Quinn Curtis is Albert Clark Tate, Jr., Professor of Law at the University of Virginia School of Law, Leo E. Strine, Jr. is the Michael L. Wachter Distinguished Fellow at the University of Pennsylvania Carey Law School, and David Webber is Professor of Law at Boston University. This post is based on their recent paper.
ABSTRACT: Incentives for individuals to save for retirement currently total 1.5% of US GDP. For that substantial investment, we get a system that actually deepens wealth inequality. The top 10% of earners capture 60% of the associated tax benefits, and employer matching contributions disproportionately favor the highest earners. Although defined contribution plans have long been subject to non-discrimination requirements aimed at ensuring that benefits do not accrue predominantly to the wealthiest participants, these rules have little bite. In an irony, we estimate that the entire 401(k) system would fail the non-discrimination test that every employer offering such a plan is expected to pass. This Article examines the structural causes of these disparities, including growing income inequality, critiques the shortcomings of the non-discrimination rules, and proposes practical reforms to the 401(k) system, alongside a supporting increase in the minimum wage. Our reforms would realign public policy to address the related needs for more economic equality and to provide equitable incentives for retirement savings for the many, not just the few. Ultimately, these reform proposals seek to get the most value for the American public out of the considerable retirement tax expenditures under §401(k).
U.S. taxpayers subsidize retirement savings through programs like 401(k) plans to the tune of 1.5 % percent of our annual gross domestic product. Despite longstanding federal legislative policies, the so-called non-discrimination rules, intended to ensure that these tax-subsidized retirement plans are not biased toward highly paid employees, the defined contribution retirement system is biased in just that way. For the bottom quintile of American workers, their average retirement savings is essentially zero. Even middle-class workers have median savings of around $64,300, which cannot provide for a secure retirement. But workers in the top income bracket have median savings of $605,000. These inequalities are even worse for black families, whose savings average less than half of those of white families.
Employers’ “matching” programs are also biased toward the affluent, with estimates suggesting that 44% of employer subsidies go to workers whose wages are in the top 20% of their workforces. And the failure of 401(k) plan designs to take into account the realities faced by low- and middle-income workers—such as the greater effect of inertia on their investing decisions, their comparative lack of intergenerational wealth, shorter tenures with employers, and the practical reality that they cannot afford to make contributions approaching the federal tax-advantage maximum levels or even take full advantage of employer matching programs—leads to plan designs that exacerbate, rather than ameliorate, the wealth gap. We calculate that if the non-discrmination rules aimed to ensure that retirement plans are structured equitably were applied to the 401(k) system as a whole, the system would fail the test.
In a new article, we make a policy proposal to address this profound problem and to deploy taxpayer-subsidized retirement subsidies in a manner that better serves the many Americans who need greater retirement security. Our proposal combines an increase in the minimum wage, a built-in retirement savings feature, and restructured regulation of employer matching programs. We show that such reforms could partially address the extreme regressivity of 401(k) plans. We then show that these reforms are politically feasible in a fractured partisan landscape because the reforms are rooted in concerns about income and retirement security that are widely shared by Americans of all political persuasions.
We begin by showing how income inequality, combined with the structural aspects of many plans—and matching programs in particular—combine to make retirement plans particularly regressive. Even seemingly equitable approaches, like a standard 1:1 match capped at a percentage contribution, tend to shift value to high-income participants. The non-discrimination rules, which from the beginning have been oriented to avoid top-heavy plans do little to constrain these effects. READ MORE »
