Will U.S. Kick 401(k) Subsidies Off Cliff?

At a time of nearly desperate negotiations to find savings needed to avert the fiscal cliff, ending the taxpayer subsidy–to the tune of $100 billion–of retirement savings accounts seems to many to be a no-brainer.

After all, a comprehensive and authoritative new study estimates that each dollar spent on the subsidy results in just a penny in increased savings. The study by U.S. and Danish researchers looked at Denmark’s retirement system because it is similar to ours and because the Danish government keeps far more detailed data on saving patterns.

Conducted by Harvard economists Raj Chetty, recipient of the MacArthur Foundation’s 2012 genius grant, and John Friedman, together with a team of Danish economists, the study found that only a segment of savers–those who are wealthiest–respond to tax subsidies.

But while this affluent cohort increases its retirement savings in response to subsidies, they reduce the amount they save in outside retirement accounts by almost the same amount.

Q.E.D., right? Harvard has apparently mustered ample evidence to demonstrate the futility of this particular subsidy, and Washington has achieved a sizable budget savings that presumably both parties can agree on; Republicans after all are looking to eliminate tax subsidies and Democrats are seeking to end favors for the rich, who derive the most benefit from the subsidy.

Alas, sometimes (maybe lots of times) the perspective of Main Street differs from the Ivory tower of Cambridge, Mass., or the ivory rotunda of Washington, D.C.

In an interview with AdvisorOne published Wednesday, Brett Goldstein, director of retirement planning for American Investment Planners in Jericho, N.Y., warned that small business owners of the kind his Long Island firm serves were likely to just shutter their 401(k) plans if contributions are capped.

“You can contribute to an IRA up to $6,500 and put the rest in an annuity. And you can save on administration costs and save on matching,” Goldstein said.

At least one academic, University of Illinois professor Jeffrey Brown, shared this real-world worry about ending tax preferences for 401(k) plans.

Blogging for the school’s Center for Business and Public Policy, Brown commended his Harvard colleagues’ empirical findings but cautioned that the large tax subsidy is precisely what motivates employers to offer retirement benefits to their employees.

Brown’s insight matches both the Harvard study–which says only a small cohort of the wealthiest people respond to tax incentives–as well as Goldstein’s Main Street perspective that his clients are likely to just shutter their plans. (Indeed, Goldstein remarked that that’s precisely what happened the last time Congress cut 401(k) subsidies in 1986, after which contributions fell 70%.)

Given that America’s retirement system is employer-based, Brown argues that employers need a “compelling financial reason” to offer their employees retirement benefits.