By Paula Aven Gladych
A new report by the Center for Retirement Research at Boston College found that large tax expenditures don’t entice households to increase their retirement savings. Instead, automatic saving options like auto enrollment and auto escalation do much more to get passive savers to participate.
The federal government provides generous tax subsidies for retirement saving in 401(k) plans and IRAs
designed to increase household saving and retirement income security, according to the report. The cost to the Treasury exceeds $100 billion a year in lost revenue.
“Given the nation’s severe budgetary pressures, it is critical to know how effective these subsidies are in raising household saving and whether other approaches would be more cost-effective,” according to the authors of the report.
The report uses data from Denmark to answer questions about the benefits of government subsidies or other options to increase retirement savings. The Danish retirement system
and patterns of retirement savings are similar to those in the United States.
What it found is that the government subsidy had only a small effect on total household saving and affected very few households. “Of those in the top tax bracket, 83 percent essentially made no change in their pension and non-pension saving when the subsidy was cut.”
On the flip side, automatic saving efforts were assessed by examining how individuals responded to an increase in employer pension contributions when switching jobs and to the introduction of the government’s mandatory saving program.
It found that the “lion’s share of the automatic increase in employer contributions was passed through as an increase in total household saving.”
From 1998 to 2003, the Danes required all of their citizens to contribute 1 percent of earnings to a retirement savings
account and retirement savings increased in those years by about 1 percent of earnings, on average, with little reduction in other types of saving. Savings increased even for individuals who were previously saving more than 1 percent of earnings in voluntary individual pension accounts.
The authors of the report looked at the differences between active and passive savers to find out why automatic contributions are so much more effective at raising saving than tax subsidies. The answer was that about 85 percent of the population is passive rather than active savers.
Passive savers adjust how much they spend in response to changes in disposable income. Money in their pocket gets spent. Money not in their pocket gets saved, the study found.
Automatic retirement contributions take money out of a person’s pocket so passive savers immediately adjust what they are spending to compensate for the loss of that money.
Active savers make saving and spending decisions based on a life-cycle planning model. They shift assets across savings accounts in response to subsidies or automatic saving, instead of altering their total saving, the report found.
Originally published on BenefitsPro.com