Tax Hikes a Retirement Readiness Detriment

December 7, 2010 (PLANSPONSOR.com) – Potential tax increases will lead to a higher number of households at risk in retirement, according to a new study.

A news release about the latest analysis of the National Retirement Risk Index (NRRI), released by the Center for Retirement Research at Boston College and sponsored by Nationwide Mutual Insurance Company, said tax hikes could produce a 3% hike in the retirement readiness index. If households respond by cutting back their saving, the rise in the Index would be greater, the news release said. .

“Significant tax increases are likely in the coming years,” said Center Director Alicia H. Munnell, in the news release. “On the surface, it appears higher taxes will have a modest effect on retirement readiness with the exception of high-income households at the verge of retirement. However, the Index only reflects part of the story, as younger households would also face substantial reductions in consumption both before and after retirement.”

The research found that when examining households by income level and age, early baby boomers (born between 1946 and 1954) in the top income bracket were most impacted by higher taxes. The percent of these households at risk increased from 37% to 49%. This effect from higher taxes is greater than that of the 2008 market crash.

This impact of potential tax increases is because older households will have less time to adjust their consumption patterns and retirement plans, the study said. The impact is compounded for high-income households, as they will bear more of the burden of the tax hikes and need more income to maintain their standard of living in retirement.

Potential tax increases have a lesser affect on the retirement readiness of younger households, as they have more time to adjust to paying higher taxes. However, the modest increase in the number of younger households at risk only tells part of the story, according to CRR.

The research assumes that to stay on track for retirement, younger workers will need to significantly reduce their consumption both before and after retirement. In fact, younger, high-income households will need to reduce their consumption by 10%, according to the study.  

The NRRI measures the share of American households ‘at risk’ of being unable to maintain their pre-retirement standard of living in retirement. The Index uses the conservative assumptions that people work to age 65, receive income from reverse mortgages on their home, annuitize all of their financial assets and taxes remain at current levels. The new study looks at what happens if taxes were to increase to help bridge the gap between government revenue and spending.

More information is at http://crr.bc.edu/images/stories/Briefs/IB_10-19.pdf.

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