Our income tax system provides incentives to save for retirement. Individuals can contribute up to $5,500 per year to an Individual Retirement Account (IRA) or $18,000 to an employer-sponsored retirement plan and not pay income tax on the amount saved. (These amounts are $1,000 and $6,000 higher, respectively, for those over 50.)
This exemption from income tax is intended as an incentive to help low and moderate income individuals save for retirement. The tax exemption for IRAs is phased out as the adjusted gross income (AGI) on one’s tax return increases. The phase out varies by a taxpayers’ status (e.g., single, married, filing jointly or separately, with or without an employer retirement plan), however, for all taxpayers with an AGI over $200,000, there is no income tax exemption.
The contribution limits are sufficient to provide, along with Social Security, a modest, but reasonable retirement income even at the lowest of the contribution limits. For example, if one put $5,500 into an IRA every year over a 40 year career ($220,000) and invested it reasonably, earning a 5% – 6% annual return, one would have over half a million dollars ($500,000) saved at retirement. With an employer-sponsored retirement plan, one could save three times as much and have quite a comfortable retirement.
However, there is a loophole in our tax laws that allows highly paid executives and investment managers to avoid income tax by putting huge amounts of money into “retirement” accounts, called deferred compensation accounts. These wealthy individuals don’t need any tax incentives to save for retirement. And it makes no sense to allow them to avoid income tax on huge sums of money that far exceed what they will need in retirement.
For example, the CEO of Progressive Insurance last year put over $26 million into his deferred compensation account. He now has over $150 million in this account, which is enough to provide him with an income of $850,000 per month for the rest of his life.
The retirement savings of the top one hundred CEOs are equal to those of 50 million American families (41% of the population). Employees at some of these CEOs’ companies have no retirement plan or savings at all. Furthermore, about half of these CEOs have traditional pensions as well; something most American workers have seen vanish over the last two decades. The CEOs of the 500 largest corporations have $3.2 billion in their deferred compensation accounts and avoided roughly $78 million in income taxes in 2014 by putting almost $200 million more into their “retirement” accounts than regular employees would have been allowed to save in their retirement accounts. [1]
The tax incentives that are supposed to be promoting saving for retirement are poorly designed and inefficient. Most of the benefits go to a small number of individuals with very high incomes. [2]
This is one example of how the rich and powerful have bent our tax laws to their benefit. It is also one reason that economic inequality is growing. And it is a piece of the puzzle of why social class mobility is diminishing in the US. These wealthy individuals obviously won’t spend all of these huge tax-deferred savings during their retirements, so these “retirement” savings will be passed on to their heirs, ensuring that the next generation of these families remains part of the economic elite.
[1] Klinger, S., & Anderson, S. (10/28/15). “A Tale of Two Retirements,” Institute for Policy Studies (http://www.ips-dc.org/tale-of-two-retirements/)
[2] Morrissey, M. (3/3/16). “The state of American retirement: How 401(k)s have failed most American workers,” Economic Policy Institute (http://www.epi.org/publication/retirement-in-america/)
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