Expand saver's credit and automatic enrollment in IRAs and 401(k)s

Under current law, low- and middle-income taxpayers may claim a saver’s credit of up to $1,000 ($2,000 for couples) if they contribute to retirement savings plans. The credit equals the credit rate times up to $2,000 of contributions to IRAs, 401(k)s, or certain other retirement accounts by each taxpayer and spouse. The credit rate for 2008 depends on income and tax filing status as shown in the following table. (For 2009, couples filing jointly must have income below $55,500, heads of household income below $41,625, and other tax filers income below $27,750 to claim any credit.) The credit is not refundable and therefore has limited value for people with little income tax liability.

The president proposes to make the saver’s credit refundable as a 50-percent credit up to $500 per individual (indexed for inflation).  The full credit would go to families with income below $65,000 ($48,750 for heads of household and $32,500 for singles and married couples filing separately) and would be automatically deposited into the qualified retirement plan or IRA.  The credit would phase out when income exceeds those limits: the maximum credit would be reduced by 5 percent of income over the relevant limit.

The government would effectively pay half the cost of up to $1,000 deposited to a retirement account each year for all eligible households. For example, a family that puts $800 aside in a retirement account would receive a $400 tax credit, lowering the cost of the contribution to $400. Turning the currently nonrefundable saver’s credit into a refundable credit would encourage low-income households to save more by boosting the effective return to their saving.  Because the credit would go directly into the saver's retirement account , the default option would agument the amount saved by half and thus further increase the amount saved for retirement.  The phaseout of the credit would, however, raise effective marginal tax rates for many middle-income taxpayers with potentially adverse behavioral effects on work effort and saving.

The president also proposes to establish automatic enrollment in IRAs and 401(k)s. Currently most employment-based retirement savings plans require workers to make a positive choice to contribute to the plan. The default option is not to contribute.  Under the president’s proposal, employers in business at least two years and with ten or more workers would have to enroll every worker automatically in a workplace pension plan unless the worker opts not to participate. Employers who do not currently offer retirement plans would have to enroll employees in a direct-deposit IRA account unless the worker opts out. Research has shown that changing from a default opt-in provision to an opt-out provision markedly increases worker participation. The administration suggests that its proposal would increase the savings participation rate for low- and middle-income workers from the current 15 percent level to around 80 percent.

Additional Resources
Tax Policy Briefing Book: Key Elements of the U.S. Tax System: Savings and Retirement: What is an automatic 401(k)? http://www.taxpolicycenter.org/briefing-book/key-elements/savings-retirement/401k.cfm
Tax Policy Briefing Book: Key Elements of the U.S. Tax System: Savings and Retirement: How might saving be encouraged for low- and middle-income households? http://www.taxpolicycenter.org/briefing-book/key-elements/savings-retirement/encourage.cfm
Tax Topics: Pensions and Retirement Savings http://www.taxpolicycenter.org/taxtopics/Retirement-Saving.cfm