BOSTON (CN) — Joe Biden wants to attack income inequality in a place that few people think about: retirement income. And if he wins, he could dramatically change the way that all Americans plan for retirement.
Biden believes that the current model of retirement savings — workers contributing part of their paychecks to tax-deferred accounts such as 401(k)s and IRAs — gives an outsized break to affluent people who would save anyway and who are already in the best position to retire comfortably. He wants to eliminate the tax deferral and come up with a brand-new model that would “equalize benefits” for lower-income families.
Biden also wants to tax virtually all inheritances, even for poor people. Rather than encouraging family wealth transfers as a form of retirement planning, he wants to increase Social Security benefits, another tactic that would make everyone’s income in retirement more equal.
This will allow “working- and middle-class Americans … to retire with dignity,” Biden says on his website.
Biden’s 401(k) proposal would work a dramatic change in retirement saving. Currently, workers can contribute part of their income to a 401(k) plan and not pay any income tax on that portion. They will have to pay tax when they eventually withdraw the funds, but at that point they will presumably be in a lower tax bracket.
The deferral primarily benefits affluent employees because they have a higher current income tax rate and thus save more in taxes when they put money aside.
“This system provides upper-income families with a much stronger tax break for saving and a limited benefit for middle-class and other workers with lower earnings,” Biden said. “The Biden Plan will equalize benefits across the income scale.”
About two-thirds of current retirement-plan tax benefits go to the wealthiest 20% of families, a Biden position paper states.
Biden doesn’t spell out exactly how he would fix this, but a likely idea is a Brookings Institution plan that would replace the tax deduction with a flat-rate refundable credit that would be deposited into savers’ accounts rather than issued as a refund. The result is that everyone would get the exact same tax benefit from adding money to an account.
In terms of encouraging saving, the current system provides a “relatively low bang for the buck” because most households have a low marginal rate and so the benefit of contributing to a 401(k) plan is not very great, said William Gale, the author of the Brookings proposal.
And for high earners, contributions “are more likely to represent funds that are reshuffled from existing savings to take advantage of the tax benefit rather than a new net addition to saving,” Gale said.
If Biden’s plan looks likely to be enacted, people in higher tax brackets should immediately put as much money as they can into their 401(k)s to maximize their tax break before it disappears, recommended Charles Trzcinka, a finance professor at Indiana University.
While Gale thinks the wealthy would save anyway, Trzcinka thinks that’s not necessarily the case. “If you give wealthy people less incentive to save, that could have a very big effect on capital formation,” he said, because rich people’s 401(k)s “have a disproportionate effect on the markets.”
Another issue is that employers might stop offering 401(k)s altogether, warned Elizabeth Bauer, a Chicago-area actuary.
Although employers always claim that they want to help all their workers save for retirement, many are in fact primarily concerned to please their top managers. If 401(k) don’t offer managers a big tax benefit, many companies might simply scrap them and raise salaries instead or create a different perk.
Biden’s website also promises that “almost all workers without a pension or 401(k)-type plan will have access to an ‘automatic 401(k).’” A 401(k) plan is automatic if workers are enrolled and a default contribution is deducted from their paycheck unless they opt out.
According to the Census Bureau, 79% of Americans have access to a 401(k) but only 32% actually contribute to one.
The 79% figure is a bit misleading, though, because 401(k)s are almost exclusively a large-company phenomenon. The reality is that only 14% of employers offer such a plan; the remainder — almost entirely small businesses — find them too complex or expensive.
So Biden has promised to “offer tax credits to small businesses to offset much of the costs.” Again, the goal is to equalize retirement assets by making big-company options available to everyone.
But it’s not clear that small businesses will want to bother if they can’t offer their top earners a big tax break.
At the state level, at least nine states have been experimenting with automatic 401(k)s for workers whose companies don’t offer one. Many of these states have set up their own plan with a state-chosen vendor (or, in some cases, a marketplace of vendors) and employees who don’t have access to a private plan can be automatically enrolled unless they opt out.
In May 2017, Biden’s running mate Kamala Harris co-sponsored legislation that would protect these state-run plans under federal law.
