Have Leakage Concerns Been Overblown?

A new analysis of tax data suggests that retirement system leakage isn’t nearly the issue that some have claimed.

 

That new analysis, “Decoding Retirement: A Detailed Look at Retirement Distributions Reported on Tax Returns,” by Investment Company Institute (ICI) economists Peter Brady and Steven Bass, concludes that reports of retirement plan leakage—pre-retirement withdrawals from retirement accounts—have been significantly overstated—and that they might actually have occurred at half the rate of previous industry estimates.

The paper explains that prior analysis characterized all taxable distributions received by individuals younger than age 55 as evidence that assets in defined contribution plans and IRAs were being “diverted” from retirement. But this, the ICI economists claim, overstates the extent of such leakage—both because it includes distributions from defined benefit plans and annuities and because exceptions to the early distribution penalty largely apply when assets are actually being used for retirement.

 

 

Instead, the economists posit as an alternative estimate of leakage the amount of distributions subject to penalty for early distributions under the tax code—and they argue that those distributions account for only around half—that’s right, half—of taxable distributions received by taxpayers younger than age 55.

 

The study compared taxpayers’ reports of retirement distributions on tax returns[1] with information reported to the Internal Revenue Service (IRS) by the payers of those distributions, including pension plans and financial institutions. Based on this information, the analysis determined that penalized distributions—where the IRS assesses a penalty specifically because the withdrawal are a better proxy for leakage. In 2010, the year for which the data were analyzed, taxpayers younger than age 55 received $93 billion in taxable distributions, of which only $48 billion (or 51%) was penalized.

 

“For years, observers have used measures of taxable distributions received by younger taxpayers to create a narrative of massive leakage from retirement accounts,” said Peter Brady, ICI senior economic adviser. “With this new analysis, we were able to dig deeper into the data, and it’s clear that non-penalized distributions generally should not be considered leakage. This is an important distinction because non-penalized distributions include, for example, regular pension benefits paid to retired military, police, and firefighters, as well as distributions made after a worker dies or becomes disabled. Using the measure of penalized distributions, we see that leakage is occurring at about half the rate previously estimated.”

 

The paper also points out that:

 

 

[1] Remember that distributions from a pension, annuity or individual retirement account (IRA) to individuals younger than age 59½ are generally subject to a 10% penalty on early distributions under the federal income tax, though there are numerous exceptions to the penalty, including pension benefits paid to retired military, public safety officers, or other government employees, and distributions made after a worker dies or becomes disabled.