September 01, 2017
Washington Post columnist Thomas Heath discussed a plan being considered by Republicans to end the tax deductibility of contributions to IRAs and 401(k)s. Under the proposal, the contributions would be subject to taxes, but all withdrawals would be tax free. This would in effect make all retirement accounts like Roth IRAs, which many people now contribute to voluntarily.
Incredibly, Heath did not make the obvious point, this change doesn’t actually save the government any money, it just changes the timing of tax collections. The government will collect more tax revenue now, as people place money into retirement accounts, but less money in the future when people are pulling the money out.
Mandating this change is a cheap trick that only makes sense as a way to hide the cost of a tax cut. This would have been worth pointing out to readers who might otherwise think that this switch serves a real purpose.
In discussing the debate over IRAs and 401(k)s as policy, it would have also been worth mentioning the argument of critics that they rip people off. The actual cost for the financial industry of maintaining and IRA or 401(k) is very low. (Vanguard doesn’t charge anything, getting its costs covered by the fees on individual funds.) Nonetheless, the average fee for an account (on top of the cost of individual funds) is close to 1.0 percent annually, with many companies charging more than 1.5 percent.
This means that someone with $120,000 in an IRA is paying $1,200 to a bank or insurance company each year for nothing. This is a great welfare program for the financial industry, but it is a needless tax on savings. These fees can be reduced with better regulation. Also, states like California, Oregon, and Illinois are making their government-run programs for public employees, which have much lower fees, available to workers in the private sector.
The Trump administration has attempted to block these state programs and efforts at better regulation. It argues that people in the financial industry are too incompetent to make an honest living so that they need the government to stack the rules in their favor so that can get the six and seven figure salaries they have come to expect.
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