In an Issue Brief from the Center for Retirement Research (CRR) at Boston College, researchers said this loss cannot be calculated simply by looking at the numbers on a cash basis, because the 401(k) tax advantage is a deferral, not a permanent exclusion. The correct approach is to calculate the present value of the revenue foregone, net of the present value of future tax payments, with respect to contributions made in a given year.
The CRR noted that the precise number depends importantly on the assumed rate of return and on whether workers face lower rates in retirement. The value of the tax expenditure is also sensitive to how capital income is taxed outside of 401(k)s. “With realized capital gains and dividends taxed at a maximum of 15%, the relative advantage of 401(k)s has declined sharply,” the report said.
Recent deficit reduction commissions have proposed capping the contribution eligible for favorable tax treatment at $20,000 or 20% of income. Others have proposed replacing the deduction with a government match. Such changes would reduce the attractiveness of 401(k)s for high earners.
On the other hand, the CRR said, the accompanying proposals to tax dividends and capital gains at the rates applied to ordinary income would enhance the value of the favorable tax provisions.The Issue Brief can be downloaded from http://crr.bc.edu/briefs/what_s_the_tax_advantage_of_401_k_s.html.
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