It’s possible that Biden might try to federalize this idea, although there would be some disadvantages. One is that it could politicize the choice of a vendor, with the government potentially having an incentive to choose companies with appropriate political leanings or that offer investment choices in line with its own objectives such as heavy purchases of government bonds or “green energy” funds.
Also, the existence of a “public option” 401(k) could further encourage employers to scrap their own plans.
Although it seems like a good idea to encourage low-wage workers to save for retirement with an automatic program, the truth is that many poor people are in debt, said Bauer. It might be better for them to pay off high-interest loans rather than contributing to a retirement account, she said.
Another part of Biden’s plan is to increase the tax on inheritances. Estate taxes should be “raised back to the historical norm,” a recent “Unity Task Force” that included representatives of the Biden and Bernie Sanders campaigns stated.
It’s not clear what is meant by the historical norm since rates and exemption amounts have changed dramatically over the years. Currently the top rate is 40% and applies only to inheritances over $11.58 million, which means that only a very tiny fraction of people pay any tax.
As recently as the George W. Bush administration, however, the tax captured 55% of any inheritance over $675,000, a number that included not only investment accounts and personal property but also the value of real estate and in many cases life insurance proceeds. Such a reversion could cause significant numbers of middle-class people to be subject to the tax.
Of more concern to the less affluent is that Biden also wants to eliminate the step-up in basis. Currently, if someone inherits an asset and sells it, its “starting value” for calculating the capital gains tax is its value as of the date the deceased person died, not its value when the person originally bought it. The original value is “stepped up” to the date-of-death value.
Eliminating this rule would significantly increase the capital gains tax on almost all inherited assets. And unlike the estate tax, which only hits people above a fairly high wealth level, the capital gains tax would apply to anyone who inherits anything at all, even people with limited means.
Biden has not made clear how this would work. One option is that anyone who receives an inheritance would have to pay tax immediately on any unrealized capital gain. This idea was proposed last year by Senator Cory Booker and is the norm in Canada, where there is no estate tax but an inheritance is treated as a sale for capital gains purposes.
The other option is “carryover basis,” where no tax is due right away but an heir who sells an asset later will have to pay tax based on the original purchase price.
Biden sees the step-up as a loophole that allows rich people to pass appreciated assets to their children while avoiding a hefty tax.
But eliminating the step-up could create administrative problems because it would be necessary to prove what a deceased person paid for an asset many years earlier. The deceased person might not have kept good records and it would be too late to ask him or her about it.
“Most people are not meticulous recordkeepers,” said Bauer. “It seems like a nightmare to try to identify the original purchase price from something you’ve inherited.”
Trzcinka called eliminating the step-up “crazy” and “a big, big burden on a lot of working-class families.” If family members can’t find financial records from decades earlier, they might have to claim a zero basis and “people are going to get hammered,” he said.
Trzcinka called the Biden proposal “anti-family” because “you’re punishing people for being willing to save for their kids.”
Bauer worries that eliminating the step-up will especially harm lower-income people because they’re less likely to have accountants and financial advisors who keep careful records as a matter of course.
She also said that the proposal unfairly punishes families with assets such as houses or farms that have appreciated over many years simply due to inflation. She suggested taxing only the amount of capital gain in excess of the inflation rate.
On the other side of the scale, Biden is promising larger Social Security payments. He would boost benefits for surviving spouses, certain public employees and people who have been collecting payments for more than 20 years; raise the minimum benefit to 125% of the poverty line; and adopt a more liberal measure for cost-of-living adjustments. He would also reduce the penalty that wage-earners experience when they take time off to care for family members.
Trzcinka worries that the Social Security program is already in danger of running out of funds in another decade or two. But he said Biden’s proposals would help poorer people who need it most and in the scheme of things, “having big benefit increases on the low end is not that much money.”
Increasing Social Security is another way in which Biden wants to equalize retirement income and offers a buffer against the stock market, which Biden likes to minimize as an element of retirement planning.
“There is very little correlation between the health of the stock market and the quality of life for the vast majority of middle-class and working-class and poor folks,” Biden said recently. “They’re just almost totally disconnected.”