IRAs and SEPs-Tax Subsidies for the Wealthy

Last year, Maryland Governor Larry Hogan introduced into the Maryland General Assembly a bill entitled the “Retirement Tax Fairness Act of 2019.”  The bill had a five-year phase-in.  The fiscal note to the bill projected that over that five-year period the exemptions under the bill would cause a $178.6 Million loss in state revenue and an approximate additional loss of $111.15 Million to local jurisdictions.  (The fiscal note only calculates the loss to local jurisdictions in the first and last years of the five year period.  I calculated the approximate loss by dividing the loss to local jurisdictions in the last year, dividing it by the loss to the state in the last year, and then multiplying the result by $178.6 Million.)

The bill would have exempted from Maryland state tax income from (i) individual retirement accounts (“IRAs”) and annuities under IRC § 408, (ii) Roth IRAs under IRC § 408(a), (iii) simplified employee pensions under IRC § 408(k), and (iv) ineligible deferred compensation plans under IRC § 457(f).  Intuitively, I knew that exempting income from the first three categories was bad public policy.  After all, all of the growth in value over the amounts contributed in all three categories had already been tax-deferred.  And, except for contributions to Roth IRAs, even the contributions to these plans were made in before tax dollars. (I address IRC § 457(f) below.)  Thus, for the most part, the assets in these plans were derived from tax-free contributions and the appreciation in all of the plans had never been subjected to income tax.   I also assumed that the financially well-off held a disproportionate share of the assets in these plans.

The bill did not make it out of committee and died when the legislative session ended.  However, a bill containing similar provisions has been introduced into the 2020 legislative session.

IRAs and SEPs are widely believed to be the “pension for Everyman” (or, if you prefer, “Everywoman”).  I began to wonder: How skewed toward the wealthy are these plans?  I was quite shocked to find out that the answer was “Really, really skewed.”  I was able to locate statistics from the IRS based upon income tax returns filed for tax year 2016.  I have prepared a chart, available here, that shows the results of my calculations.  (The URL to the portal for the IRS source statistics is set forth on the chart.  I used three tables from the IRS.  I have uploaded the tables here, here, and here.)

This chart shows that in 2016 only 6.45% of all taxpayers made IRA contributions.  While 77.26% of all taxpayers were eligible to make such contributions, only 8.35% of those eligible actually made contributions.

By the end of 2016, only about 19.88% of taxpayers had money in IRAs or SEPs and the average market value in those IRAs & SEPs was only a little over $35K.  The real eye-popping numbers, however, are those that show how skewed toward the wealthy IRAs and SEPs are.

Only about 155,625 taxpayers reported income in 2016 of more than $1M.  They represent only 0.0762% of all taxpayers.  However, the market value of their  IRAs and SEPs was, on the average, $235,274 and represented 5.25% of the total market value of all IRAs and SEPs.   Taxpayers reporting income of over $100K represented 4.66% of all taxpayers.  Yet, they held 60.46% of the market value of all IRAs and SEPs.

Stated simply, as to IRAs and SEPs, the Maryland proposal would exempt from Maryland state and local income tax wealth that has, for the most part, already escaped taxation.  The primary beneficiaries would be the wealthy.

Oh, yeah, I promised a discussion of ineligible deferred compensation plans under IRC § 457(f).  I can’t find precise statistics as to these plans, but it is clear that the beneficiaries of these sorts of plans are already quite wealthy.

IRC § 457(f) provides a deferral of income under certain non-qualified deferred compensation plans operated by a state, political subdivision of a state, and any other tax exempt organization.  Who are the beneficiaries of such plans?  Highly paid personnel of colleges, universities, foundations, and hospitals such as executives, doctors, and, of course, college athletic coaches.  Not exactly a group in need of special tax breaks.  Unlike the bill introduced last year, the bill introduced in the current session excludes IRC § 457(f) plans from tax-exempt distributions.

The statistics concerning IRAs and SEPs open the question of whether the rules pertaining to exemption should be either repealed or radically modified.  While the IRA/SEP provisions are widely viewed as being egalitarian, in operation these provisions disproportionately benefit the wealthy.


7 thoughts on “IRAs and SEPs-Tax Subsidies for the Wealthy”

  1. States give tax breaks to the wealthy probably for the same reason they give tax breaks to companies to induce them to move to the state or stay in the state. These people and companies have options. The 80% of people who fail to save do not have much in the way of options.

