Do Retirement Saving Programs Increase Saving

A large fraction of American families reach retirement age with virtually no personal financial assets. The median level of all personal financial assets of families with heads aged 55 to 64 was only $8,300 in 1991; excluding Individual Retirement Accounts (IRAs) and 401(k) balances, the median was only $3,000. Almost 20 percent of families had no financial assets at all. Thus, other than Social Security benefits, employer-provided pension benefits, and housing wealth that is illiquid, the typical family has very limited resources to use in meeting unforeseen expenses. In addition to individual hardship, one consequence of the low U.S. saving rate is the prospect of limited future economic growth at the aggregate level. Two saving programs introduced in the early 1980s were intended to encourage individual saving. IRAs rapidly became a very popular form of saving in the United States after they were made available to all employees in 1982. Any employee could contribute $2,000 per year to an IRA account, and a non-working spouse could contribute $250. The contribution was tax deductible. Annual contributions grew from about $5 billion in 1981 to about $38 billion in 1986, approximately 30 percent of total personal saving. Contributions declined precipitously after the Tax Reform Act of 1986, even though the legislation limited the tax deductibility of contributions only for families who had annual incomes over $40,000 and who were covered by an employer-provided pension plan. By 1990, less than $10 billion was contributed to IRAs. Whereas over 15 percent of tax filers made contributions in 1986, only 4 percent contributed in 1990. The other program, the 401(k) plan, grew continuously and almost unnoticed, with contributions increasing from virtually zero at the beginning of the decade to over $51 billion in 1991. In 1991, almost 25 percent of families contributed to a 401(k). Deposits in 401(k) accounts are also tax deductible and the return on the contributions accrues tax free; taxes are paid upon withdrawal. But these plans are available only to employees of firms that offer such plans. Prior to 1987 the employee contribution limit was $30,000, but the Tax Reform Act of 1986 reduced the limit to $7,000, and indexed this limit for inflation in subsequent years. The contribution limit is $9,235 for the 1994 tax year. By 1991, contributions to all personal retirement saving plans exceeded contributions to traditional employer-provided pension plans. It seems evident that if it were not for the 1986 tax legislation, personal retirement saving would have been much larger. Whether these programs increase net saving can be of critical importance to future generations of older Americans and to the health of the economy in general. The issue remains an important question of economic debate. In a series of papers based on very different methods of analysis, Steven F. Venti and I and James M. Poterba, Venti, and I have concluded that contributions to these accounts represent new saving in large part. In determining the effect on saving of IRAs and 401(k)s, the key problem is saver heterogeneity: some people save and others don't, and the savers tend to save more in all forms. For example, families with IRAs have larger balances in all financial assets than families without IRAs. But this does not necessarily mean that IRAs explain the difference. Thus a continuing goal of the analysis has been to consider different methods of controlling for heterogeneity, or individual-specific saving effects. The methods that could be used when each analysis was conducted were largely dependent on the data available at that time. As new data became available, we used alternative and possibly more robust methods. Early Parametric Analysis of Substitution at the Outset of the IRA Program When we began this work in the mid-1980s, data were available for a limited time period; assets typically could be measured at only two points in time, one year apart. …