High income employees receive the majority of the tax benefits of 401(k)s, according to a new Government Accountability Office report. The analysis found that 401(k) tax benefits accrue primarily to highly paid employees and do relatively little to help lower income workers save for retirement.
Only about half of the private sector workforce has access to any type of retirement benefits at work, with low income workers being the least likely to be offered the opportunity to participate. And even when a plan is available, smaller paychecks limit the ability of low income workers to participate in a 401(k) plan and capture the valuable tax benefits.
Employees can contribute up to $16,500 to a 401(k) in 2011, or $22,000 if they are age 50 or older. But only workers who can afford to contribute that much fully take advantage of the tax break. Only about 5 percent of more than 40 million 401(k) participants contribute at or above these limits for tax deferred contributions. Most of the participants whose contributions are at or above the limits (72 percent) are high earners bringing home $126,000 or more per year. Less than 1 percent of those who earn less than $52,000 annually are able to fully take advantage of the tax deferral, GAO found.
Those who maximize the tax break have a median account balance of $175,000, compared to a median balance of $23,000 for those who contribute below the limit. Households that capture the entire tax break are also much more likely to have plenty of other assets including checking accounts, savings accounts, houses, IRAs, and stocks than retirement savers overall. For example, 65 percent of those contributing at or above the limit also have an IRA, compared to 29 percent of those contributing below the annual maximum.
The limit on 401(k) contributions has increased from $10,500 in 2001 to $16,500 in 2011. The option to make catch-up contributions of up to $5,500 in 2011 at age 50 or older was added to 401(k) plans to help older workers, particularly women, catch up in saving for retirement. But whenever the tax deductible limit on 401(k) contributions is increased, it is primarily only high income households that take advantage of it, GAO found.
Most people who make catch-up contributions already have relatively large account balances. The median account balance for those contributing at or above the catch-up contribution limit is $340,000, compared to a median account balance of just $51,000 among all 401(k) participants age 50 and older. “The additional $5,500 contribution permitted to participants 50 and older may not allow moderate income workers to catch up anytime soon,” according to the GAO report. “A disproportionate share of these tax incentives accrues to higher income earners.” And far more older men than women utilize catch-up contributions. Over three quarters of older employees who make catch-up contributions are men.
The American Society of Pension Professionals and Actuaries (ASPPA) disagrees with the GAO report conclusions. “401(k) plans have proven to be incredibly successful at getting moderate income workers to save,” according to ASPPA executive director Brian Graff. “These plans are subject to stringent nondiscrimination rules that are a part of the tax code and were designed by Congress to make sure these plans provide benefits fairly to everyone.”
There are some provisions of 401(k) plans specifically aimed at low income workers. Retirement savers with a modified adjusted gross income of less than $28,250 ($56,500 for couples) in 2011 may be able to claim the saver's credit. This nonrefundable tax credit can be used to reduce the federal income tax you pay by up to $1,000 for individuals and $2,000 for couples.
Retirement tax incentives are the second largest income tax expenditure, according to the Office of Management and Budget. They are expected to cost the federal government approximately $105.1 billion in fiscal year 2011 and a total of $602.2 billion in fiscal years 2012 through 2016. The saver’s credit for low income retirement savers is estimated to account for $1.4 billion of that amount in 2011.