Tax-Favored Savings Accounts: Who Gains? Who Loses?

Policy Reports | Taxes

No. 249
Thursday, January 31, 2002
by Jagadeesh Gokhale and Laurence J. Kotlikoff


For the vast majority of low- and moderate-income households, saving significant sums in tax-deferred retirement accounts is a bad idea. Only those at the top end of the income spectrum realize lifetime tax reductions. For such households, these tax savings are remarkably large. Low- and moderate-earning families who participate fully in these types of retirement accounts end up with less money to spend now, and higher taxes to pay later. The just-enacted credit for retirement account contributions limits the damage that low-income earners experience, but does little to change the overall highly regressive nature of tax-deferred saving incentives.

"Conclusion: Make Roth IRA taxation available to 401(k) plan savers."

The good news for low- and moderate-income households is that contributing to Roth IRAs is guaranteed to save taxes over their lifetime. Thanks to the new credit, these savings can be substantial for the lowest-income households. However, despite the credit, the tax gains remain meager for most low- and moderate-income households compared to those available to the rich from tax-deferred saving in general.

At a minimum, we should give all taxpayers the option of prepaying taxes on tax-sheltered accounts so that the Roth IRA method of taxation is also available to those who save through 401(k) plans and other tax-favored accounts.

Under current law, employers will be able to offer employees Roth-type 401(k) accounts beginning in 2006. In principle, the tax credit would apply to deposits to these accounts except that the credits are scheduled to expire at the end of 2005. And, of course the entire act expires at the end of 2010.

Clearly, additional reform is needed.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.

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