No, 401(k)s Aren't a 'Great and Popular Middle Class Tax Break'

President Trump may spare the accounts from a proposed cap on annual contributions, but saving for retirement is still broken in America.

President Trump speaks about tax reform in Middletown, Pennsylvania.
President Trump speaks about tax reform in Middletown, Pennsylvania, on October 11. (Alex Brandon / AP)

Following reports that congressional Republicans were, as part of a planned tax reform, considering a cap on contributions to tax-deferred 401(k) plans, President Trump on Monday promised such a change wouldn’t happen. “There will be NO change to your 401(k),” the president tweeted. “This has always been a great and popular middle class tax break that works, and it stays!”

But even as he rushes to the defense of 401(k)s, the president—with the help of fellow Republicans on Capitol Hill—has over the course of his presidency already made it harder for millions of Americans to save for retirement. In fact, he managed to squeeze two misleading statements into his tweet about 401(k)s. First, the benefits of tax-deferred 401(k) plans currently flow disproportionately to households near the top of the income distribution—not the middle class. And second, the current strategy of encouraging retirement savings through tax incentives such as 401(k) plans is not one that “works.” According to a recent estimate from researchers at the Census Bureau, fewer than one-third of American workers participate in 401(k) plans and other workplace retirement accounts, and the failure of 401(k) plans to cover broad swaths of the population is a major cause of the country’s retirement-savings shortfall.

Over the past nine months, President Trump and congressional Republicans have gone out of their way to make saving for retirement more difficult for workers who need the most help. This spring, Republicans invoked the Congressional Review Act—a law that had been used only once until this year—to undo an Obama administration rule critical in allowing states to offer their own plans to help private-sector workers save for retirement. The action will affect systems in several states—including California and Illinois—that automatically enroll private-sector workers in state-sponsored individual retirement accounts (IRAs) if their employers don’t offer retirement benefits.

An estimated 55 million workers don’t have access to a retirement savings plan through their employers, and the Obama-era rule permitted states and localities to set up auto-enroll schemes that cover these workers without violating a 1974 law called the Employee Retirement Income Security Act. But the investment industry—apparently fearing that automatic enrollment would give workers using these plans bargaining power to drive down the fees that mutual funds now charge customers—lobbied hard to kill the initiatives. State officials—Republicans as well as Democrats—pushed back, and one survey found that 72 percent of Americans who consider themselves Republicans agreed that state plans are a good idea. But congressional Republicans, betraying their usual paeans to states’ rights, bowed to industry pressure and repealed the Obama-era legal exception. In May, President Trump signed the repeal measure into law.

A further blow to American workers saving for retirement came in August, when the Trump administration delayed implementation of the Department of Labor’s so-called fiduciary rule, which would have required all types of retirement investment advisers to put their clients’ interests above their own. The rule would have barred brokers from engaging in unsavory practices such as steering clients toward high-fee mutual funds that pay the brokers to do so.

The August action wasn’t Trump’s first attack on the fiduciary rule. During the presidential campaign, one of his advisers, Anthony Scaramucci, likened the rule to the Supreme Court’s infamous Dred Scott decision, which held that African Americans were not U.S. citizens. Soon after taking office, the Trump administration delayed implementation of the rule for 60 days. But the August action, which put key parts of the regulation on hold until July 2019, is the administration’s biggest step to thwarting the rule yet. The Economic Policy Institute, a left-leaning think tank, has calculated that the delay will cost retirement savers approximately $10.9 billion in higher fees over 30 years.

While the effort to undermine state auto-enroll programs and the delay of the fiduciary rule appear to have been aimed at pleasing financial-industry interests, the recent 401(k) proposal was driven by a different desire: the need to pay for proposed tax cuts that will benefit businesses and (mostly high-income) individuals. To make up for some of the government revenue that would be lost after these deep tax cuts, congressional Republicans considered imposing a $2,400-per-year cap on contributions to traditional tax-deferred 401(k) plans. (The current cap for most workers is $18,000.) The motivation for this move appears to be mere fiscal gimmickry: The change would make the cost of the Republicans’ package of tax cuts appear to be lower over the next decade, which would help them meet their self-imposed deficit targets. But the change actually wouldn’t do much to raise revenue over the longer term—it would just change the timing of tax collections to make the cost of the Republicans’ tax plan look smaller than it is.

