Tie the 401(k) Limit to the Minimum Wage
The IRS just raised the maximum annual 401(k) contribution from $17,500 to $18,000 to keep pace with inflation. Saving is a good thing, and Americans plainly don't do enough of it, so maintaining a high contribution limit is good news, right?
Wrong. The limit is actually a part of our wealth-inequality problem. The government goes to great lengths to help the very wealthy save more money while neglecting everybody else. Rather than making sure the maximum contribution keeps pace with inflation, as the IRS is currently required to do by statute, we should lower the limit significantly.
How, exactly, does a generous 401(k) maximum give the wealthy a leg up? Because when it comes down to it, almost no one actually maxes out their contributions. The few who do tend to have very high incomes and are more likely to save at higher rates anyway.
According to the Urban Institute, just 6 percent of 401(k) participants are affected by the contribution cap. Another study found that only 8 out of 645 employees surveyed (or 1 percent) were affected. Automatically raising the contribution cap provides benefits only to a small minority of the very highest earners and does nothing for more than 90 percent of American families.
The households we're talking about simply cannot be described as middle-class. Consider that the median retirement-account balance for all working-age households is $3,000. That means your average U.S. household has the same amount saved in total as a maximum contributor saves in two months. And if middle-class means middle-income, it's worth noting that over 60 percent of working-age households making below the median income don't even have a retirement account, let alone save $18,000 each and every year.
It's no wonder high-income households contribute more to their retirement accounts: They get far more benefit from saving in them. Every $100 saved in a 401(k) by an earner in the top tax bracket -- 39.6 percent -- provides an immediate benefit of $39.60. (Those who contribute the maximum can pocket up to $7,128.) By contrast, a single mother making minimum wage will earn $15,080 a year, which is less than the contribution cap. If that struggling mother is resourceful and fortunate enough to save $100 in a 401(k), the tax code will provide an immediate tax benefit of exactly $0 because she has no income-tax liability.
All told, the top 5 percent of earners receive 40 percent of all the federal government's retirement subsidies. The bottom 60 percent get 7 percent.
In 2015, the overall yearly cap on employer and employee contributions to retirement accounts, which includes the $18,000 contribution limit from employees, will be $53,000. To get a sense of how few taxpayers would be affected by lowering this amount, we can look at a proposal from the Urban Institute to reduce the overall cap by as much as 63 percent, to $20,000. It's estimated that reducing the overall cap by this much would increase taxes on just 3 percent of U.S. taxpayers in 2015. Sure, this is likely to be an unpopular proposition with this 3 percent, but the tax dollars recovered by eliminating this regressive government subsidy could be redirected to provide more effective saving supports to more workers who need the most help saving for retirement.
$20,000 isn't much more than $15,080 -- so why not link tax-preferred savings for the wealthy to our minimum-wage-earning single mother's yearly income? This would have the dual benefit of cutting down government inefficiency and forcing policymakers to give some help to working families by raising the minimum wage if they really want to provide more subsidies to the rich.
401(k) contribution limits affect a small minority of American workers. The government should stop focusing on maintaining the value of this wasteful subsidy and instead help the majority of American workers build sufficient assets to retire with dignity.
Elliot Schreur is a policy analyst with the Asset Building Program at New America.