Challenging the Conventional Wisdom on Retirement Benefits

By Andrew Remo • January 22, 2016 • 0 Comments
Economists and retirement policy wonks gathered at a Washington D.C. think tank Jan. 20 for a presentation and discussion about the distribution of retirement benefits.

The discussion focused on new research from Peter Brady, a senior economist at the Investment Company Institute, that examined the distribution of benefits in our retirement system. Brady led the discussion by explaining his research methodology and findings, which are detailed in a new book, How America Supports Retirement: Challenging the Conventional Wisdom on Who Benefits.

Brady’s key argument is that the distribution of the benefits in the U.S. retirement system is progressive as expressed through the present value of lifetime benefits (combining the Social Security program and individual savings in tax-advantaged vehicles) as a percentage of the present value of lifetime total compensation. He also argues that the main reason high income earners benefit more from the retirement savings tax deferral is not because of their higher tax rates, but because the limits of the progressive Social Security benefit schedule compel the wealthy to save more money in tax-advantaged vehicles in order to hit their target income replacement rate in retirement.

The event also included presentations from Bill Gale, an economist with the Brookings Institution, and Alan Viard, a resident scholar at the American Enterprise Institute (the organization which hosted the event). These presentations were designed to highlight some criticisms of Brady’s research, a format typical of an academic peer review.

While not disputing Brady’s analytics, Gale challenged some of Brady’s conclusions, arguing that the wealthy disproportionally benefit from the current system in absolute terms, even though the average net benefit (as a percentage of lifetime benefits versus earnings) is progressive. Gale also criticized Brady’s assumption in his simulation model that all income earners have access to a 401(k) plan with an employer match throughout their entire working career. Gale argued that, in reality, most low-income workers do not have access to such a generous workplace based retirement plan.

Therefore, Gale believes that Brady’s model likely overstates the benefit of the retirement savings tax deferral for lower income workers. Gale has previously advocated replacing the current tax preferences for 401(k)s with flat rate refundable tax credits (see “Tax Reform Options: Promoting Retirement Security” and an analysis of that impact by the Employee Benefit Research Institute in “Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances.”)

Viard and Gale both suggested that the true focus of the value of retirement tax deferral should be on whether the incentive actually increase the total level of savings of individuals instead of how the tax benefits are distributed. Gale believes that the retirement tax deferral does not increase the total level of savings of the wealthy. Instead, Gale, citing a 2013 Raj Chetty paper examining savings behavior in Denmark, argued that the wealthy in America use these vehicles as a tax shelter. The applicability of that analysis to the U.S. population and retirement system has, however, been challenged (see “Tax Preferences and Mandates: Is the Danish Savings Experience Applicable to the United States?” and “Missed Behaviors."

Andrew Remo is the American Retirement Association’s Director of Congressional Affairs.