Fiscal cliff could be a boon to retirement advisors

Or, the worst thing ever, if leaders cut deferrals for high-income families

(AP Photo/Dean Treml/File) (AP Photo/Dean Treml/File)

Obviously the fiscal cliff is on everyone’s mind, but what does it mean for sponsors of 401(k) plans and retirement plan participants?

If nothing is done to avert the fiscal cliff, tax rates will go up, which “generally will make 401(k) deferrals more attractive because that’s what 401(k) deferrals get you, an ability to defer taxes,” said Brian Donohue, a partner with October Three LLC in Chicago, Ill.

Higher income tax rates and an increase in tax rates on capital gains and dividends, that are set to take effect in 2013, also would spur people to put more money away in their qualified retirement plans, he said.

“Higher taxes are good for the retirement business. They make retirement plans more attractive,” he said.

The fiscal cliff isn’t the only cliff investors could face in 2013, as Washington attempts to fix the budget and reduce the deficit.

There has been talk about lowering the amount individuals can defer into their retirement plans as a way of boosting tax revenue or eliminating the tax deferral on retirement plans altogether.  Currently, individuals can contribute $17,000 a year, pre-tax, to their 401(k) plans.

These two options would “make retirement plans less compelling,” Donohue said. Individuals may take their money and put it elsewhere if there is no incentive to save it in their 401(k) plans.

If Congress decides to limit deferrals or lower the cap, “I wouldn’t be surprised if some employers said, ‘we don’t need to be in this business anymore.’ It could have a negative impact on employers’ willingness to sponsor plans,” he said.

“People think the fiscal cliff is so unthinkable that something has to be done. I wouldn’t mind if we ended up going over the fiscal cliff. I think we should probably raise taxes and cut spending in this country and that’s what the fiscal cliff does,” Donohue said. It takes politics out of the equation and makes broad sweeping changes in one fell swoop.

One of the compromises being proposed to avert the fiscal cliff is eliminating deductions and imposing tax hikes on families that make more than $250,000 a year. That proposal would reduce 401(k) contributions by as much as 64 percent, according to Brett Goldstein, director of retirement planning at American Investment Planners, LLC, based in Jericho, N.Y.

“The last time Congress slashed 401(k) contributions was in 1986. 401(k) contributions were cut by 70 percent and many 401(k)s were terminated,” he said. “Congress should be encouraging Americans to save money for retirement, not making it more difficult for them.”

The reduction in 401(k) contributions would have a major impact on low-income workers.

“Employees earning $30,000 or less rely almost exclusively on company matching and Social Security for their retirement,” Goldstein said. “Under the proposal to limit 401(k) contributions, low-income employees could see a 20 percent reduction in employer contributions, which would hurt their retirement nest egg.”

Goldstein advises clients to consider alternatives for retirement income such as IRAs and annuities if the decrease in 401(k) contributions materializes. “Many annuities today have lifetime income options, which can be beneficial,” he said.

Republicans and Democrats are at the negotiating table right now trying to come up with a way to avoid the fiscal cliff that both sides can support.

The White House proposed raising $1.6 trillion in revenue and saving $350 billion from changes made to Medicaid and Medicare.  Speaker of the House John Boehner’s counteroffer, which came out Dec. 3, proposed $800 billion in federal government savings over the next decade by reforming Medicaid and providing states with greater flexibility to better deliver health security to beneficiaries.

In his letter to President Barack Obama, Boehner referenced a middle ground approach proposed by Erskine Bowles, co-chair of the president’s debt commission, that would include both spending cuts and $800 billion in new revenue.

Erskine Bowles responded to the letter this week saying, “while I’m flattered the Speaker would call something ‘the Bowles plan,’ the approach outlined in the letter Speaker Boehner sent to the President does not represent the Simpson-Bowles plan, nor is it the Bowles plan. In my testimony before the Joint Select Committee on Deficit Reduction, I simply took the mid-point of the public offers put forward during the negotiations to demonstrate where I thought a deal could be reached at the time.”

He added that circumstances have changed since the joint Select Committee failed to reach a deal, so it is up to “negotiators to figure out where the middle ground is today. Every offer put forward brings us closer to a deal, but to reach an agreement, it will be necessary for both sides to move beyond their opening positions and reach agreement on a comprehensive plan which avoids the fiscal cliff and puts the debt on a clear downward path relative to the economy.”

“It’s pretty much status quo. The real question is what changes? How will the players change their behavior and that is an unknown. For retirement plans it is all about tax reform and whether they’ll nick us or not,” Ed Ferrigno, vice president of Washington affairs for the Plan Sponsor Council of America, said after the November election.

He added that he believes that tax reform will probably take the form of an overall cap based on income and the phasing out of various tax deductions.

Ferrigno said he also expects a lot of proposed provisions on how to change the employer-provided retirement system, including mandated employer-provided IRAs or George Bush’s idea for a super-401(k) plan that all salaried individuals could defer money into.

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