Marco Rubio Wasn't the Only One Who Cashed Out an IRA Last Year

By :: May 26th, 2015

It is easy to mock Senator Marco Rubio, who cashed out $68,241 in IRA retirement funds last September. The GOP presidential hopeful, who made about $230,000 last year, told Fox News he needed the dough to prepare for his campaign, buy a new $3,000 refrigerator, and fix his busted a/c. As it happens, he is far from alone.

Using retirement money to buy a high-end appliance may not be the wisest financial decision. Investing the cash in a presidential run may be more prudent. After all, as the Clintons have shown, post-White House money-making opportunities can be quite lucrative. And even also-rans can turn failed races into money-making career enhancers. Just ask Mike Huckabee.

But it turns out that Rubio is not the only 40-something draining a retirement account. Substantial assets leak because people under age 59 ½ take early withdrawals or borrow against their IRAs or 401(k). And the problem raises an important and challenging policy question:  Should the money in these accounts be available for non-retirement purposes?

Exactly how much is lost is unclear, but it is not a trivial sum. My Urban Institute colleagues Barbara Butrica, Sheila Zedlewski, and Philip Issa estimate that more than 8 percent of working-age retirement account owners made at least one withdrawal between 2004 and 2005. And they pulled out about 20 percent of their total balances.

Overall, at least 1.5 percent of all retirement savings leaks out of the system each year, although some studies estimate it is much more than that. And even withdrawals at the low end of the estimates can result in a substantial reduction in retirement savings. According to Alicia Munnell and Tony Webb at the Center for Retirement Research at Boston College, early withdrawals of about 1.5 percent ultimately reduce total IRA and 401(k) wealth at retirement by about one-quarter.

In most respects, Rubio is atypical. Unlike many who take money out early, he’ll still probably have a secure retirement. The Urban study found that those most likely to withdraw early were age 25-34, had low-incomes, and had little net worth. African-Americans are more likely to withdraw than whites. And those who pull out money when they are young can significantly lower their standard of living in retirement.

Interestingly, several of the studies found that divorce, death of a spouse, or job loss correlate strongly to withdrawals. Not surprisingly, these shocks have their biggest effects on low-income workers.

In 2013, Robert Argento, Victoria Bryant, and John Sabelhaus of the Federal Reserve looked that how the Great Recession affected withdrawals. After all, if income shocks increase withdrawals, you’d think the effects would be especially strong when millions of Americans lost their jobs.

It turned out that while early withdrawals were higher after 2007 than before, they were not that much higher. And they seemed to merely continue a long-standing national pattern of steady increases. Still, in 2010, according to the Fed study, nearly half the value of new contributions by working-age households were offset by early withdrawals.

What to do? How do policymakers distinguish between low-income people who dip into retirement savings to cushion a financial shock and someone earning a six-figure income who wants a new Sub-Zero? How does government encourage retirement savings—the purpose of the tax subsidy, after all—and still give workers some financial flexibility when they really need it?

Early withdrawals are not a cheap way to get money. They are subject to both tax and, in most cases, those younger than 59 ½ also owe a 10 percent penalty.  In addition, people of working age can only pull money from 401(k)s when they change jobs or for reasons of hardship (for instance, for medical or funeral expenses or to prevent foreclosure or eviction). IRA withdrawals can be made for any reason, though they are still subject to taxes and usually penalties.

Should the rules be tougher?

We know that even modest policy adjustments can change behavior. In a 2012 National Tax Journal article, my Tax Policy Center colleagues Len Burman and Bill Gale, along with Norma Coe and Michael Dworsky, looked at how policy changes in 1986 and 1992 encouraged people to hang on to their retirement accounts when they changed jobs. They found that raising taxes on cash-outs encouraged people to roll over their accounts to IRAs instead of pocketing the money. Merely relabeling the added tax as a penalty or withholding taxes on cash-outs also increased roll-overs, though neither changed the amount of tax owed.