The proposal being considered by congressional Republicans would have affected traditional 401(k) plans, but not the rules governing the closely related Roth 401(k)s. In a traditional 401(k) plan, workers aren’t taxed on their savings at the time they contribute, though they are taxed when they withdraw. By contrast, in a Roth 401(k) plan, workers are taxed on their contributions but can withdraw funds tax-free six months before they turn 60. The proposal being considered by congressional Republicans would require that all contributions above $2,400 be made to Roth plans.

For workers whose marginal tax rate remains roughly the same throughout their lifetimes, a shift from traditional to Roth plans would have at most a modest effect. But such a shift in saving would harm people whose incomes decline significantly in their later years—precisely the people who need the most help saving for retirement. For example, a worker who is in the 25 percent tax bracket today but who will drop to the 10 percent bracket in retirement would much prefer to be taxed at a lower rate later rather than a higher rate now. In those circumstances, the worker will have materially more to spend in retirement if she can save through a traditional plan rather than a Roth.

Why, then, would Republicans have wanted to shift to a system that benefits workers whose incomes are likely to rise in their later years? While one of us has suggested a policy justification for a transition to Roth plans, that rationale is not what appears to have motivated the Republican proposal. Rather, the answer lies in the fact that Senate Republicans have passed a budget resolution allowing them to add no more than $1.5 trillion to the deficit over the next decade. The current tax proposal from the Trump administration and Republican leaders nevertheless looks like it will cost much more than that—$2.4 trillion over the next 10 years, according to the nonpartisan Tax Policy Center. Republicans need to find a way to plug that gap.

And that’s where the 401(k) proposal would have come in. By imposing a cap that would force workers to switch from traditional to Roth plans now, Republicans would ensure that the federal government will raise more revenue over the next decade, because money put into Roth plans will be taxed at the time it is contributed. Without the short-term revenue boost that would come with the proposed 401(k) cap, it’s not clear how Republicans can meet the $1.5 trillion target upon which some members of their caucus have insisted; some options include raising income taxes on the rich or limiting a contemplated expansion of the Child Tax Credit. And there’s a chance that President Trump’s tweet doesn’t mark the end of the 401(k) proposal. Once he realizes that he needs revenue from somewhere to plug a nearly trillion-dollar hole in his tax plan, President Trump may reconsider his position—as he has flip-flopped so many times before.

Moreover, President Trump’s newfound concern about 401(k) plans doesn’t reflect a genuine commitment to helping low- and middle-income workers save for retirement. The primary beneficiaries of traditional 401(k) plans and other tax-deferred retirement accounts are not the “middle class”: Rather, the Treasury Department estimates that half of the tax benefits of these accounts go to households in the top tenth of the income distribution. A mere 3.5 percent of the benefits go to families in the bottom half.

Plainly, 401(k)s are no solution to the country’s retirement-savings problem. And it’s a problem reaching crisis proportions: The Federal Reserve reports that more than one-quarter of working Americans have no retirement savings or pension. A generation ago, many more Americans enjoyed the support of sustainable private and public pensions to meet their retirement needs. Those without pensions enjoyed a decades-long boom in both real-estate values and the stock market to buoy their personal wealth. And in preceding generations with lower life expectancies, a solvent Social Security system more easily covered the needs of correspondingly shorter retirements. In the future, however, Americans will spend more time in retirement without the generous support of pensions or Social Security.

So what can could be done to fix the retirement system? The government could more enthusiastically embrace the proposals of the Nobel laureate Richard Thaler and his collaborator Cass Sunstein, who recommend making it a default that workers are automatically enrolled in 401(k) plans, automatically contribute meaningful amounts to those accounts, and automatically invest in low-fee funds. That is, the government could support the state auto-enroll plans that Trump and congressional Republicans have tried to kill. Another fix—as one of us has proposed—would be to open the federal Thrift Savings Plan (TSP) to all Americans. The TSP is a half-trillion-dollar savings plan run by the investment firm BlackRock for more than 5 million federal employees that offers 10 sound investment choices at an average fee of just 0.038 percent—far below the average fee of 0.82 percent for actively managed equity mutual funds. Opening up the TSP to private-sector workers would give ordinary Americans access to the retirement-savings options that members of Congress now enjoy.

Until now, though, the Trump administration and congressional Republicans have shown little enthusiasm for these ideas—and much more interest in keeping workers away from auto-enroll programs and low-fee options. Trump’s intervention on 401(k) plans is no exception. And while this should bring satisfaction to some in the financial industry of knowing that campaign contributions have been well spent, it will leave more and more workers entering their retirement years with nothing in the bank.