Do savings incentives like tax preferences in defined contribution plans exacerbate the racial saving gap?
It’s the subject of a recent working paper titled Who Benefits from Retirement Saving Incentives in the U.S.? Evidence on Racial Gaps in Retirement Wealth Accumulation from researchers at the Massachusetts Institute of Technology (MIT), the latest to suggest the incentives favorably (and unfairly) skew towards higher income individuals.
The authors noted that the average contribution rate of Black and Hispanic workers is roughly 40% lower than that of White workers and that the rich—and their children—save more.
While racial differences in their incomes (and their parents’ incomes) are largely the reason, “tax and employer matching subsidies further amplify these saving differences by channeling more resources to those who save more.”
“We estimate that breaking the link between contribution choices and saving subsidies, through revenue-neutral reforms, would significantly reduce racial gaps and intergenerational persistence in wealth,” they wrote.
MIT Assistant Professor of Economics, Finance, and Accounting Lawrence D.W. Schmidt pointed to what he said is a growing body of evidence of significant gaps in wealth accumulation due to several factors, including race, ethnicity, and family background. The Black American to White American wealth gap is six to one, something that has remained constant for roughly 40 years.
“One of the biggest ways to build wealth in today’s economy is through defined contribution retirement plans,” Schmidt acknowledged. “Yet, it’s structured so that the only way to benefit is to participate. Despite these very powerful subsidies, which can be a great way to build wealth and are probably the best investment opportunity that there is going right now, we know lots of households don’t participate.”
He added that if one group finds it much easier to start their career capturing these large employer matching subsidies (and, in turn, the tax benefits), it can lead to significant differences in wealth accumulation.
"The other significant finding from our work is that, even for coworkers with similar income levels, there are substantial gaps in who benefits from the matching (and, in turn) tax benefits by race, parental income, educational attainment, and family structure, among other factors," he said. "In other words, it is not simply that race and parental background are correlated with income, but also there are large and predictable differences even conditional on income and looking at employees of the same firm."
Schmidt also mentioned leakage as a contributing factor.
“We’ve intentionally made these accounts illiquid,” Schmidt said. “The assets themselves are not intrinsically illiquid. Yet, because we’re concerned about people pulling money from these accounts for the wrong reasons, we’ve put sticks in place to try to keep money in the accounts. We found in the paper that there’s a lot of evidence that there are real differences across people in terms of their material needs.”
While it’s something that SECURE 2.0 acknowledged with its emergency savings provision, he argued that there’s a recognition the liquidity features matter more than initially realized, which could have significant (and counterintuitive) policy implications.
“If the goal is to encourage more savings by low-income employees who lack liquid resources, single parents, for example, it could be that making these accounts more liquid could actually have the counterintuitive effect of encouraging more people to participate,” Schmidt concluded. “We worry about [savings leakage] from the bucket, but you might have more water being poured into the top of the bucket to mitigate the leaks.”
The argument that the tax incentives primarly benefit the rich is something the Investment Company Institute (ICI) recently said is "easily dispelled."
"The facts are that most workers accumulate resources from retirement plans at some point in their careers and eventually receive retirement income from these plans," ICI Senior Economic Advisor Peter Brady said, citing the organization's research. "And the benefits of tax deferral are not restricted to high earners."
