B.O. wants to limit the value of all tax deductions, defined contribution exclusions and IRA deductions to 28% of income — and include an overall cap on all retirement accounts, including pensions, that could bring in $1 billion a year in new tax revenue, according to a Pensions & Investments report. Companies must now buckle-in for a 1-2 retirement punch.
According to the report, the proposals are designed to direct more of the tax preference for retirement savings toward getting more low- and middle-income people into the habit of saving.
Based on current tax brackets, Pensions & Investments reported that the 28% limit would reduce the tax advantages of retirement savings for people earning more than $183,000 or couples earning more than $225,000. And the overall cap for all tax-preferred retirement accounts would limit them to providing an annual retirement income of $205,000, which would currently cap tax-preferred accounts at $3.4 million, but could go lower as interest rates rise.
So, who might feel the effects of this proposal? Largely, the top 5% of tax payers. According to the Tax Policy Center, a partnership between the Urban Institute and Brookings Institution, there are about 6.07 million Americans who earned above $200,000 in 2011 and they make up the top 4.2% of taxpayers, according to published reports.
And what do experts have to say about what the president might propose? In the main, they say the rich need not worry that their tax breaks for saving for retirement will be cut.
“We’ve heard these kinds of proposals being discussed in policy circles for a couple of years now,” said Skip Schweiss, president of TD Ameritrade Trust Co. and managing director of TD Ameritrade Institutional. “It would not surprise me to see these ideas become more formalized through President Obama’s 2015 budget proposal.”
But even though experts expect the president to propose reductions to some of the tax advantages for employer-sponsored retirement plans for higher-income earners, few expect any congressional action. “Given the congressional divide, it’s hard to see something like this becoming law, but of course one never knows,” said Schweiss.
From his perspective, Schweiss said there are at least three problems with the proposal that should be considered carefully.
The first, said Schweiss, is that contributions to retirement plans are made on a tax-deferred basis, not a tax-deductible basis. “That is, while I may receive a tax deduction this year for making my contribution, the government will get its money down the road when I withdraw the funds in my retirement years,” he said. “And it will get more, as it will tax the earnings as well as the contributions.”
This stands, Schweiss said, in contrast to deductions like home mortgage interest and employer-sponsored health insurance premium deductions: once those deductions are received by the taxpayer, the government will not realize the tax revenues from those items, ever.
The second consideration, said Schweiss, is that if someone is in an upper-income bracket, say 35%, and only gets a 28% deduction on her retirement plan contributions, she will pay taxes on the other 7% this year, and pay taxes on those funds later when withdrawn in retirement. “So those income dollars would be taxed twice under this type of proposal,” he said.
And a third potential problem, said Schweiss, is that the more restrictions on tax benefits we impose on retirement plans, the less attractive it will become for a business owner to sponsor a plan. “And who loses then?” he asked “The worker, not the business owner.”
Lena Haas, senior vice president of retirement, investing and saving, for E*TRADE Financial, said those in the industry have a sense of what makes for a good individual retirement plan. And President Obama’s proposals might not be in the best interest of savers.
“There are many ways to encourage individuals to save for retirement: through education and guidance, automatic contribution features, or incentives in the form of tax advantages,” said Haas. “A successful plan uses a combination of these. If one of these features is reduced or taken away, these plan designers are going to have to rely more heavily on the other features to drive participation and engagement.”
“In this instance, less incentives means a greater reliance on education, guidance, or automatic contribution features,” Haas said. “Saving for retirement is hard — you can’t expect participants to participate without some sort of a helping hand.”
Others also say keeping tax breaks in place for saving are critical.
“Retirement security is a shared responsibility between government, business, and individual and a system that is designed to motivate all stakeholders will drive the best outcome for Americans to achieve retirement security, said Joe Ready, director of Wells Fargo Institutional Retirement and Trust.
Ready said he’s hopeful there will be a thoughtful approach to strike a balance between the need for Americans to save and the budget deficit. “The reality is that it’s hard to ignore the fact that pretax advantages drives good retirement savings behaviors, and we need to remember that this is a tax deferral, and that once retirees begin to withdraw from their 401(k) accounts, they do pay taxes,” Ready said.
Although there are things that can be improved about the workplace retirement plan, Ready believes that if employees are given access and improve their savings rate, the system can significantly improve.
What sort of laws are really needed?
To be sure, there are new laws that should be proposed. “The U.S. needs more incentives for people to save for retirement, not fewer,” said Schweiss. “To do otherwise is to create yet more pressure on the social safety net down the road.”
In fact, Schweiss noted that we already have just over half of American workers with access to a retirement plan because many small businesses don’t sponsor one. “We should make it less burdensome and less expensive for a small business to allow its employees to save for retirement, not more,” he said.
So what’s needed? Ideas such as the “auto-IRA,” where employers open their payroll system for employees to contribute into an IRA account, would help, said Schweiss. “We know that if an American does not have access to a workplace retirement plan, only about 5% of them will save on their own,” he said. “We need to make it easier, not harder.”
Ready said legislative proposals that leverage the already existing plan designs would be best. “Of the almost 80 million 401(k) participants, 80% of them make less than $100,000 and are significantly benefiting from the 401(k),” he said. “From our research, we’ve seen that people with access to a 401(k) plan have saved three times more than those without access to a plan.”
According to Ready, one good example of changing the 401(k) plan design that is been discussed in the industry and would not greatly impact the middle class would be limiting the pretax deferral amount to $10,000 and then the balance of $7,500 after tax money could go into a Roth 401(k). “This would keep the $17,500 limit and the taxes from the Roth 401(k) would help with the fiscal budget,” he said.
By the way, just 5% of the roughly 60 million 401(k) plan participants contribute the maximum amount to their 401(k), which is $17,500 in 2014 for those under age 50 and $23,000 for those 50 and older. And roughly another 5% would contribute the maximum amount, if their companies let them.
And according to a Vanguard study of 2,000 401(k) plans with 3 million participants, 11% of 401(k) participants contributed the maximum possible amount in 2012.
No matter what becomes law, Haas had this bit of advice for all: “One thing is clear: we face an uncertain future when it comes to tax treatments of retirement plans,” said Haas. “So in the same way that you want a diversified portfolio of various assets, you also want to consider diversifying your funds among the various retirement account types — taxable, tax-free, and tax deferred — to address that uncertainty.”
This piece is credited to Robert Powell of MarketWatch, February 21, 2014.
