Thomas L. Hungerford
Specialist in Public Finance
Jane G. Gravelle
Senior Specialist in Economic Policy
Current law provides many incentives to promote saving. The goal of these provisions is to increase saving for special purposes such as education or retirement, and to increase national saving. Increased national saving can lead to faster wealth and capital accumulation, which can boost future national income.
An increasingly important retirement saving vehicle is the individual retirement account (IRA). IRA savings is encouraged by two mechanisms—a carrot approach and a stick approach. First, tax provisions allow individuals to defer taxes on IRA contributions and investment earnings or to accumulate investment earnings tax free. Second, withdrawals before the age of 59½ are generally subject to a 10% penalty tax in addition to regular taxes.
There are two types of IRAs: the traditional IRA and the Roth IRA. The traditional IRA allows for the tax-deferred accumulation of investment earnings, and some individuals are eligible to make tax-deductible contributions to their traditional IRAs while other individuals are not. Some or all distributions from traditional IRAs are taxed at retirement. In contrast, contributions to Roth IRAs are not tax deductible, but distributions from Roth IRAs are not taxed on withdrawal in retirement. Expanded contribution limits were adopted in 2001, but were scheduled to expire after 2010; the Pension Protection Act of 2006 made those increases permanent.
In November 2005, President Bush’s Advisory Panel on Federal Tax Reform proposed changes to IRAs. The panel’s plan would have created Save for Retirement Accounts (SRAs) to replace traditional and Roth IRAs. Additionally, President Bush proposed consolidating IRAs into a Rothstyle retirement savings account. The Obama Administration appears to be taking a different tack by proposing additional incentives to increase saving by low- and moderate-income workers in existing retirement saving accounts that have proven effective in evaluations.
Neither conventional economic theory nor the empirical evidence on savings effects tends to support the argument that increased IRA contributions are primarily new savings—often increased retirement saving comes at the expense of reduced nonretirement saving. Roth-style accounts are less likely to induce new private savings than are traditional ones. Furthermore, these proposals would predominantly benefit higher-income individuals and families, who are the ones most likely to save without the added incentive.
Proposals that increase retirement saving among low- and moderate-income workers could be effective in increasing new saving because these workers typically have little or no nonretirement saving to reduce.
Date of Report: March 27, 2013
Number of Pages: 23
Order Number: RL30255
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