1755 Massachusetts Avenue, NW Suite 550 Washington, DC 20036 202.483.1370 202.483.1460 www.retirementsecurityproject.org The Effect of Asset Tests on Saving Gordon McDonald, Peter R. Orszag, and Gina Russell 1 The trend over the past two decades away from traditional, employer-managed pension plans and toward retirement saving arrangements directed and managed largely by employees themselves, such as 401(k)s and IRAs, is in many ways a good thing. But for too many middle- and low-income households, the 401(k) and IRA revolution has fallen short. 2 In this paper, we focus on one of the explanations for this failure: for the vast majority of middle- and low-income households, existing incentives to save for retirement are weak or non-existent. As a new research analysis from The Retirement Security Project (RSP) documents, federal policy actually often penalizes those who save for retirement in a 401(k) or IRA by disqualifying them from means-tested benefit programs, like food stamps, Supplemental Security Income, cash assistance for poor families with children, or Medicaid. 3 The rules associated with the asset tests were largely written before the dramatic shift in the pension system toward 401(k)s and IRAs, and the rules have not adequately been updated since then. As a result, the asset tests often impose surprisingly steep implicit taxes on saving undertaken through 401(k)s and IRAs (even though they generally exempt defined benefit plans). This policy brief reviews the relevant economics literature on the effects of the asset tests within means-tested benefit programs. The asset tests represent perhaps the most substantial financial disincentive for many families to save in retirement accounts. 1 Gordon McDonald is Senior Policy and Research Associate at the Retirement Security Project. Peter R. Orszag is Director of the Retirement Security Project and the Joseph A. Pechman Senior Fellow in Economic Studies at the Brookings Institution. Gina Russell is a Research Assistant in Economic Studies at the Brookings Institution. 2 For a broader discussion of these issues, see William G. Gale and Peter. R. Orszag, “Private Pensions: Issues and Options,” in Agenda for the Nation, edited by Henry J. Aaron, James M. Lindsay, and Pietro S. Nivola (Brookings, 2003), pp. 183-216; Peter R. Orszag, “Progressivity and Saving: Fixing the Nation’s Upside-Down Incentives for Saving,” Testimony before the House Committee on Education and the Workforce, February 25, 2004; and J. Mark Iwry, “Defined Benefit Pension Plans,” Testimony before the House Committee on Education and the Workforce, Subcommittee on Employer-Employee Relations, June 4, 2003. These and other related publications are available on The Retirement Security Project website (www.retirementsecurityproject.org). 3 Zoё Neuberger, Robert Greenstein and Eileen Sweeney. “Protecting Low-Income Families’ Retirement Savings: How Retirement Accounts Are Treated in Means-Tested Programs And Steps to Remove Barriers to Retirement Savings” Retirement Security Project Policy Brief No. 2005-6. June 2005. The Retirement Security Project is supported by The Pew charitable Trusts in partnership with Georgetown University’s Public Policy Institute and the Brookings Institution