Baby Boomers, 401(k) and Social Security

One of my strongest 401(k) selling points when I was a plan administrator in 1982 was that employee contributions were not subject to FICA. It also helped that workers had more disposal income from which to save as FICA taxes were lower then. Then 1983 happened. Riding to the rescue of Social Security, political leaders raised FICA tax rates and imposed FICA taxation on participant 401(k) contributions. With this decision policymakers diminished the attractiveness of 401(k) and reduced the pool of disposal income available for 401(k) savings. In essence baby boomers were told in 1983 that in exchange for giving the government trillions of dollars more than was necessary to meet its ongoing Social Security obligations baby boomers would be sure to get the system’s promised benefits when they retired.

In theory this seemed a good idea. Unfortunately, it’s not working out in practice. The government loaned the FICA surpluses to itself by investing in special US Government bonds so it cannot use the surpluses to pay benefits without imposing new taxes to redeem the bonds. In short Social Security benefits to baby boomers cannot be paid at current levels without tax increases, and as some suggest, reducing baby boomer Social Security benefits—exactly the situation the 1983 solution was imposed to avoid.

Politically, the Social Security promise is a contract that baby boomers will not allow to be broken. In the coming battle for resources to pay their Social Security benefits, baby boomers will be lead by retirees who have been political activists on both sides of the political spectrum since the 60’s and they have the money and numbers to win with pure muscle alone. Some will call them selfish. They will say they’re owed.

Fortunately, America's workers have accumulated nearly $9 trillion dollars in employer defined contribution plans and rollover funded IRAs, and this total will grow for several more years. Nearly all of this money is tax deferred. By saving in tax deferred plans, workers not only sacrifice current consumption to enrich their retirement futures they force the government to set aside immediate tax consumption as well. 401(k) is a dam storing future federal revenue.

Literally trillions of dollars of income tax will be paid from this pool as retirees consume their tax deferred savings. This 401(k) generated tax resource will help the government meet its Social Security promise to baby boomers and perhaps reduce the future tax burden on younger workers. 401(k) is about more than just individual retirement savings.