Can nixing 401(k) tax benefits solve Social Security’s funding crisis?

Also: A New Bill Aims to Fix Social Security by Eliminating Taxes on Benefits

͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌ ͏‌  No images? Click here February 21, 2024 Congress is in need of a bright idea to fix Social Security’s cash flow problems — without one, beneficiaries could see a more than 20% reduction in benefits in the next decade. Economists Andrew Biggs and Alicia Munnell laid out a perhaps surprising idea in a recent proposal. Biggs, a senior fellow from the right-leaning think tank American Enterprise Institute, and Munnell, director of the Center for Retirement Research at Boston College, argue that limiting current tax preferences for certain retirement plans could create enough revenue to fix Social Security’s finances. When you contribute to a defined contribution plan like a 401(k), you do so with pre-tax dollars and usually don’t pay any taxes until you start making withdrawals in retirement. That means whatever you contribute lowers your taxable income for the year by the same amount. The contribution limit for workers in 2024 is $23,000, and employees 50 and older have the option to put away up to an extra $3,500 in “catch-up” contributions. Tax preferences for retirement plans reduced federal income tax revenue by roughly $185 billion in 2020, with 401(k) tax benefits making up the majority of that lost revenue thanks to their widespread use and higher annual contribution limits. The researchers say that money could be used as a subsidy to fill the Social Security funding gap (though it wouldn’t quite cover the entire shortfall). They also argue that repealing these tax benefits wouldn’t have much effect on average savers because they mainly benefit high earners and don't really incentivize Americans to contribute more. But other economists aren’t too keen on the proposal from Briggs and Munnell. In an opposing analysis, researchers from the Mercatus Center at George Mason University say that the plan not only fails to address the root of Social Security’s funding issues, but that it also would effectively dry up taxpayers’ retirement savings.  “Taxing the returns on these savings again would amount to a second layer of taxation on the same income,” the Mercatus team said in their brief. “To say that it will be extremely disruptive of Americans’ savings is an understatement.” You can find out more about Munnell and Biggs’ controversial funding solution from Money reporter Pete Grieve’s story. Drop me a line at mcags@money.com with your thoughts, retirement questions or any stories you’d like to share.  — Mary Ellen Cagnassola, Money reporter P.S. If you got this newsletter from a friend, sign up here for email delivery to make sure you don't miss the next issue.

Retirement Stat of the Week: $4,940

How much do Americans need per month to be comfortable in retirement? Asset management company Schroder’s 2023 U.S. retirement survey puts the average at just under $5,000 — though 37% of current retirees said their monthly income is under $2,500.

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Retirement 1, 2, 3

Traditional advice often encourages people to pay off debts before retirement. But a growing number of older Americans find that keeping a mortgage and putting their money elsewhere is better for their financial needs, according to the New York Times. New research finds that IBM’s recent shift back to offering pension-like retirement plans to its employees is more beneficial for the company than its workers. Schroder’s annual survey also found that Gen Xers will need to keep working in retirement, the company’s chief strategy officer explains in recent commentary.

More Insights and Advice from Money

social security When Social Security Recipients Will Get Their Checks in February More February Social Security checks are heading to some beneficiaries this week. READ MORE Olive Burd / Money; Getty Images

SOCIAL SECURITY A New Bill Aims to Fix Social Security by Eliminating Taxes on Benefits A small group of lawmakers wants to eliminate taxes on Social Security benefits as part of a proposal they claim could help fund the flagging program. READ MORE Money; Getty Imags

RETIREMENT More Americans Are Optimistic They’ll Get Social Security Benefits When They Retire Despite ongoing concerns about Social Security becoming insolvent in the next decade, more Americans are optimistic they'll receive benefits when they retire. READ MORE Money; Shutterstock; Getty Images

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