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Lower Tax Rate on Savings Accounts to Incentivize Saving

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Over the break, I read about the winning idea for the TIAA-CREF’s Raise the Rate competition and was surprised that it was selected as the winner. I’m surprised because I wouldn’t think that savings would be a reliable factor in the probability that you would default, which is what the credit score is designed to measure, and because it would be a bit of a bear to implement.

My submission was to lower the tax rate you paid on the interest you earned from savings account. You already receive this information as a 1099-INT, so the IRS already knows this is interest earned from an interest bearing account. While it would fail the “difficult to implement” test (which we don’t know if it was factored), I bet you more people would save money if they knew they would be taxed less on the interest. (Many people invest in dividend yielding stocks for this very reason)

I’d go as far as to say you get the first $X in interest tax free. You can set that at $500, $1,000, or higher. People respond to financial incentives and removing the tax would give people an incentive, but unfortunately, at least right now, it goes against the government’s goals of wanting to boost consumer spending.

While less “novel,” I thought the people’s choice winner’s idea of creating a Women’s Savings Club would be more effective at increasing people’s savings rate.

Integrating savings rate into your credit score is certainly novel and interesting, especially since it’s already being factored in by lenders, but I don’t think it will increase people’s saving. Do you?

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20 Responses to “Lower Tax Rate on Savings Accounts to Incentivize Saving”

  1. It’s true that having people save money works for the longer term. We don’t want to see an impoverished population of seniors.

    But today, the government would be better served if people spend and do not save. On an individual level, that’s foolish. We must protect ourselves.

    But as a policy, I doubt you will see any action that acts as an inducement to save.

    Regards

  2. SoonerNATX says:

    personally, i like your idea jim. although my idea would be to raise the actual rates but that is too easy.
    if i dont need to borrow money… then i would get no benefit from the winning idea. your idea at least benefits every spectrum. also, the woman idea, besides it being extremely hypocritical to the whole equality/fair-treatment movement, it does not benefit every spectrum.

  3. cubiclegeoff says:

    In Massachusetts, the first $100 of interest from a savings account in a bank in the state is except from state taxes. I could see the benefit of expanding that. However, with rates so low, it would take a lot of money to reach $500-$1000 in interest.

  4. Matt K says:

    Honestly, it’s a horrible idea.
    One of the biggest purchases that the credit score matters most is buying the house. for first time buyers, they’ll have a decent chunk of money in savings when shopping for mortgage. but, once they complete the transaction, all that savings goes out the window as the down payment.
    For buyers of their second/third, etc…. they don’t actually have that money in the bank. They’re selling the house, and using that built up equity (hopefully), as the downpayment of their new house.

    How much you have saved up should not affect your mortgage rate at all, because in the end, it all goes away.

    Same with any other large purchase where your credit score matters. you have down payments that your savings goes towards, so for the lender, that savings disappears too quickly.

    the savings has no bearing on how you will be able to pay the loan, and thus, inconsequential to your CREDIT score.

    If people just want to be graded on their fiscal responsibility, sure, create a new fiscal responsibility grade. but it shouldn’t have any bearing on your credit score

  5. zapeta says:

    I think the winning idea is terrible. People who have a bunch of money saved up don’t need to borrow money, and the rest of us end up having higher rates. I wish they’d lower the tax rate on interest income but the government wants you to spend now so I doubt that will happen anytime soon.

  6. Evan says:

    Lowering the tax rate would be a fantastic idea, and extremely easy to implement! I love it. I am shocked it hasn’t already been offered in front of Congress.

  7. Bey says:

    With the pitiful amount earned on FDIC-insured accounts, how much could it possibly save? I only earned a grand on such bank accounts in 2010 (because I have better things to do with most of my money). Lower my tax rate from 25% to 15%, for example, and you’ve saved me a whopping $100. There are many things that could be done with taxes, but a flat tax is the fairest overall and makes the most sense. Make a buck, pay a fixed percentage — the same for every one and every dollar.

    • NateUVM says:

      Unfairly penalizes the poorer people that would be subject to such a tax.

    • Courtney says:

      You earned $1000 in interest on FDIC-insured bank accounts last year and still have better things to do with “most” of your money?? I thought we earned a lot of interest when I added it up and it came to $150…

    • Bey says:

      NateUVM, “fair” is always a relative term. I believe this country will be fair only when the same rules apply to each and every citizen. Liberals try to artificially level the playing field, and thus we have the inefficient and bloated tax and entitlement structure that today’s government offers. Flat tax now!

      Courtney, research high-yield checking accounts. My bank lowered their interest rate again this month, but I’m still earning 3% on up to $50K.

  8. Matt says:

    Your idea sounds nice – but the real way to get the savings rate up is to get people that aren’t saving to start saving. Do you think those people are not saving because they are worried about getting taxed on interest? I doubt many of them know that interest is taxed since they do not currently have savings.

    • Jim says:

      I disagree, I think that the goal is to get people who are already saving to save even more by offering an incentive. Everyone has some “savings,” whether it’s a few dollars in a checking account or a few hundred in an online savings account. It may only have a lifespan of a few days or a few hours, but everyone has a little something. Those who aren’t living paycheck to paycheck have something and the key is to get them to save more. (Those living paycheck to paycheck cannot save. They aren’t actively choosing not to save, they simply cannot yet.)

      Also, I think people know interest is taxed. If they didn’t know, they’d save more because it’s free money!

      • cubiclegeoff says:

        In some places, though, many people don’t have savings accounts, at least the lower-income individuals don’t. They would be the ones that would probably benefit, but getting them accounts would go a long way in itself.

  9. TomM says:

    Why not eliminate the tax in dividends and interest all together? The government already got their fair share of tax when you earned the money. You either took the risk to invest or had the discipline to save…..how is it that government deserves anything from the money made in either event?

    Once again, if you want to stimulate the economy and cut the debt…..reduce taxation and curb government spending. It will never happen but it’s a nice thought.

  10. Arlene A. says:

    Believe it or not, I am old enough (62 in 5 more days) to remember a time when the first $500 of interest or dividends WERE tax-free in America. Those were also the days when huge incomes were taxed much, much higher than they are today the highest at 90%), and the country was in fine shape economically!

  11. Bart says:

    It would be nice if you could get our government to follow this same policy. They could start by not spending money they don’t have!

  12. Dotsconnectors says:

    One of the non-finalist entries at:

    http://www.youtube.com/watch?v=OrAYT2GXXP0

    was a 15% consumption tax to replace the lion share of U.S. employment taxes.

  13. eric says:

    Actually I think your idea is pretty good Jim! I know I would save more, but then again I’m already a bit of a saver. Still, I like the idea!

  14. Craig Grella says:

    I think deals like this can move the average American, and I that is supported by the data.

    Each month the government releases income and savings data, and the trend for both income and average disposable personal income continues to increase.

  15. Old Car Buff says:

    In a way, I like the idea of the FICO score adding in a component for savings, and possibly other ‘fiscal responsibility’ items. Today, the FICO score is used for so much more than the lending purposes it was originally designed for. For someone like my son, who is 25 but owns a house outright (inherited) and several vehicles (always purchased with cash) and no credit cards, but thousands in savings and retirement savings, a 0 FICO score just doesn’t make sense.


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