In July 2015, the Government began a consultation on changing how the UK incentivises private pension saving, and the Chancellor is expected to respond to this consultation in the Government’s annual Budget in March 2016. The Future of Private Pension Saving, kindly supported by Age UK, brought together Parliamentarians, business, academics and industry experts to discuss how best the UK Government can incentivise private pension saving. The debate was opened by initial remarks from Angela Rayner MP (Shadow Pensions Minister), Jackie Wells (Head of Policy and Research, Pensions and Lifetime Savings Association), Sarah Luheshi (Deputy Director, Pensions Policy Institute), and Yvonne Braun (Director, Long-Term Savings Policy, Association of British Insurers). On Wednesday 27th January, David John, Senior Strategic Policy Adviser at AARP’s Public Policy Institute, and Deputy Director of the Retirement Security Project at the Brookings institute delivered a presentation on tax incentives for pension saving in the US context at an informal reception hosted by Age UK. Discussions from this event contributed to a formal representation to the HM Treasury regarding Government policy on pensions tax relief and private pension saving.

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US Tax Benefits for Retirement Saving:
Who Benefits and Why?
January 25, 2016
David C. John
Senior Strategic Policy Advisor
AARP Public Policy Institute

2. Coming Attractions
• What is the Purpose of Tax Benefits?
• Context: Quick Overview of the US System
• Traditional Treatment (EET)
• “Roth” Treatment (TEE)
• Savers Credit & A Better Savers Credit
• Comparing results
• Do Tax Benefits Incentivize Saving?

3. What Is the Purpose of Tax Benefits
for Retirement Saving?
• To encourage people to save or save more?
• To increase savings balances (& thus
retirement income)?
• Both?

4. US Tax System
• Extremely complex
• 7 marginal tax brackets between 10% and
39.6%. Also capital gains.
• Standard deduction + personal exemption +
itemized deductions reduce taxable income
• 43% pay no net income tax
• Also FICA (Social Security & Medicare) + state
& local income taxes

5. US Retirement System
• Social Security based on wage indexed lifetime earnings
– Benefits increase annually by prices
– Average benefit about $16,000 – range $5k to $35k
• Few private sector DB plans
• Both EET and TEE retirement savings plans available
• About half have employer-sponsored plans
• Rest can save in Individual Retirement Accounts (IRAs)
– Only about 1-in-20 actually do
• Funds can be accessed early (may be a tax penalty)
• No tax-free lump sum and few annuitize

6. Traditional (EET)
• Reduces taxable income & shows a deduction
on paycheck. Assumes lower tax bracket in
retirement.
• No income limit in employer or individual
plan.
• Withdrawals before age 59½ taxable + 10%
penalty.

7. Traditional (EET) - Benefits
• Easy to understand. Benefit can be seen
throughout the year.
• Deduction is an incentive to save for all
income levels regardless of actual benefit.
• Deduction especially valuable if no employer
plan.

8. Traditional (EET) - Negatives
• Size of benefit depends on marginal tax rate.
• If taxpayer has no tax liability, he or she gets
no real benefit.
• Wealthy get much more; low income get no
real value.
• Benefit increases consumable income – not
savings.

9. Traditional (EET) – Government
Finance
• Reduces revenue today – extremely visible &
quantifiable (both now and in the future).
• Tax deferral, not tax exempt. Most lost
income eventually recaptured.
• Taxes on internal buildup are collected.

10. Roth (TEE)
• Created in 1997. Contributions after tax up to
contribution limits. All internal buildup and
withdrawals tax free.
• No tax on early withdrawal of contributions.
• Roth IRA only available up to annual incomes
of $114,000 (single). Roth employer plans
available to all income levels.
• Income limit to keep wealthy from using it as a
tax shelter.

11. Roth (TEE) - Benefits
• Simple to understand.
• No tax ever on internal buildup.
• Lower income do get a benefit.
• Upper incomes get an even greater benefit.
• Especially used by upper income and
upwardly mobile younger white collar
workers.

12. Roth (TEE) - Negatives
• Upper income can use loophole for unlimited
Roth benefit.
• No immediate savings incentive – especially
for lower incomes.
• As contributions reduce consumption income,
contributions & participation may decline.

13. Roth (TEE) – Government Finance
• Appears to produce more immediate
government income.
• Tax never collected on internal buildup.
Foregone future revenue may be huge &
growing.
• Wealthy can use to shelter income & assets.
• Tax benefit assumes that government keeps
its word.

14. Savers Credit
• Special additional benefit for lower income
savers regardless of tax treatment.
• Provides 50% of up to $2,000 contribution for
incomes below $36k. Much lower matches up
to family incomes of $61k.
• Only offsets tax liability. If none, then no
benefit is paid. Also, must be claimed on long
tax forms.

15. Problems with the Savers Credit
• Few claim the credit or know about it.
• Most eligible have no tax liability & use
shorter forms where Savers Credit is not
available.
• Credit comes as consumable payment.
• No incentive to save as credit comes long after
decision has been made.

16. A Better Version
• Simple credit available on short tax forms
regardless of tax liability.
• Provides 50% credit for contributions that
goes directly into the account. Not available
for early withdrawal.
• Deposited into the same investment choice as
rest of account.

17. New Version - Positives
• Actually benefits population it is intended to
help.
• Builds savings balances and increases
retirement incomes.
• Easy to claim. Can be automatic in tax
software.
• Growing balance is an incentive to save.

18. New Version - Negatives
• Revised savers credit has a high budget cost –
up to $20 billion/year.
• Savers may not understand that they cannot
use early withdrawal for match.

19. Do Tax Benefits Increase Saving?
• There is evidence that 85% of retirement
savers are passive & only 15% are actively
involved.
• Passive savers react to automatic enrollment
much more than tax incentives.
• Active savers react to tax incentives, BUT…
– Chetty, Friedman, et al., ACTIVE VS. PASSIVE DECISIONS AND CROWD-OUT IN
RETIREMENT SAVINGS ACCOUNTS: EVIDENCE FROM DENMARK

20. What About the Wealthy?
• Very upper income savers reallocate savings
according to tax incentives. They do not
change the amount saved, just where it goes.
• Lower income savers are more likely to react
to a change in take home income.
• They save due to automatic enrollment, but
little data on auto into TEE accounts. May
stop if they see a significant drop in income.

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Contact Us:
David C. John
Senior Strategic Policy Advisor
djohn@aarp.org
AARP Public Policy Institute
www.aarp.org/ppi
Twitter:@AARPpolicy
www.Facebook.com/AARPpolicy
Blog: www.aarp.org/policyblog