The EARN Act’s Roth 401(k) Switcheroo Is A Gimmick, Not Sound Fiscal Budgeting

For some time now, one pocket of good news coming out of D.C. has been the “Secure Act 2.0,” a set of legislative enhancements to 401(k)s/retirement savings, expected to pass, when all is said and done, in a bipartisan fashion and in “regular order.” The House had passed its version of this legislation back in March, setting the stage for the Senate to move the process forward. The provisions are, as in the original Secure Act, a collection of many small changes rather than fewer more radical changes, including indexing (adjusting for inflation) the catch-up contribution limit, allowing employers to “match” student loan payments in the same way as 401(k) contributions, requiring auto-enrollment for new employees, increasing the RMD starting age up to 75, enhancing the Saver’s tax credit, allowing employer matching contributions to be made as Roth contributions, and requiring 401(k) catch-up contribution be Roth. It’s a long list.

Now the Senate has released its version, the EARN Act, with many similarities — and has also released a cost estimate: according to the “10 year budget window” math, the bill is fully paid-for, with the costs offset by the financial gain to the federal budget of shifting retirement savings from traditional tax-deferred savings to Roth accounts, in which taxpayers use money that they’ve already paid taxes on, but then benefit from the earnings being tax-exempt. So far, so good, right? People who need extra help get it and those who benefit from traditional IRA/401(k)s still get a retirement savings benefit, just with less-generous provisions.

But that’s not what’s happening. Here’s what the Committee for a Responsible Federal Budget had to say in its analysis:

“The $39 billion cost of the bill is offset entirely with timing gimmicks related to Roth IRAs. Even with the gimmicks, the bill would increase annual deficits from 2028 onward. In the steady state, we estimate the bill would cost $84 billion over a decade, including $12 billion in 2032 alone. . . .

“[T]the bill relies on gimmicks and timing shifts to achieve this supposed budget-neutrality. The legislation expands the saver’s credit and ABLE accounts and reduces taxes for first responders employee stock ownership plans but delays the start of these policies for 4 or 5 years. And it increases the required minimum distribution age for IRAs from 72 to 75 but not until 2032.

“Perhaps most egregiously, the legislation is offset by policy changes that would shift the timing rather than the amount of tax collections. Specifically, the legislation would require and allow greater use of “Roth contributions” to retirement accounts, which are taxable when made but allow for tax-free withdrawal (conventional retirement accounts are the opposite). While these provisions would raise $39 billion over the first decade, they would reduce future revenue as retirement funds were withdrawn. The net effect is somewhat uncertain, but it is very likely these provisions would be net deficit-increasing on a present value basis.”

They’ve got a handy table of the effect of these changes and I encourage readers to, as they say, Read the Whole Thing.

What’s more, the CRFB released its analysis a week ago. Earlier this month, Professor Olivia Mitchell of the Wharton School at the University of Pennsylvania and hte Director of the Pension Research Council (she’s a big name in the field) and her co-authors released a new study on exactly this issue: “How would 401(k) ‘Rothification’ alter saving, retirement security, and inequality?” “Rothification” is, essentially, what the EARN Act would promote, in part, referring to a shift into Roth-style instead of tax-deferred accounts. It’s an extensive analysis, but they helpfully provide the key results of their research in their abstract. (They use the jargon TEE and EET to refer to Roth and traditional tax-deferred accounts because it’s the international way of referring to these two types of retirement savings.)

“We find that taxing pension contributions instead of withdrawals leads to delayed retirement, somewhat lower lifetime tax payments, and relatively small reductions in consumption. Indeed, the two tax regimes generate quite similar relative inequality metrics: the relative consumption inequality ratio under taxed-exempt-exempt (TEE) is only 4% higher than that in the exempt-exempt-taxed (EET) case. Moreover, results indicate that the Gini measures are also strikingly similar under the EET and the TEE regimes for lifetime consumption, cash on hand, and 401(k) assets, differing by only 1–4%.”

In other words, according to top experts in the field, in the long run, rather than a 10 year budget window, “Rothification” does not send more money into government coffers to pay for other needs. It’s just a timing shift, collecting more money now and less later. And mandating or encouraging Roth accounts compared to traditional accounts does not have a significant impact on income inequality, again in the very long run.

So, yes, I’m all for improving retirement savings in as many (responsible) ways as we can. But the 10-year budget window is again proving to have pernicious effects on how Congress spends our money.

As always, you’re invited to comment at JaneTheActuary.com.