Second Round of Tax Reform Might Address Retirement Accounts

TaxNotes reported today (subscription required) that lawmakers are considering a comprehensive rewrite of retirement tax incentives as part of tax reform phase two, thought to begin this summer. According to the article, House Ways and Means Committee Chair Kevin Brady (R-TX) has said that some lawmakers intend to revise the tax treatment of retirement savings to make them bigger, more flexible, and easier to use. Rather than focus on small changes to limits or rules like those in the Retirement Enhancement and Savings Act of 2018, Congress ought to consider comprehensive solutions like universal savings accounts, which would simplify the structure of savings vehicles, and remove the tax code’s bias against saving.

In the United States, personal saving is taxed in a variety of ways, which often results in a bias against saving. The structure of retirement savings vehicles, however, limits this bias. In traditional-style, or tax-deferred, accounts, the initial savings are not subject to income tax and the returns are subject to tax when they are withdrawn. In Roth-style accounts, the initial savings are subject to income tax and the account grows tax-free. These plans provide an important source of retirement income, more than half of which flows to middle-class households with adjusted gross income under $100,000.

While it is good that the tax code provides a way for some savers to avoid multiple layers of taxes on their savings, it does so with a lot of complexity. For example, the Internal Revenue Service website lists 15 general types of retirement plans, and many of these plans have their own sets of rules on contribution limits, tax deduction limits, and guidelines when savers can contribute and withdraw their funds. If individuals want to save more than these limits allow, or use their savings for purposes other than retirement, they face penalties that discriminate against saving.

We know that saving benefits the individual saver, and that it benefits the economy as a whole, too; the tax code shouldn’t create a barrier for how much, or for what purposes, people save. While the Senate and House lawmakers are discussing various policy ideas to encourage retirement saving and ease some restrictions, such efforts fall short of comprehensive reform. Congress should seriously consider ways to remove the tax penalties on all long-term saving by lifting or eliminating restrictions and reforming the structure of the various types of savings vehicles in the tax code. Traditional-style universal savings accounts are a good model to consider.