My client, Jessica, worked in retail for the month of January last year before she was diagnosed with stage 2 breast cancer. Jessica was a planner by nature and was trying to put her financial life back together after divorce. Her separation agreement entitled her to a fifth of her husband’s income as alimony payments for a handful of years until he was old enough to receive Social Security. Jessica had limited retirement savings and so decided to live off her alimony payments and save her modest retail income into her 401k plan so it could grow tax deferred for her senior years. She managed to save a total of $500 before her devastating diagnosis.
After surgery and several bouts of chemotherapy, Jessica is now in remission and has regained her strength. But IRS rules have discriminated against her and have left her paying far more in taxes than she would have had she not been stricken with cancer and had been able to continue working. Because Jessica worked for an employer that offered a retirement plan, she was disqualified from contributing to a tax deductible IRA (Individual Retirement Account) even though she worked for less than one month of the calendar year and contributed only $500 to a 401k plan. This is because her ex-husband, a highly paid executive who earned more than $400,000 per year, paid Jessica $80,000 in alimony payments and so Jessica’s income exceeded IRS IRA deduction limits. Had she not been eligible to contribute to an employer plan, she would have been able to contribute $6,500 to a tax deductible IRA.
Meanwhile, Jessica’s ex-husband, Jack, the high earner, has no income restrictions on participating in his employer’s 401k plan. So while Jessica could contribute only $500 to her 401k with no ability to contribute further to a deductible IRA, Jack and his generous employer could contribute up to $59,000 to his 401k plan, according to 2016 IRS limits.
I have been a financial planner for over twenty years. But no matter how many times I mull over the inconsistencies of retirement contribution limits, I cannot follow the logic of why some people are so restricted by the rules and others are in effect given massive taxpayer subsidies. Is tax policy supposed to incentivize people to save for retirement? If so, why not give Jessica the same rules as Jack? Or is our tax code supposed to collect the maximum income tax per earner in accordance with our progressive tax system? If so, make Jack pay income tax on all of his income with only minimal deductions, the way Jessica has to.
Retirement planning is dull and complex. But these rules matter and we have to pay attention because women have been receiving the short end of the stick for a very long time. For example, a recent Vanguard study found that men have average employment retirement account balances that are 50% higher than women’s. This statistic would grow if IRA balances were factored in.
In other words, men are receiving income tax deferment or, to put it more bluntly, tax subsidies, at a 50 percent higher rate than women. In our example above, while Jessica managed to defer about $100 of taxes from retirement contributions in 2016, her ex-husband deferred more than $20,000 of taxes ($59,000 of retirement contributions times an estimated 35% combined federal and state income tax rate).
The truth is I do have a pretty good idea as to why our retirement system is so illogical and regressive. It has to do with who is at the bargaining table when rules are lobbied for. I think it’s safe to bet that high earning executives have their interests represented and people like Jessica, who make a modest wage but need a secure retirement nonetheless, have no voice in the process. Let’s give Jessica voice.