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May 28, 2015

How income inequality is becoming retirement inequality

Analysis Retirement
03242015_Retirement @WeAreHolidays /Twitter

A happy retirement is all about location.

Americans need bigger retirement nest eggs, there is no doubt about that. More than half of us have saved less than $25,000, according to the Employee Benefit Research Institute.

Policy experts often point to such figures to underscore the looming retirement security crisis, and proposals have been flying this year from Republicans and Democrats alike for ways to encourage people to sock away more money.

Just one problem: Middle- and lower-income households often do not earn enough to save meaningful amounts due to decades of stagnant wage growth, job insecurity and the rising costs of housing and healthcare.

Only high-income households have managed to build significant savings, and the Center for Retirement Research at Boston College says 52 percent of today's working-age households face the shock of declining living standards in retirement.

In other words, income inequality is translating into retirement inequality.

Here is a better option: Expand Social Security benefits to help people who need it most.

"If you have a dollar to spend on retirement security, it's much better to spend it on Social Security than by spreading it out along tax brackets to incent retirement savings," says Ben Vegthe, research director of the Social Security Works advocacy group.

Vegthe makes the case for using Social Security to address retirement inequality in a persuasive research paper set for publication in the June issue of the journal Poverty and Public Policy. He recommends expanding benefits and funding the cost primarily by scrapping the cap on wages subject to payroll taxes ($118,500 this year).

He would also add a 6.2 percent tax on investment income (equivalent to the current individual payroll tax rate) and restore the estate tax to where it was in 2000. At that time, estates worth $1 million were exempted (compared with $5.4 million this year), and the top marginal tax rate was 55 percent (compared with 40 percent this year).

Those changes would eliminate the funding shortfall now facing Social Security. The combined retirement and disability trust funds are projected to run out in 2033, when retirement benefits would have to be cut by 25 percent across the board.

Vegthe estimates that one-third of the shortfall is due to slow and unequal wage growth in the economy.

 By law, Social Security taxes should be levied on 90 percent of the country’s wage base, and that was the case in 1984 after the last round of major reforms were enacted. But today, 17.5 percent of taxable earnings fall above the maximum, according to Social Security Administration data.

Equally important, the tax hikes could also fund expansion. What would that look like? Now-retired Iowa Senator Tom Harkin, a Democrat, last year proposed boosting benefits across the board by about $72 per month, and his proposal is expected to be introduced in the Senate again this year. Social Security Works has called for a 10 percent across-the-board raise, up to a maximum increase of $150 per month.

Either of those plans would primarily help lower- and middle-income workers because the Social Security benefit formula already replaces a larger share of earnings for those households than for high earners. The Harkin plan would give an extra boost to benefits for the lowest-income group.

Some lawmakers are actually aiming to cut Social Security benefits as part of a broader deal to rescue the program’s ailing disability insurance fund. But others are focused on encouraging saving, and some useful ideas have been proposed.

Representative Joe Crowley, a Democrat from New York, has proposed a Roth-style retirement saving account that every child would receive at birth, seeded with a $500 government contribution, and expanded child tax credits for additional contributions by parents.

Republican Senator Orrin Hatch from Utah has proposed a Starter 401(k) for small businesses that would allow employees under age 50 to save up to $8,000, much more than the $5,000 limit on individual retirement accounts.

Senators Susan Collins, a Republican from Maine, and Bill Nelson, a Democrat from Florida, have introduced legislation that would make it easier for smaller businesses to cut administrative costs by forming multiple-employer 401(k)-style plans.

But ideas like these would probably benefit mainly upper-income people.

An analysis of Federal Reserve data by the Center for Retirement Research found that in 2013, pre-retirement households (age 55-64) with annual income below $39,000 had median total retirement savings of $13,000 in 401(k) and IRA accounts; middle-class households (income from $61,000 to $100,000) had median savings of $100,000. Only in the highest-income band ($138,000 or more) were accumulations significant at a median of $452,000.

Perhaps there is a bipartisan deal to be had: Expand savings options and Social Security at the same time.

I am convinced Social Security expansion offers the best path to addressing the retirement crisis, but why not try both approaches and find out which delivers the goods?