An American Enterprise Institute paper published in January by the prominent policy researchers Alicia Munnell and Andrew Biggs immediately sparked a debate with its straightforward but provocative argument: Congress should end tax breaks for workplace retirement plans and IRAs and direct the newfound revenue to fund Social Security.
Such accounts primarily benefit the wealthy, who already enjoy relative security in retirement, the paper purports, and the Social Security program, upon which lower-income Americans rely heavily to avoid poverty in retirement, is on the fast track to insolvency. So, why not do the difficult but necessary thing and sacrifice tax-free growth in more affluent people's 401(k)s to save an essential anti-poverty program for the elderly?
A flurry of economists and researchers have argued both in favor of and against the "Munnell-Biggs" proposal. Among the latter camp is Peter Brady, an author and senior economist at the Investment Company Institute, a trade group representing regulated investment funds. He spoke this week with ThinkAdvisor about the unfolding debate.
Brady emphasized his respect for Munnell and Biggs throughout the interview, but he was also not shy about pointing out what he sees as a few fundamental flaws in their argumentation.
Perhaps the biggest of these, he argued, is that Munnell and Biggs fail to consider the bigger picture and the potential unintended macroeconomic consequences of so fundamentally altering the retirement savings and investing landscape Americans have come to understand and expect.
"The paper suggests that the tax incentives for America's voluntary retirement plan system do not appear to work and that the only benefits of the system are flowing primarily to high earners," Brady said. "That sounds troubling, of course, but facts are that most workers accumulate resources from retirement plans at some point in their careers and eventually receive retirement income from these plans — and the benefits of tax deferral are not restricted to high earners."
An Effective, If Imperfect, Savings System
According to Brady, the heart of the counterargument he and others are making against the new proposal is the fact that American retirees rely on the combination of Social Security benefits, retirement plan income and any additional sources of savings or wealth they may have, such as a pension, an annuity, an inheritance or even the sale of a home.
It's the proverbial three-legged stool, he noted, and it's always going to be misleading to consider only one essential part of the retirement furniture at a time.
"It is generally true that many tax policies, expressed in dollars, will be skewed to high earners," Brady acknowledged. "This is just because both income and taxes paid are highly skewed. What the argument really misses, though, is that the supposed 'excess benefits' are not going to those people in the top 1% or top 5% of income, as you might imagine. It's going to folks with incomes in the third and fourth quintiles."
Americans in this segment of the income distribution (between roughly $100,000 and $200,000 per year) face a big retirement challenge, Brady observed. They generally don't have access to pensions and typically will only see a fraction of their working income replaced by Social Security — meaning tax-advantaged retirement plans are an essential tool in their retirement planning tool belt.
On the other hand, Brady emphasized, Social Security benefits replace a higher share of wages for low-income earners. Yes, the wages in retirement are lower, but that is a result of deeper issues, including big earnings disparities. As a result, lower-earning workers rely more heavily on Social Security in retirement, while middle- and higher-income workers rely more on employer plans and individual retirement accounts.
