Citation URL: http://www.urban.org/JMarkIwry

This report describes the Roth 401(k) and discusses its potential effects. We find that the Roth 401(k) option will add complexity for employees and employers with little collateral social gain. The Roth 401(k) is unlikely to induce significant new private saving; almost all of the benefits are likely to accrue to high-income and wealthy taxpayers who are able to shift existing taxable assets into tax-favored savings plans. Moreover, the Roth 401(k) will increase the amount of resources that taxpayers can shelter and thus will likely have a negative effect on long-term federal budget revenue.

The federal tax system provides little incentive for participation in tax-preferred saving plans to households that most need to save more for retirement and whose contributions would most likely represent an actual increase in savings. By contrast, the tax code provides its strongest incentives to those who already are generally better prepared for retirement and who are more likely to use tax-preferred vehicles as a shelter than as an opportunity to increase overall saving. The saver's credit, helps correct this "upside-down" structure of tax incentives for retirement saving.

The federal tax system provides little incentive for participation in tax-preferred saving plans to households that most need to save more for retirement and whose contributions would most likely represent an actual increase in savings. By contrast, the tax code provides its strongest incentives to those who already are generally better prepared for retirement and who are more likely to use tax-preferred vehicles as a shelter than as an opportunity to increase overall saving. The saver's credit, helps correct this "upside-down" structure of tax incentives for retirement saving.

The "automatic 401(k)" is a simple concept with enormous potential. An automatic 401(k) plan would have intelligent defaults at each phase of the 401(k) savings cycle: participation, contribution levels, investment allocations, rollovers, and withdrawal options. Workers would be free to opt out of these defaults if they chose to. For example, under an automatic 401(k) workers would participate unless they actively choose not to. For workers, the automatic 401(k) helps ensure that they make appropriate financial choices even if they are not financial experts. For plan sponsors, the automatic 401(k) improves nondiscrimination results by increasing lower paid employees to participate and offers a possible way to provide fiduciary and non discrimination safe harbors. The steps involved in building an automatic 401(k) are not complicated, and the benefits could be substantial; indeed, a growing body of empirical evidence suggests that the automatic 401(k) may be the most promising approach to bolstering retirement security for millions of American families.

The saver's credit, enacted in 2001 as part of the Bush administration's tax cut legislation, provides a government matching contribution for voluntary individual contributions to 401(k) plans, individual retirement accounts (IRAs), and similar retirement savings arrangements. It is the first and only major federal legislation directly targeted to promoting tax-qualified retirement saving for moderate- and lower-income workers. Yet its current status as both temporary-it is scheduled to expire in 2006-and nonrefundable hinders its ability to be a real help to low- and middle-income families. This policy brief outlines several ways to improve the credit. [© Brookings Institution]

This paper provides an overview of the rationale, history, and possible modifications to the saver's credit, which was enacted as part of the 2001 tax legislation. The tax system in general provides little incentive for participation in tax-preferred saving plans to households who most need to save more for retirement and who, if they do contribute, are most likely to use the accounts to raise net saving. By contrast, the tax code provides its strongest incentives to those who are generally already better prepared for retirement, and who are more likely to use tax-preferred vehicles as a shelter than as an opportunity to increase overall saving. The saver's credit helps to correct this "upside down" structure of tax incentives for retirement saving. It is the first and only major federal legislation directly targeted to promoting tax-qualified retirement saving for moderate- and lower-income workers. The limited experience with the saver's credit to date has been encouraging. Options for strengthening the credit include making the credit refundable, making it permanent, expanding it to provide larger incentives for middle-class households, and rationalizing the phase-out of the credit. Such changes--which are under active consideration by leading pension policymakers--would help lower- and middle-income families save for retirement, reduce economic insecurity and poverty rates among the elderly, and raise national saving.

This paper provides an overview of the rationale, history, and possible modifications to the saver's credit, which was enacted as part of the 2001 tax legislation. The tax system in general provides little incentive for participation in tax-preferred saving plans to households who most need to save more for retirement and who, if they do contribute, are most likely to use the accounts to raise net saving. By contrast, the tax code provides its strongest incentives to those who are generally already better prepared for retirement, and who are more likely to use tax-preferred vehicles as a shelter than as an opportunity to increase overall saving. The saver's credit helps to correct this "upside down" structure of tax incentives for retirement saving. It is the first and only major federal legislation directly targeted to promoting tax-qualified retirement saving for moderate- and lower-income workers. [© Brookings Institution]

The law governing the funding of private-sector defined benefit pension plans is in need of both long-term reform and short-term adjustment. After replacing the obsolete 30-year Treasury bond as the basis for the statutory discount rate used to measure plan liabilities, Congress should turn to more comprehensive and permanent reforms. The requirement that employers accelerate their contributions to underfunded plans must be made more timely and less volatile, and exceptions currently permitting inappropriate funding holidays for underfunded plans must be eliminated. Congress can protect the security of workers' pensions by providing for adequate funding, without discouraging employers from continuing to sponsor employer-funded plans. [© Brookings Institution]

The retirement security of 44 million workers and retirees depends on adequate funding of private-sector defined benefit pension plans. In considering reforms, Congress must balance the need to reduce chronic underfunding against the potential impact of large funding demands on plan sponsors' financial condition and willingness to maintain plans. Congress can better minimize funding volatility so that required funding increases from year to year remain on a reasonably smooth path, and should require improved and more timely disclosure. However, to promote pension coverage and protect workers' reasonable expectations, restricting benefits or benefit improvements or curtailing government—provided pension insurance should be a last resort. [© Brookings Institution]

Millions of employees' 401(k) savings are inadequately diversified because they are too heavily invested in their employers' stock. Yet legislation Congress is considering would mainly prohibit companies from forcing employees to invest in employer stock. It would not prevent future Enron-type 401(k) losses because it would not address the real problem of "investment drift"--employees' tendency to remain overinvested in employer stock even if not explicitly mandated by the employer. Post-Enron publicity regarding the consequences of overinvesting in employer stock has not changed employees' behavior; boilerplate government-required disclosure is also unlikely to do so. This paper suggests alternative legislative measures to protect taxpayers' interest in sound retirement investments by improving diversification while preserving reasonable choice for employees.

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