In response to the recent burst of inflation, the IRS is raising contribution limits for the full range of retirement savings accounts. That’s great news. If you make a lot of money.
But it won’t make the slightest difference to the vast majority of working-age Americans, who contribute far less than the existing limits, or nothing at all.
This is no criticism of the IRS, which is doing exactly what the tax law requires when it increases these limits to account for inflation. But it is yet another reason why the entire retirement savings system needs to be overhauled so that it benefits those who need the help, not those who have plenty of opportunity to put away money for old age and the Wall Street firms that service their accounts.
Inflation adjustments
The agency raised the 2023 contribution limit for 401(k) and similar work-based plans by $2,000 to $22,500. It raised the annual contribution limit on IRAs to $6,500 from $6,000.
The 401(k) catch-up contribution limit for employees ages 50 and older will rise from $6,500 to $7,500. Thus, these older workers will be able to save up to $30,000 starting in 2023.
Some owners of pass-through businesses will be able to contribute as much as $73,500 to their tax-advantaged retirement savings accounts.
In all these cases, savers can defer tax on traditional retirement accounts until they take distributions years later. Separate rules apply to Roth-type accounts, where contributions are made with after-tax money but distributions are tax-free.
Raising maximum contribution amounts is an effort to keep them relatively steady after accounting for inflation. But who benefits from this largesse? Certainly not ordinary workers.
Who saves for retirement?
The Federal Reserve estimated that in 2019, only a bit more than half of all middle-income people even had retirement accounts, while 80% of those in the highest 80th-90th percentile income group had them, and 90% in the top 10% had retirement savings.
In 2018, the average annual IRA contribution was about $4,200, well below that year’s contribution limit.
Vanguard estimates that in 2021, about 14% of workers in plans it administers maxed out their contributions. Fewer than 2% of those making $75,000 or less contributed the maximum, while nearly 60% of those making at least $150,000 reached the legal limit (see figure 42).
TPC looks at contributions through a different lens—the value of the tax benefit for each income group. But it tells the same story. Low- and middle-income workers put away very little in retirement savings, while high-income workers saved a lot. The group that benefits the most on average is the highest-income 80th-99th percentiles, those households making between about $190,000 and almost $1 million this year. They get more than half the benefit of retirement savings tax breaks. All households making about $100,000 or less get about 20% of the benefit.
High-income savers are not the only wealthy beneficiaries of this year’s inflation adjustments. The 2023 estate tax exemption is increasing by a whopping $1.72 million for a couple to $25.8 million.
That will benefit only a handful of heirs of a few thousand mega-rich decedents. The inflation adjustment for retirement savings will help out millions of upper-middle-income people. Who don’t need it.
Helping small account holders
Instead of building in automatic inflation adjustments that benefit high-income savers, Congress could encourage workers to start saving for retirement and boosting small accounts of those who do. The retirement savings bills floating around Congress have features that do that, although they also include provisions that would largely benefit high-income savers and retirees.
Some ideas: Enhance the savers credit, where the government could match up to half the contributions of low- and moderate-income savers through a tax credit, expand incentives for or even require firms to set up retirement accounts for their employees, and make retirement accounts portable so workers can bring their savings with them when they change jobs rather than lose track of them or cash them out early. .
In the aggregate, Americans had nearly $35 trillion in retirement savings as of June 30. Unfortunately, much of it is in the hands of a few. The Vanguard report found even among those who have accounts, half of those age 65 or older had assets of less than about $90,000 (figure 55).
The consequence: While high-income workers with lots of disposable income will be able to boost their retirement savings to keep up with inflation, low- and middle-income workers keep falling short of what they’ll need for retirement.