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.