5k to $35k • Few private sector DB plans • Both EET and TEE retirement savings plans available • About half have employer-sponsored plans • Rest can save in Individual Retirement Accounts (IRAs) – Only about 1-in-20 actually do • Funds can be accessed early (may be a tax penalty) • No tax-free lump sum and few annuitize
  6. 6. Traditional (EET) • Reduces taxable income & shows a deduction on paycheck. Assumes lower tax bracket in retirement. • No income limit in employer or individual plan. • Withdrawals before age 59½ taxable + 10% penalty.
  7. 7. Traditional (EET) - Benefits • Easy to understand. Benefit can be seen throughout the year. • Deduction is an incentive to save for all income levels regardless of actual benefit. • Deduction especially valuable if no employer plan.
  8. 8. Traditional (EET) - Negatives • Size of benefit depends on marginal tax rate. • If taxpayer has no tax liability, he or she gets no real benefit. • Wealthy get much more; low income get no real value. • Benefit increases consumable income – not savings.
  9. 9. Traditional (EET) – Government Finance • Reduces revenue today – extremely visible & quantifiable (both now and in the future). • Tax deferral, not tax exempt. Most lost income eventually recaptured. • Taxes on internal buildup are collected.
  10. 10. Roth (TEE) • Created in 1997. Contributions after tax up to contribution limits. All internal buildup and withdrawals tax free. • No tax on early withdrawal of contributions. • Roth IRA only available up to annual incomes of $114,000 (single). Roth employer plans available to all income levels. • Income limit to keep wealthy from using it as a tax shelter.
  11. 11. Roth (TEE) - Benefits • Simple to understand. • No tax ever on internal buildup. • Lower income do get a benefit. • Upper incomes get an even greater benefit. • Especially used by upper income and upwardly mobile younger white collar workers.
  12. 12. Roth (TEE) - Negatives • Upper income can use loophole for unlimited Roth benefit. • No immediate savings incentive – especially for lower incomes. • As contributions reduce consumption income, contributions & participation may decline.
  13. 13. Roth (TEE) – Government Finance • Appears to produce more immediate government income. • Tax never collected on internal buildup. Foregone future revenue may be huge & growing. • Wealthy can use to shelter income & assets. • Tax benefit assumes that government keeps its word.
  14. 14. Savers Credit • Special additional benefit for lower income savers regardless of tax treatment. • Provides 50% of up to $2,000 contribution for incomes below $36k. Much lower matches up to family incomes of $61k. • Only offsets tax liability. If none, then no benefit is paid. Also, must be claimed on long tax forms.
  15. 15. Problems with the Savers Credit • Few claim the credit or know about it. • Most eligible have no tax liability & use shorter forms where Savers Credit is not available. • Credit comes as consumable payment. • No incentive to save as credit comes long after decision has been made.
  16. 16. A Better Version • Simple credit available on short tax forms regardless of tax liability. • Provides 50% credit for contributions that goes directly into the account. Not available for early withdrawal. • Deposited into the same investment choice as rest of account.
  17. 17. New Version - Positives • Actually benefits population it is intended to help. • Builds savings balances and increases retirement incomes. • Easy to claim. Can be automatic in tax software. • Growing balance is an incentive to save.
  18. 18. New Version - Negatives • Revised savers credit has a high budget cost – up to $20 billion/year. • Savers may not understand that they cannot use early withdrawal for match.
  19. 19. Do Tax Benefits Increase Saving? • There is evidence that 85% of retirement savers are passive & only 15% are actively involved. • Passive savers react to automatic enrollment much more than tax incentives. • Active savers react to tax incentives, BUT… – Chetty, Friedman, et al., ACTIVE VS. PASSIVE DECISIONS AND CROWD-OUT IN RETIREMENT SAVINGS ACCOUNTS: EVIDENCE FROM DENMARK
  20. 20. What About the Wealthy? • Very upper income savers reallocate savings according to tax incentives. They do not change the amount saved, just where it goes. • Lower income savers are more likely to react to a change in take home income. • They save due to automatic enrollment, but little data on auto into TEE accounts. May stop if they see a significant drop in income.
  21. 21. Title text here Contact Us: David C. John Senior Strategic Policy Advisor djohn@aarp.org AARP Public Policy Institute www.aarp.org/ppi Twitter:@AARPpolicy www.Facebook.com/AARPpolicy Blog: www.aarp.org/policyblog

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