As the proposed congressional tax bill has taken shape, there has been (and continues to be) much speculation about what the final bill will look like. The proposal passed by the House provides significant tax cuts to businesses and the very wealthy, but it eliminates many tax deductions that individuals rely on. One piece of good news for individuals, however, is that contrary to earlier conjecture, this bill does not reduce the annual limit of pretax retirement contributions.
As many news agencies have noted, further capping 401(k) contributions (currently limited to $18,000 annually for people under 50 years old) could increase revenue from income tax in the short term, but it would come at the expense of future tax revenues when citizens withdraw money from a 401(k). Behavioral science also suggests that instead of driving retirement savings to after-tax accounts like Roth IRAs, a lower cap could very well suppress overall retirement savings, leaving more Americans less prepared for retirement.
When we delay savings, they may never happen at all, or at least not to the degree we had initially intended.
“The planning fallacy” is the tendency for people to be overly optimistic about accomplishing a future task or to underestimate how much time that task will take. Without an immediate advantage to moving money to savings—like avoiding taxes this year, as is the case with a 401(k)—people generally have low motivation to begin putting money aside. Younger individuals especially are likely to put off saving for retirement, thinking that they will instead increase contributions in later years to make up for the gap. Not only does putting off savings undervalue exponential growth, but the evidence suggests these increases are unlikely to materialize at all—people get accustomed to a certain lifestyle and find it very difficult to start making sacrifices in their spending for the sake of their future selves. So when we delay savings, they may never happen at all, or at least not to the degree we had initially intended.
And this move would have happened at a time when retirement savings are already low. Only about half of U.S. households age 55 and older use a retirement savings vehicle (a 401(k) or an IRA) according to the United States Government Accountability Office. Worse still, the 65-and-older population is growing; according to the Census Bureau, that age group will increase over 50 percent between 2016 and 2030. With a growing elderly population and low retirement savings, many worry about a coming retirement crisis. Lowering the cap to 401(k) contributions could have meant even more people having to postpone their retirement (or forgo retiring at all) and running out of money faster when they did retire. This, in turn, would likely have led to more Americans relying on government support (or on help from family and friends) in their later years—essentially spurring demand for additional government funds.
One way for companies to work against these tendencies is to automatically enroll employees in a post-tax account, like a Roth IRA, and the company could manage these funds just as they do today’s 401(k) accounts. These strategies, which hinge on making it easy to save more by reducing friction and using auto-enrollment, have already been shown to help people to make better decisions for themselves earlier and to avoid procrastination and the planning fallacy. Companies aren’t always comfortable acknowledging or using the ability they have to design a better choice-environment for their employees, but in this instance, to abstain would have been a true disservice.
