Cutting Retirement Plan Tax Break Would Hurt Low-Income Workers Most: EBRI Survey

EBRI noted that several proposals have surfaced to reform the 401(k) system in recent years. These have been based on the assumption that higher-income individuals receive more tax-related benefits from these programs than do individuals in lower marginal tax brackets (as well as those who may pay no federal income taxes in a particular year). Some of these proposals have included modifications of the current federal income taxation treatment that excludes some or all of the contributions employees make to tax-qualified defined contribution plans.

From a strictly financial perspective, VanDerhei said, it is logical to assume that the lower-income individuals (those most likely to pay no or low marginal tax rates and therefore have a smaller financial incentive to deduct retirement savings contributions from taxable income) would be least likely to rate the exclusion of employee contributions for retirement savings plans from taxable income as "very important."  

However, the RCS data show that those in the household income category of $15,000 to $25,000 actually have the largest percentage of respondents classifying the tax deductibility of contributions as very important. VanDerhei said that although higher-income workers would be the most likely to be negatively affected by a reduction or elimination of the exclusion of employee contributions for retirement savings plans from taxable income, behavioral economics has shown that workers' reaction in similar situations are often at odds with what would have been logically predicted.

The EBRI analysis notes that determining the overall tax advantage of making before-tax contributions to a 401(k) plan involves the prediction of several factors, including amounts and timing of contributions, marginal tax rates during the accumulation and decumulation periods, rates of return and withdrawal behavior during the decumulation period.

EBRI reported other findings:

• Results by savings level:Of the full-time workers who are currently saving for retirement who report that they currently have less than $1,000, 71.3% say they would reduce the amount saved. This value declines to 38.8% for those with savings between $1,000 and $10,000.
• Results by education level: Approximately 32% of high school graduates indicate they would reduce savings, whereas only 22% of those with a graduate or professional degree have a similar response.

EBRI is a private, nonprofit research institute based in Washington, D.C., that focuses on health, savings, retirement, and economic security issues. The organization does not lobby and does not take policy positions.