As Congress readies to put the finer points on the Trump administration’s pledge to reform the country’s tax code, questions remain as to whether lawmakers will tap the tax-preferred treatment of qualified retirement savings plans to fund lower individual rates.
The so-called Rothification of defined contribution and IRA savings deferrals is reportedly still under consideration.
This despite a concerted lobbying front from consumer and employer advocates and the financial services industry, who argue Rothification would negatively impact the amount of savings workers would defer to retirement plans.
But one tax and administrative law expert considers that argument a red herring.
Daniel Hemel, an assistant professor of law at the University of Chicago, says profit motive best explains the financial services industry’s push back against Rothification—not concern over savings rates.
“Their incentives seem quite clear,” Hemel told BenefitsPRO. “Asset managers have a strong interest in stopping Rothification. They want assets under management to be higher, and they are higher under the traditional model.”
Eliminating or capping the amount of retirement plan contributions made on a pre-tax basis would bring revenues collected decades down the road to the Treasury Department’s balance sheet in sooner.
According to the Joint Committee on Taxation, defined contribution deferrals will cost the IRS about $102 billion in foregone revenue in 2017, and about $584 billion between 2016 and 2020.
Traditional IRA contributions will cost another $16 billion in revenue in 2017, and $86 billion between 2016 and 2020.
Hemel, who clerked for Supreme Court Justice Elena Kagan before joining the faculty at Chicago Law, applies simple math to back his thesis.
In a recent blog post, he compared the hypothetical savings outcomes and asset management fees for a retirement investor falling in the 40 percent tax bracket before and after retirement.
A $100 investment that grows at 6 percent over twenty years will yield the same after-tax return for the investor under a traditional or Roth system.
But asset managers’ earnings on fees would be vastly different. At an annual management fee of 1 percent, fund managers would earn about $35 nominally after 20 years in the traditional, pre-tax account, versus about $21 under the Roth model.
Hemel thinks the interests of fund managers, and vast influence of their lobby, will prevent Rothification from happening at the expense of federal coffers.
“Asset managers are making more money under the traditional model,” Hemel said. “That money has to come from somewhere—it’s coming from the government.”
Sending out an S.O.S
Earlier this year, a coalition of uncommon bedfellows formed to lobby Capitol Hill on the perils of Rothification.
The Save Our Savings Coalition counts asset managers Fidelity, The Capital Group, Northern Trust, The Principal Financial Group, T. Rowe Price, TIAA, and Wells Fargo among its members.
The SPARK Institute, a non-profit advocacy for various channels of retirement services providers, is also a part of SOS. Its members include BlackRock, Charles Schwab, Bank of America, Vanguard, JP Morgan, Prudential, Invesco, and John Hancock.
The ten largest fund mangers of defined contribution assets tracked by Pensions & Investments are accounted for in SOS and SPARK’s membership.
Tim Rouse, executive director of SPARK, said the SOS coalition “stands ready to defend our retirement system against any policy changes that would be detrimental to Americans’ ability to save for retirement.”
Rouse said SPARK doesn’t take positions on hypothetical policy changes, and is waiting for Congress to release specifics of tax reform proposals.
Speaking on background, a representative of SOS underscored the coalition is based on a broad array of interest groups beyond asset managers.
AARP is also an SOS member. That lobby has been perhaps the most powerful group fighting so-called Wall Street interests on the Labor Department’s fiduciary rule.
The Plan Sponsor Council of America and American Benefits Council, both of which represent the interests of employers, are also members. So is the Committee on Investment of Employee Benefit Assets, a group that specifically represents chief financial officers of companies that provide retirement benefits.
“Consumer and employer interests would not be aligned if this were just a service provider issue,” said the SOS representative.
Data from several of the coalition’s members underscores the role of tax incentives on workers’ savings rates.
A survey from Investment Company Institute, which represents the interests of asset managers, shows that 80 percent of 401(k) participants say the tax break on their retirement contributions creates a big incentive to save, and 90 percent of surveyed participants are against eliminating tax breaks on savings. ICI is not listed as a member of SOS, but a representative said they are working with the coalition.
Data from sponsor members of PSCA shows 94 percent of employers think savings rates will slow if the tax incentives are eliminated or reduced. Sponsors overwhelmingly called Rothification a “bad idea” in a recent PSCA survey of employers.
Reverberations of Rothification would be felt most by the middle class and small employers, says the SOS representative.
“The most important factor in saving for retirement is having access to a workplace plan,” the rep said. “This is a voluntary system—employers don’t have to do anything. For a lot of employers—especially small employers—the tax incentives are what gets them into the retirement game.”
Plan providers often leverage the tax benefits to pitch the value of offering a 401(k). “You can save more money than you spend on the plan—the economics work for employers and employees,” the representative said.
SOS acknowledges the role of Roth for some savers. But its position on compulsory Rothification, and the impact on small businesses, is unambiguous: “without a strong tax incentive, smaller employers would be considerably less likely to start and maintain a retirement plan for their workforce,” the SOSS rep said.
Potential to drive up record-keeping costs
Charlie Nelson, CEO of Retirement for Voya Finnancial, which includes the firm’s record-keeping unit, says partial Rothification has the potential to increase the cost of record-keeping for sponsors and participants.
“Congress needs to be mindful of that,” said Nelson.
Whether Rothification would discourage savings rates is an unknown, thinks Nelson. But what can be guaranteed under a partial Rothification system is a spike in investor confusion after industry and employers have been working for the past decade to demystify retirement savings through the workplace.
“It certainly would increase plan complexity and make communication with plan participants more challenging,” said Nelson.
Like a lot of stakeholders, and retirement experts outside the financial services industry, Nelson thinks baking retirement policy into tax reform is dangerous proposition.
He is holding out hope that a bipartisan approach on tax reform will illuminate those dangers.
“Retirement policy should be looking to expand coverage and improve savings rates,” said Nelson. “Right now the discussion is not focused there. We need the Administration and Congress to address those issues.”