  2. In fact, that was the rationale given for the bill last year. It’s baloney. How do I know? Once again, data from the IRS resolves the issue.

    The IRS has state to state migration data. Data for the years 2017/2018 can be accessed here:

    In that period, there were 91,790 returns of people migrating from Maryland to other states, which returns reflected a total of 166,339 exemptions. In other words, 166,339 people on 91,790 returns migrated from Maryland to other states.

    However, there were 82,812 returns of people migrating to Maryland from other states, which returns reflected a total of 145,570 exemptions. That is, 145,570 people on 82,812 returns migrated to Maryland from other states.

    Therefore, the net migration from Maryland as shown on tax returns was only 20,769. At the end of the year, Maryland had 4,628,099 exemptions shown on returns. Thus, the 20,769 figure represents only 0.46% of the Maryland population filing returns. That is, essentially a rounding error.

    1. Right. And there’s been many cases of research into the thesis that “raising state/local taxes causes richies to flee.” Turns out, they never do for that reason. Instead, they finagle things so they can declare legal residence in some low-tax state while spending their time in that high-tax jurisdiction they so love. “for the lifestyle”.

      Tne exception that proves the rule: I know a guy [committed Randian, NRO reader, wingnut par excellence] who grew up in CA and ended up moving to Burleson TX. Man, he was so bummed with that place — it’s so damn boring. But no way no how he’s movin’ back to CA, b/c “taxes”. So he just complains about TX.

  3. In addition to the obvious issues about the availability of money, let’s consider how lower marginal rates and low interest/returns have messed with the incentives for tax-advantaged savings. $1,000 into an IRA saves you $150-250 (more for the rich, of course) at the cost of not having that money easily available. Then, sure, you don’t get taxed on the $20-30 the IRA makes, but you don’t get taxed on lots of illiquid investments until you sell, so that’s not really a gain. And you have to keep track of the paperwork, which is a small but noticeable cost. So if you’re in the unlikely position of being in the lower brackets but having enough money to save and having no fear of excess expenses anytime in the next few decades, sure. For every dollar you put away you’ll get back enough to pay a year’s credit interest (maybe) should you find it necessary to borrow for expenses because you didn’t have the dollars you would have had if you’d put that money in a liquid place.

    (I have an above-average IRA balance, but it’s not actually my doing, rather the result of my former employers dumping what would have been their contribution to my pension into my individual account when I left.)

  4. Ecclesiastes was right.

    “They were ruined, when they were required to send laboring children to school; they were ruined, when inspectors were appointed to look into their works; they were ruined, when such inspectors considered it doubtful whether they were quite justified in chopping people up with their machinery; they were utterly undone, when it was suggested they need not always make quite so much smoke. Besides Mr. Bounderby’s gold spoon which was generally received in Coketown, another prevalent fiction was very popular there. It took the form of a threat. Whenever a Coketowner felt he was ill-used—that is to say, whenever he was not left entirely alone, and it was proposed to hold him accountable for the consequences of any of his acts—he was sure to come out with the awful menace, that he would “sooner pitch his property into the Atlantic.”

    Charles Dickens
    Hard Times

  5. You are painting with too broad a brush here. Your percentages include me, and many of my coworkers who have one of those 457 accounts you are condemning. We are not doctors or lawyers. We’re admin support people for a state government agency, holding jobs usually deemed lower middle class to middle class. None of us is wealthy. Most of my coworkers scramble to meet expenses every month. I don’t scramble only because I don’t have kids to support. I also have no relatives wealthy or otherwise who could assist me; I’m on my own financially. After a lot of research and calculations and several visits to Smart Money coaching, I have found I will avoid homelessness in my old age through the combination of Social Security, my state pension, and the dough in that 457 (and the 401ks from prior jobs). I wish there was some other way to finance retirement but since that’s what there is, I’ve used it.

    And speaking of painting with too broad a brush, there’s a lot of people who have good incomes on paper but have high expenses, and not for luxuries, either. I used to work for a lawyer whose mother had Alzheimer’s. He supported her for years, first in her home, then in a memory care facility. He was also helping 2 kids through college. That combination ate a big chunk of his retirement savings.

    1. The question arises: Why should tax benefits go to rich people who have mothers with Alzheimer’s and two kids in college, but not those among the other 95% of the population who are similarly situated?

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