Mises Wire

Yet Another Way the Feds Make It Harder to Save for Retirement

On August 31, President Donald J. Trump signed the Executive Order on Strengthening Retirement Security in America, a preliminary step in allowing seniors more economic freedom and security in retirement.

As part of the executive order, Trump discussed how rules regarding 401(k) distributions prevent Americans from saving as much money as they otherwise would.

Up to age 70 ½, retirees are not required to withdraw any distributions from their accounts at all.

After they reach this age, though, they must take required minimum distributions (RMDs), which are set amounts of funds that must be withdrawn from their accounts by law.

While RMDs do not require that money be spent, they require that a certain amount be removed from tax-deferred 401(k) accounts, which then becomes subject to the income tax.

In preventing interest from growing on retirees’ tax-free account funds, fewer loans can be made to potential investors, and there is consequently less wealth in the economy than there otherwise would be.

As long as certain quantities of money are forced out of 401(k)s and subsequently taxed, consumption in the economy becomes artificially stimulated.

Since retirees’ saving and investing become penalized by taxation (to the degree of the particular rate), their time preference rates increase, ceteris paribus, again encouraging spending and consumption. RMDs, hence, hinder investment in multiple respects.

The real trouble falls on retirees, though. Instead of deciding for themselves how much they should spend and save, RMDs force them to save less, leaving them with less money saved for future consumption, emergency situations, and their estate inheritors.

They are consequently forced to begin buying more goods than they would have liked to, because they are be incentivized to turn their distributed money into untaxed assets, e.g., consumers’ goods).

If they did not buy more goods, that money would simply be transferred from their income to the federal government.

Worse still, RMDs are calculated by factoring a given retiree’s age and the balance of their 401(k) account; the larger the balance and the higher the retiree’s age, the higher the RMD.

As such, RMDs increase gradually with each subsequent year (as a percent of account balance) meaning that for each year that retirees exceed 71 ½ years old, the government mandates that a higher percentage of their tax-deferred funds leave their accounts and be taxed.

Thus, even though healthcare and other life maintenance costs tend to rise for seniors as they become older and near the end of their lives, RMDs force them to reduce their savings further and more progressively.

This makes it more likely that seniors will run out of money in retirement, being left to subsist on social security, as well as maybe a pension or the goodwill of private charity.

Though they would still have some means of subsistence if their 401(k) accounts completely drained, they would have far less money than they would otherwise, making them far worse off.

Failure to withdraw the proper distribution for a given year results in an additional 50% tax on the amount of money not taken out that legally should have been.

Clearly, this would result in even less wealth for retirees, making it in their better interest to withdraw RMDs.

This built-in enforcement system makes compliance with the government’s wealth-destructive regulations essentially unavoidable, by making the only alternative terribly undesirable.

RMDs seem to be burdensome at best, and incredibly destructive at worst, hurting nearly all consumers, entrepreneurs, and retirees.

Aside from the privileges that some firms may receive from the effect of RMDs on consumption, the only real winner is the Internal Revenue Service (IRS).

Interestingly enough, one of the only reasons that RMDs exist is because of the high time preference of the IRS. That is, the IRS wants your money now, rather than later.

Forcing retirees to take out certain sums of money from their account puts a cap on the amount of interest collectable from the tax-deferred money in 401(k) accounts.

Instead of allowing this wealth to grow in the account owners’ 401(k)s, the government ensures that it is taken out and taxed right away, even though letting the wealth grow could lead to higher tax revenue later on in the future.

Of course, the federal government is not oblivious to the fact that RMDs impede the growth of wealth.

The opposite is true. After all, Congress eliminated RMDs for the year of 2009 to keep retirees’ accounts from depleting during the financial crisis.

Despite all this, the government continues in imposing RMDs so to collect tax revenue sooner (albeit smaller in quantity) and to artificially stimulate consumption.

This makes sense after all, since government employees have no interest in preserving the long-term profitability of the state, but only in extracting as much personal benefit as they can from it.

As Hans-Hermann Hoppe explains in Democracy: The God That Failed, “a government’s temporary caretaker [e.g., a bureaucrat, politician, lobbyist, etc.] will quickly use up as much of the government resources as possible, for what he does not consume now, he may never be able to consume” in the future.

As such, their only interest is in short-term gains, and that means that state officials prefer to realize less tax revenue in the near future over realizing much more in the distant future; this is the primary reason for which RMDs exist.

Thus, the collective will of state officials is substituted for the volitions of individual persons, and in doing so the economy is bent in favor of the former.

While Trump is not looking to completely get rid of RMDs, he wants to reduce them to reflect more recent death statistics.

This issue is crucial to the well-being of seniors, who are, on average, living longer than they were in 2002 when the Treasury Department last updated its life expectancy tables.

As long as RMDs do not accurately reflect present data, seniors’ 401(k) accounts could be drained long before they pass away, given the longer life expectancy of modern times.

Trump’s proposal, then, would protect many more retirees, leaving them with more money throughout the span of their retirement.

Still, some individuals are bound, by nature, to be outliers of life expectancy data, meaning that even if RMDs are based on the most up-to-date death statistics (as Trump wants them to be), there will still be some retirees whose 401(k) funds disappear far too quickly.

Hence, the problem with RMDs, as has been explored above, far exceeds the outdated data upon which they are based. RMDs, rather, are flawed in principle in their distortion of market affairs and suspension of free choice.

All this aside, though, Trump’s proposal to lower RMDs would, at the very least, be a step in the right direction.

Making the level of mandatory distributions lower would allow for much more flexibility in retirement.

Those retirees who still wish to withdraw large sums of money from their 401(k)s would still be free to, of course; the difference is that those whose preferences and conditions dictate that they take out much less would now also be free to.

The market would be distorted less severely in terms of spending and saving, more wealth would be allowed to grow, and retirees would be permitted to make far more decisions for themselves.

By the end of February 2019, recommendations from the Departments of Labor and the Treasury will be made regarding Trump’s proposed lowering of RMDs, and these recommendations will be used later to begin drafting relevant legislation.

When it comes time to do so, one can only hope that the 116th US Congress will feel strongly enough about free enterprise and retirement security to loosen the shackles of ruinous, federal regulation.

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