Last week the Internal Revenue Service (IRS) announced new limits on various tax advantaged saving vehicles, such as IRAs and 401(k) contributions, for 2023. As expected, rising inflation increased these limits significantly. For example, the annual 401(k) contribution limit will increase to $22,500, from $20,500, while the annual IRA contribution will increase from $6,500 to $7,500.
Like the major attention paid to Social Security’s record high 8.7 percent cost-of-living adjustment for current retirees, it is important to pay attention to how these various retirement saving vehicles are evolving. And not just the contribution limits, but also how the design of these plans has changed over time to make sure future retirees have sufficient options available to save for a financially secure retirement.
Over the years, the popularity of these retirement saving vehicles has increased thanks to sound policymaking that used the findings of research in behavioral economics as its guide. 2002 Nobel Prize in Economics winner Daniel Kahneman and his co-author Professor Amos Tversky paved the way with their research in the 1970s. They showed that when faced with complex problems and uncertainty, people used heuristics or rules of thumb to guide action, resulting in less-than-optimal outcomes. Professor Richard Thaler took this research further, studying the financial aspects of behavioral traits such as procrastination and inertia, ultimately bringing him the 2017 Nobel Prize.
Based on this groundbreaking research and follow up studies by countless talented economists, a simple change in the law in 2006, making it easier for companies to automatically enroll their employees in 401(k) plans and to automatically escalate their contributions, was a major success in driving the uptake of these plans. According to 2022 T Rowe Price Research, “Automatic enrollment almost doubles plan participation and successfully gets participants who might not have otherwise started saving.”
Available research also underlines the positive sentiments that Americans have towards 401(k) plans. According to an annual survey conducted by the Investment Company Institute, Americans value the discipline and investment opportunity these plans represent. Ninety percent of survey respondents agree with the statement that these accounts helped them think about the long term, not just their current needs, and 89 percent agree that payroll deductions make it easier for them to save.
Obviously, this is not the end of the story when it comes to retirement savings and associated legislation. Despite the success stories, we still have some ground to cover based on a changing economy. Lack of retirement plans offered by small businesses, due to various costs (monetary, legal or time, among others) was a key issue in the most recent finalized retirement legislation.