Temporary Retirement Account Loss Deduction

All told, Americans lost $1.6 trillion in retirement savings as a result of the financial crisis. While younger workers will have time to rebuild their savings, near and new retirees have less time to allow the markets to recover. As a result, they face the potentially dire prospect of a vastly diminished nest egg and the loss of the retirement security they had planned for. A temporary tax break in the form of a retirement account loss deduction can help cushion the blow to their retirement wealth.

THE PROBLEM

Near and new retirees took a heavy hit during the financial crisis

The financial crisis wreaked unexpected and unprecedented damage on American retirement accounts, dramatically undermining the ability of middle-class Americans to plan for the retirement they want and deserve. Many new and near retirees experienced an almost overnight evaporation of their retirement wealth, causing many to rethink their plans for retirement or to downsize their expectations.

The financial crisis ravaged retirement accounts.

During the crisis, retirement accounts lost approximately 18% of their value or a total of almost $1.6 trillion.¹ One in four retirees reports a decline in retirement income in the past year and two thirds of near-retirees, adults ages 50-64, say they lost money in their mutual funds, individual stocks, or 401(k)-type retirement accounts in 2008.² Of those who report such losses, two in ten say they lost more than 40% of their investments’ value and nearly four in ten say they lost 20%-40%.³ According to the Employee Benefit Research Institute’s 2010 Retirement Confidence survey, only 16% of Americans are “very confident” that they will have enough money to live through their retirement years, a more than 10% drop from just 3 years ago.⁴

There isn’t sufficient time for seniors’ retirement accounts to recover.

Unlike younger Americans, who have many years before retirement to get their portfolios back in shape, near retirees and retirees have little time to recoup their losses in the market.⁵ 63% of individuals between the ages of 50 and 61 say they may have to delay their retirement because of the recession.⁶ Many retirees are in an even worse position because they have already begun drawing down their 401(k) accounts to fund their retirement. For these seniors, their retirement accounts may never fully recover. It took 15.5 years for the stock market to fully recover from the bear market of the Great Depression, and it took 4.6 years for the stock market to recover from the bear market of the relatively less severe recession of the early 2000s.⁷ Indeed, even in cases where individuals invested more conservatively in a mix of stocks and bonds, it could still take several years to recover the losses that were sustained during the financial crisis.⁸

THE SOLUTION

Temporary Retirement Account Loss Deduction

To help older Americans restore the value of the retirement accounts that they rely on to cover their day to day expenses during retirement, Third Way proposes a temporary retirement account loss deduction for individuals over the age of 59½. This proposal would be modeled after the current capital loss carry-over provision.

Under this proposal, beginning in tax year 2010, taxpayers over age 59 ½ who withdraw funds from their 401(k) account, individual retirement account, or similar tax-deferred retirement account⁹ would be entitled to a $3,000 deduction for any losses incurred in that account in tax year 2008. Losses that exceed the $3,000 annual deduction can be carried over for a maximum of two additional years, provided that gains don’t fully offset any carried over losses. This proposal would only apply to single taxpayers with incomes up to $100,000 and married taxpayers with incomes up to $150,000. The following examples illustrate how the proposal would work:

• Example 1: Jane Smith, 64, had a 401(k) account that lost $10,000 in value during 2008. Her account value remained stable from 2009-2012. In tax year 2010, she would be able to take the maximum loss deduction of $3,000 and carry over $7,000 in losses. In tax years 2011 and 2012, she may also be able to take the maximum loss deduction of $3,000.
• Example 2: Jane Smith had the same losses to her 401(k) account as in example 1 but this time her account gained $6,000 in value in 2011. Jane would be entitled to take the maximum loss deduction of $3,000 in 2010. But because her 401(k) gained $6,000 in 2011, Jane would only be able to take an additional $1,000 deduction in 2011 and no deduction in 2012.

A temporary retirement account deduction will help older Americans maintain the standard of living that they had planned for prior to the financial crisis.

Prior to the financial crisis, many near-retirees and retirees had been saving and planning for their retirement for years, projecting the amount they would need to live on during retirement and adjusting their savings and investments accordingly. For many of these seniors, the losses incurred by their retirement accounts during the financial crisis have severely affected their plans. 56% of individuals 65 or older and 75% of individuals between ages 50-64 predict that the recession will make it harder for them to take care of their financial needs during retirement.¹⁰ A temporary retirement account loss deduction would help blunt the pain of having lost a significant amount of value during the financial crisis.

A retirement account loss deduction will be targeted to those who need the funds to pay for necessary living expenses.

For most individuals, the better course of action would be to let their retirement accounts recover, and those who are still employed can do so. Indeed, 54.1% of people between the ages of 60 and 64 and 16.8% of people over the age of 65 continue to work.¹¹ However, many seniors who have already retired or otherwise can’t find gainful employment need the money they saved in their retirement accounts for day-to-day expenses. Nearly half a million workers 65 and older want to work but cannot find a job—more than five times the level earlier this decade and the highest unemployment rate for this group since the Great Depression.¹² It is these people whose lives have been directly affected by the financial crisis who would benefit most from the relief provided by a retirement account loss deduction.

THE ROLLOUT

• Hold a press conference with retirees and near-retirees that cannot find a job and have retirement accounts that plunged during the recession.
• Release a report detailing the impact of lost retirement savings and employment trends on seniors ability to weather the recession.

CRITIQUES & RESPONSES

Temporary Retirement Account Loss Deduction

It’s too expensive.

In 2008, the government shelled out more than $700 billion to help Wall Street get back on its feet after a severe financial crisis caused by its own excessive risk-taking and the federal government’s failure to appropriately regulate such activity. This is a worthwhile investment to help near-retirees and retirees restore retirement savings decimated during this financial crisis for reasons completely beyond individual control.

People under the age of 60 also lost money during the financial crisis.

It is true that many people’s retirement accounts, regardless of age, declined in value during the financial crisis. However, unlike retirees and near retirees, who now or will shortly rely on the funds in their retirement accounts for living expenses in retirement, younger individuals who do not have an impending retirement have an opportunity to remain in the workforce longer, contribute to these accounts, and allow them to recover.

Seniors should have anticipated this risk by diversifying their financial holdings and holding fewer equities.

The typical retirement account owned by a senior tends to have fewer stock holdings, which reduces the exposure to market fluctuations.¹³ Historically, this approach along with diversification would have helped seniors weather the storm. Unlike other recessions, though, no sector was spared from this financial crisis.¹⁴ Portfolios composed of stocks, bonds, real estate, hedge funds, and futures lost 29.1% from October 2007 to November 2008.¹⁵ A simple stock-bond portfolio lost 26.3% in the same period.¹⁶ Stocks were particularly hard hit and no sector was spared.¹⁷ Financial stocks declined about 74%, industrials were down 56%, consumer staples were down 22%, and healthcare stocks declined about 31%.¹¹⁸ Every category of stock—value, growth, and blend declined 50%, and international and emerging markets fared even worse.¹⁹ Even if seniors could have anticipated this downturn in the market, this financial crisis could not have been diversified away with more conservative investment strategies.