IRA and 401(k) contribution limits are increasing. That’s great news if you’re rich

In response to the recent surge in inflation, the IRS is raising contribution limits for the entire range of retirement accounts. That’s great news. If you make a lot of money.

But for the vast majority of working-age Americans, who contribute far less than existing limits or nothing at all, it won’t make the slightest difference.

This is not a criticism of the IRS, which is doing exactly what the tax law requires in raising these limits to account for inflation. But it’s another reason why the entire retirement savings system needs to be overhauled so that it benefits those who need the help, rather than those who have ample opportunities to save for retirement and the Wall Street firms that manage their accounts.

inflation adjustments

The agency increased the 2023 contribution limit for 401(k) and similar work-based plans by $2,000 to $22,500. It raised the annual contribution limit for IRAs from $6,000 to $6,500.

The 401(k) catch-up contribution limit for employees age 50 and older will increase from $6,500 to $7,500. As a result, these older workers could save up to $30,000 by 2023.

Some pass-through business owners can put as much as $73,500 into their tax-advantaged retirement accounts.

In all of these cases, savers can defer taxes on traditional retirement accounts until they make distributions years later. Separate rules apply to Roth accounts, where deposits are made with post-tax money, but distributions are tax-free.

The increase in maximum contribution amounts is an attempt to keep them relatively stable after accounting for inflation. But who benefits from this generosity? Certainly not ordinary workers.

Who saves for old age?

The Federal Reserve estimated that in 2019 just over half of all middle-income people had any retirement accounts, while 80% of those in the highest income bracket in the 80th to 90th percentile had one, and 90% in the top 10 %. had retirement savings.

In 2018, the average annual IRA contribution was about $4,200, well below that year’s contribution limit.

Vanguard estimates that by 2021, approximately 14% of employees in plans administered by Vanguard will have exhausted their contributions. Less than 2% of those earning $75,000 or less contributed the maximum amount, while nearly 60% of those earning at least $150,000 met the legal limit (see Figure 42).

TPC looks at contributions through a different lens – the value of the tax benefit for each income bracket. But it tells the same story. Low- and middle-income workers saved very little for retirement, while high-income workers saved a lot. The group that benefits the most, on average, are the highest-income 80th to 99th percentiles, those households earning between about $190,000 and nearly $1 million this year. You’ll get more than half the benefits of retirement tax breaks. All households with an income of about $100,000 or less receive about 20% of the benefit.

High-income savers aren’t the only wealthy beneficiaries of this year’s inflation adjustments. The 2023 estate tax exemption increases a whopping $1.72 million for a couple to $25.8 million.

Only a handful of heirs benefit from a few thousand mega-wealthy offspring. Inflation adjustment for retirement savings will help millions of middle-income people. Who doesn’t need it.

Help small account holders

Instead of building in automatic inflation adjustments that benefit high-income savers, Congress could encourage workers to start saving for retirement and encourage small accounts for those who do. The retirement savings bills floating around in Congress have features that do so, although they also contain provisions that would largely benefit savers and high-income retirees.

Some ideas: increase savings credit, where the government could match up to half the contributions of low- and middle-income savers with a tax credit, expand incentives for or even require companies to set up retirement accounts for their employees and Retirement accounts are portable so workers can take their savings with them when they change jobs, rather than losing track of them or having them cash out early. .

Collectively, as of June 30, Americans had nearly $35 trillion in retirement savings. Unfortunately, much of it is in the hands of a few. The Vanguard report found that even among those who have accounts, half of those over 65 had net worth of less than about $90,000 (Figure 55).

As a result, while high-income, high-disposable workers can top up their retirement savings to keep up with inflation, low- and middle-income workers are less and less sufficient for what they need for retirement.

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