The House and Senate unveiled similar bipartisan retirement savings bills this week. Among the differences: The House bill, approved on April 2 by the Ways & Means Committee, would allow penalty-free withdrawals of up to $5,000 from Individual Retirement Accounts to pay the costs of a birth or adoption. The Senate measure would not. I’m with the Senate.
Tax-preferred retirement savings accounts should be for…retirement. Early withdrawal penalties are a long-time feature of the tax law. And they are there to discourage people from using the funds in these accounts for other purposes. But over time, Congress has allowed penalty-free withdrawals for more than a dozen different reasons. Among them: the purchase of a first home, unreimbursed medical expenses, health insurance premiums if you are unemployed, and higher education for you or a family member. Now, the House bill, called Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, would add the cost of having a baby to the list.
I get it: Younger people may face costly expenses and have no other way to pay for them than to dip into retirement savings. And why worry about paying for health care decades from now when you can’t pay for insurance today? After all, if you can’t get good medical care when you are 30, you might not live to 59 ½, when you can begin taking penalty-free withdrawals.
But most of us will live to 59 ½–and well beyond. On average, those who make it to 65 today will for nearly 20 more years. Average lifetime out-of-pocket health care costs for a 65-year-old couple (even with Medicare) will be $285,000 in today’s dollars, according to Fidelity. And half of older adults will require long-term supports and services. The average cost in 2015 dollars for that high level of care: another $140,000.
Few save for the long-term
The whole point of IRAs, 401(k)s, and the like is to use the tax code to encourage people to create nest eggs for their old age. But the more we allow people to pull money out early, the less effective those incentives are and the less Americans will save for the long-term.
And the problem is serious. In 2017, even after a nine-year bull market, half of the retirement accounts at Vanguard had balances of $26,331 or less. Worse, median account balances were lower in 2017 than they were in 2007, just before the Great Recession.
Lack of savings is, not surprisingly, a particular problem for young people. According to the Federal Reserve, 41 percent of people 18-29 and 28 percent of those 30-39 say they have no retirement savings at all. According to the Employee Benefit Research Institute (EBRI), in 2016 those aged 30-34 had median IRA balances of $6,472. Those 35-39 had median balances of $10,830.
For most ages, average account balances look better, but that’s because they are skewed by a relatively small number of very large savers.
At least as troubling, a surprisingly large share of those with low balances already are taking withdrawals. EBRI reports that in 2016, almost 15 percent of those with balances of $5,000-$10,000 pulled money from their IRAs as did nearly one in five of those with balances from $10,000-$25,000.
Tax benefits are supposed to encourage us to plan for retirement. But the easier it is to use the money for other things, the less we will save for our old age. And Congress is giving far too little thought to the consequences of those choices.