Two proposals to revamp the tax code as it relates to retirement plans and pensions will only hurt Americans’ ability to save for retirement, according to industry experts.
They also have the potential to dissuade plan sponsors, especially small businesses, from offering qualified defined contribution plans, which would reduce the number of people able to contribute to a retirement plan.
The 20/20 contribution plan, which is mentioned in the Obama Administration’s “The Moment of Truth” federal deficit reduction plan, would cap annual tax-preferred contributions to the lower of $20,000 or 20 percent of income, affecting both high income and low income workers, according to Jack VanDerhei, research director for the Employee Benefit Research Institute, in his testimony before the Senate Finance Committee on Sept. 15.
“This alternative formulation of capping tax-preferred contributions would substantially reduce the current limits available under qualified defined contribution 401(k)-type plans. Currently, the combination of employee and employer contributions is the lesser of a dollar limit of at least $49,000 per year and a percentage limit of 100 percent of an employee’s compensation,” he said.
EBRI also believes the caps would affect retirement plan sponsor behavior, including their willingness to offer qualified defined contribution plans, especially among plans offered by small employers.
The second proposal, to replace tax deductions with a flat-rate refundable credit that serves as a matching contribution in a retirement savings account, could affect employers’ incentive to offer 401(k) or pension plans, VanDerhei said. It also could discourage employers from matching their employee 401(k) contributions.
In March, EBRI conducted a survey of retirement confidence. It asked respondents how they would react if they were no longer allowed to deduct retirement savings plan contributions from taxable income and how important were these deductions in encouraging them to save for retirement. Nearly 90 percent of workers responded that the deductions were very important or somewhat important in encouraging their retirement investments.
“If one were to look at this from a strictly financial perspective, one would assume that the lower-income individuals would be least likely to rate this as ‘very important.’ However, those in the lowest household income category ($15,000 to less than $25,000) actually have the largest percentage of respondents classifying the tax deductibility of contributions as very important (76.2 percent),” VanDerhei said.
The report also found that one in four full-time workers would reduce or eliminate their retirement contributions if the ability to deduct them was eliminated.
Analysis that the tax treatment for retirement plans is skewed to immediately and more prominently benefit the wealthy has propelled arguments that lower income workers need a plan that will appropriately serve them.
“[The government is] looking for ways to reduce the deficit. We think there are legitimate questions about tax expenditures for these retirement plans when it seems that wealthier people benefit more from these tax benefits than lower income workers,” said Nancy Hwa, spokesperson for The Pension Rights Center. “If the purpose of tax benefits is to encourage people to save for retirement, we need to look at the best ways to help lower and middle income workers.”
The average salary in America is $40,000 a year, Hwa says. The government shouldn’t look at the question of retirement security as a way to reduce the deficit, “They should look at it to reduce a different deficit…the difference between what people have saved today for retirement vs. what they should have saved by today for retirement.”
A recent report by The Pension Rights Center put that deficit at $6.6 trillion dollars.
Retirement savings should be a “shared responsibility,” Hwa said. “The employer needs to contribute; the employee needs to contribute; and the government needs to make it easier for both sides in that process.”
The two plans to revamp retirement security are looking at the problem with flawed assumptions, according to Brian Graff, president of the American Society of Pension Professionals and Actuaries.
“The flaw is that they think that the ‘cost’ of these incentives are a tax expenditure when in fact it is not,” he said. “It ignores the fact they are unlike any other deduction you have on your tax return. It is just a deferral, not a tax deduction. When you take money out of the plan, you get taxed on it.”
Graff added that, “We don’t get credit for the fact the money will ultimately be taxed. We did a study on this. The bottom line is that it is not going to raise the revenue they think it is going to raise. It is tragically flawed to look at it from a deficit perspective. It won’t raise money. The last thing they should be doing is discouraging savings.”
The proposals would devastate plans. “A lot of workers are trying to catch up on their retirement savings,” Graff said. Many people have to put their kids through college and have additional money they can put away and “Congress says, ‘you can’t save any more money.’ Everyone is criticizing [401(k)s] for inadequacy and then they cut people’s ability to save. It makes no sense at all, especially when they are not going to raise the money they think they are going to raise.”
The way the system is currently set up, employers are incentivized to offer matches to their employees’ retirement contributions because they pay less to the IRS if the money goes into a plan. If you cut out that incentive, small employers won’t be motivated to offer their workers a retirement plan, Graff said.
“By cutting benefits, they are doing more harm than good. Benefits are not that high to begin with, so they are cutting the rug out from under people,” Hwa said. “Unless we find long-term solutions to these problems, we’re going to face even bigger problems: generations of impoverished elderly who can’t afford medications or afford to live. It hurts income and takes people out as consumers. Good retirement income helps the economy too.”