Munnell and Webb think it’s time for Congress to reconsider tax-advantaged savings: Should they be focused entirely on boosting retirement assets or should they play the dual role of encouraging savings for retirement and for unexpected hardship at working age?

It is a good question. And the personal experience of Marco Rubio—who, after all, has proposed a major tax reform of his own--may prove a useful spark for the conversation.


Roads, Schools, Sales and Wills

By :: May 26th, 2015

Congress is in recess this week. The Daily Deduction will return to its regular schedule on Monday, June 1. Congress delays a highway bill for two more months. Just before leaving town for its Memorial Day recess, and with no funding solution in the tank, Congress extended spending authority until the end of July. That’s […]

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Robbing Peter to Pay Paul

By :: May 22nd, 2015

Congress will be in recess next week. The Daily Deduction will post on Tuesday, May 26, 2015, after Memorial Day, and will return to its regular schedule on Monday, June 1. Wisconsin’s GOP: Tax bikes to pay for bike paths, use tax dollars to expand private schools. Presidential hopeful Governor Scott Walker’s colleagues proposed this […]

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Rewarding Work, Paying by the Mile, a Windfall, and… Tax Magic 


By :: May 21st, 2015

Redesign the EITC to help more low-income workers. TPC’s Elaine Maag thinks that’s the way to go. She explains in her new paper: “A worker credit based on individual earnings, and not contingent on having children at home, could provide substantial benefits to all low-income workers, ease administration for the IRS, and encourage work for childless individuals and secondary […]

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A Redesigned Earned Income Tax Credit Could Encourage Work by Childless Adults

By :: May 20th, 2015

The earned income tax credit (EITC) lifts millions of working families out of poverty, but provides little support to workers without children and some low-wage workers married to other low-wage workers. Congress could fix this flaw by scaling back the EITC and creating a new worker credit that is based on individual earnings and not […]

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A Down Payment, A Giveaway, A New Tax, and A Delay

By :: May 20th, 2015

Better something than nothing? House Ways & Means Chairman Paul Ryan has thrown in the towel on broad-based tax reform—at least for the next two years. He says the best possible deal the GOP can manage while President Obama is in office would be a “down payment” that would address international taxation and a permanent […]

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Are GOP Presidential Candidates Downplaying Tax Cuts Or Hiding The Ball?

By :: May 19th, 2015

Last week, I blogged on the many GOP presidential candidates who are talking about tax reform rather than tax cuts. This week, tax historian Joe Thorndike published a rebuttal on the Tax Analysts blog and on Forbes.com. Joe, who is very much in the watch-what-they-do-not what-they-say (WWTDNWTS) camp, noted that while few GOP presidential hopefuls […]

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The Supreme Court Kills A Maryland Tax

By :: May 19th, 2015

Maryland’s tax on some out-of-state income is unconstitutional. Maryland gives residents only a partial tax credit for income that is earned—and taxed—outside the state. The US Supreme Court said yesterday that this violates the Commerce Clause by discouraging individuals from conducting business across state lines, since their income would be taxed twice. Residents who tried […]

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A Divided Supreme Court Rejects Maryland’s Tax On Out-Of-State Income

By :: May 18th, 2015

In a 5-4 decision, the U.S. Supreme Court ruled today that a Maryland law is unconstitutional because it allows residents only a partial tax credit for out-of-state income that is taxed in other states.  The decision not only invalidates the Maryland law but may also limit similar taxes in New York, Pennsylvania, Indiana, and Ohio. […]

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Runnin’ on Empty

By :: May 18th, 2015

Long-term federal highway funding: Still stuck in the breakdown lane. House Transportation and Infrastructure Committee Chair Bill Shuster and Ways & Means Chair Paul Ryan need more time to “reach a bipartisan agreement” on financing the Highway Trust Fund so they introduced a bill to extend the program for two months. The Senate seems ready […]

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