How Do People Save for Retirement?

October 14, 2011

Just over half (52 percent) of all workers who filed tax returns in 2006 participated in some form of tax-favored retirement plan, CBO reports—in a study released today. The highest rates of participation were among workers between the ages of 45 and 59; those whose income was $40,000 or more; and those who were the primary (that is, the higher) earner in a two-earner household. The lowest rates were among workers under the age of 30; those whose income was under $20,000; and those who were unmarried.

Shown below, this study, the fourth in a triennial series on participation rates in and contributions to various plans, examines data for 2006. The first in the series, Utilization of Tax Incentives for Retirement Saving (August 2003), presented data from 1997; the subsequent updates presented data for 2000 and 2003.

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What Kinds of Incentives Does the Federal Income Tax System Provide?

The federal income tax system contains two types of incentives to encourage workers to save for retirement. With traditional incentives, workers make contributions (up to a statutory limit) into certain accounts from their before-tax income and defer tax payments until the funds are withdrawn. With so-called Roth-style incentives, workers contribute from after-tax income but pay no tax at the time of withdrawal. In either case, the resulting investment income is effectively earned tax-free.  (This is true even for traditional incentives, because of the benefits to the taxpayer from being able to defer paying taxes on investment income until the time of withdrawal.)

Among the retirement savings vehicles permitting workers a choice between traditional and Roth-style incentives are 401(k)-type plans offered by employers and individual retirement accounts (IRAs). Contributions to 401(k)-type plans can be made by employers as well as employees, but employers’ contributions can benefit only from the traditional incentive. Unlike 401(k)-type plans, some employment-based plans (a diverse group referred to collectively as noncontributory plans in the study) are funded primarily by employers; only traditional benefits are available for such plans.

Participation Rates and Contributions

In addition to the overall participation rates described above, Exhibits 1 through 12 show the following for 2006:

  • Participation was concentrated in employment-based plans; 48 percent of all workers either contributed to or were covered by such plans. Only 7 percent of workers contributed to IRAs; some of those workers also participated in employment-based plans.
  • Twenty-nine percent of workers contributed to 401(k)-type plans while another 18 percent participated in noncontributory employment-based plans only.
  • Participants in 401(k)-type plans contributed an average of $4,350 in 2006. Average contributions were higher for those with higher earnings: Average contributions were $670 among participants whose income was below $20,000 and $11,000 among those earning $160,000 or more.
  • Slightly fewer workers contributed to traditional IRAs (3 percent) than to Roth IRAs (4 percent). Contributions to traditional IRAs were larger ($2,840), on average, than contributions to Roth IRAs ($2,590).

Looking at trends over time, CBO finds that:

  • Overall participation in some form of tax-favored retirement plan was nearly the same in 1997, 2000, 2003, and 2006—ranging from 50 percent to 52 percent.
  • Average contributions to all types of plans increased in real (inflation-adjusted) terms between 2003 and 2006, reflecting mostly the scheduled increases in the maximum contribution under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

Effects of EGTRRA’s Increases in Contribution Limits

Tax law has always limited contributions to tax-favored retirement plans—both in dollar terms and as a percentage of compensation. Exhibits 13 through 17 show the effects of EGTRRA’s increases in contribution limits on the percentage of contributors who are constrained by them (which represents an upper bound on the percentage who might be induced to save more if the limits were higher). Unlike most other aspects of EGTRRA, the higher contribution limits are not scheduled to expire after 2012—they were made permanent in a separate law in 2006. Specifically:

  • EGTRRA reduced the proportion of participants who were constrained by the contribution limits for 401(k)-type plans in 2006 from 12 percent to 5 percent.
  • For traditional IRAs, EGTRRA reduced the proportion of participants constrained by the contribution limits in 2006 from 73 percent to 52 percent; for Roth IRAs, EGTRRA reduced the proportion of those constrained from 62 percent to 39 percent.

The Saver’s Credit

The saver’s credit—discussed in the final group of exhibits—was introduced by EGTRRA to encourage retirement saving by providing tax credits to lower-income taxpayers who contributed to an IRA or 401(k)-type plan. The rate of credit varies between 10 percent and 50 percent, depending on adjusted gross income, and applies to the first $2,000 of qualifying contributions.  The credit cannot reduce income tax liability below zero. The saver’s credit originally was scheduled to expire after 2006, but was made permanent in that year. CBO finds that:

  • In 2006, 25 percent of all workers who filed tax returns were eligible to take the saver’s credit (down from 30 percent in 2003) on the basis of their income and tax liability. Only 20 percent of those eligible actually contributed to a retirement account (down slightly from 21 percent in 2003), and 65 percent of those who contributed claimed the credit (up from 59 percent in 2003).
  • Taxpayers whose income was low enough to qualify for the 50 percent credit rate were the least likely either to make qualifying contributions or to claim the credit if they did. Those whose income made them eligible for the 10 percent credit rate were the most likely to make qualifying contributions and to claim the credit. The average amount of the credit was $156.

This study was prepared by Paul Burnham of CBO’s Tax Analysis Division.