10/6/2011 9:45 PM ET|
Will changes sink retirement plans?
A proposal that would cut or modify tax incentives for savings vehicles such as 401k's is raising concerns that contributions could suffer.
The government officials considering changes to how retirement savings vehicles such as 401k's work may want to note a survey this year by the Employee Benefit Research Institute.
Nearly 90% of respondents said it was either "very important" or "somewhat important" to deduct their retirement contributions from their work pay, with one in four of these full-time workers saying they would reduce -- or stop -- their contributions if the ability to deduct them from their taxes is eliminated, a change Congress could announce as soon as December.
Despite the disputed claim that the changes would affect those primarily in higher-income brackets, Congress should note: Those earning between $15,000 and $25,000 had the most negative reaction to the notion of changing retirement plans, with nearly 57% saying they would reduce savings.
In an America without widespread pension plans, this could mean millions of the nation's poorest people turning more, if not exclusively, to Social Security to pay for all of their retirement needs, even though the system is portrayed by many politicians as already facing a crisis.
Such reliance is particularly troubling for 401k advocates, because the average Social Security beneficiary gets only slightly more than $14,000 each year, hardly enough to retire comfortably on. (Will your 401k provide enough in your retirement? Find out with MSN Money's calculator.)
Attorney and CPA David White, the president and founder of David B. White Financial in Bloomfield Hills, Mich., doesn't mince words as he watches the ongoing debate.
"The ramifications are very serious and severe," he says. "I think it would be a huge mistake to do this."
Such fears that changes could reduce incentives for saving -- including making employers less inclined to promote and support the plans they do now -- are abundant, despite efforts to make the changes part of a careful strategy that seeks opportunity in crisis by looking at a long-term overhaul good for all involved.
A variety of tax incentives and strategies are at work with retirement plans, according to the American Society of Pension Professionals & Actuaries. Employer contributions to qualified retirement plans are deductible to the employer and not subject to FICA tax. Income tax on investment earnings on those contributions is deferred until distribution. In addition, people with adjusted gross income of less than $27,750 and married couples with an AGI of less than $55,500 may qualify for a Saver's Credit ranging from 10% to 50% of the first $2,000 a person contributes to an IRA or employer-sponsored defined-contribution plan.
Any and all of the current tax incentives could be eliminated or modified as part of a deficit-reduction strategy.
In his opening remarks at a Senate Finance Committee hearing on Sept. 15, Max Baucus, D-Mont., laid out concerns with the current retirement system.
"Our tax code has several key provisions that encourage Americans to save for their retirement," he said. "The tax benefits apply to pensions, Individual Retirement Accounts and employee stock ownership plans. These tax incentives add up. In total, they cost more than the tax preference for employer contributions to health insurance plans, and they cost nearly 50% more than tax expenditures on the home mortgage interest deduction. The United States has the most successful private retirement system in the world, but for the amount our country spends on retirement savings, are we getting enough bang for our buck?"
Baucus pointed out that, unlike many defined-benefit plans such as pensions, defined-contribution plans such as 401k's do not provide stipends or insurance to cover long-term care expenses.
"This means that a retiree can outlive his retirement savings whether due to inflation, market declines, unexpected health expenses or even the good fortune of living longer than expected. And many do," Baucus said. "In spite of the tremendous tax preferences for retirement savings, many Americans are left without sufficient resources to maintain a comfortable retirement."
Budget negotiators and Treasury officials have estimated that eliminating tax breaks for 401k plan contributions would pump more than $67 billion back into federal revenues in 2012 alone. That estimate is disputed and called "overstated" by the American Society of Pension Professionals & Actuaries.
The changes are merely "robbing from future tax revenues," the organization says.
"It should be stressed -- and is often forgotten in this debate -- that the tax expenditures associated with retirement savings are a deferral of taxation, not an avoidance of taxation," says Michael Falcon, the head of retirement for J.P. Morgan Asset Management, who isn't hopeful about the likely impact on savings.
"Replacing the current deferral of taxation would have an impact beyond the timing of deposits to participant accounts," Falcon says. "The fact that (employee) contributions are not subject to federal withholding (they are subject to FICA tax) means that participants can save more while seeing a smaller impact on their take-home pay. If an employee's tax withholding on $100 was $20, contributing the $100 to the plan would only cost $80 in take-home pay.
"If participant contributions were subject to taxation, this could result in lower contributions, as employees would not get the benefit of the 'withholding bonus.' This would be compounded if the employer contributions were now subject to immediate federal tax withholding and FICA," Falcon says.
Reducing contribution limits or replacing tax deferrals with a tax credit "could dissuade small employers from sponsoring plans," Falcon says. "If the tax benefit to small-business owners is limited, they could choose to avoid the costs of setting up a retirement plan."
White, of David B. White Financial, agrees. "Employers are going to drop plans. A big factor in small businesses is that if it doesn't benefit the top people, they are going to cancel it, and that is going to hurt the small people too."
He sees the changes as "just another diabolical redistribution-of-wealth scheme. It is another way of hiding a tax hike. All you are doing is robbing Peter to pay Paul and moving money from one pocket to another. The biggest thing is that you are going to hurt the economy, and you are going to hurt savings."
White sees the current system of pretax contributions as an important savings tool.
"The reason 401k's are more successful that IRAs is because of the automatic withholding that is done for them, because it comes out first instead of last," he says.
In December, the National Commission on Fiscal Responsibility and Reform released its document on federal debt reduction, titled "The Moment of Truth."
"Although their guiding principles and values specifically mention the need to keep America sound over the long run by implementing 'policies today to ensure that future generations have retirement security, affordable health care and financial freedom,' the document puts forth a tax reform plan that would modify retirement plans by capping annual tax-preferred contributions to (the) lower of $20,000 or 20% of income," says Jack VanDerhei, research director for the Employee Benefit Research Institute.
"This is often referred to as the 20/20 cap. This alternative formulation of capping tax-preferred contributions would substantially reduce the current limits available under qualified defined-contribution plans," such as 401ks, VanDerhei says.
The current 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% of an employee's compensation.
"The 20/20 cap would, as expected, most affect the highest-income workers, but it also would cause a significant reduction in retirement accumulations for the lowest-income workers," VanDerhei says.
A similar take on the matter is expressed by the Pension Rights Center.
"The reason Congress conferred preferential tax treatment is because policymakers recognize how hard it is for people to save for retirement -- particularly low- and moderate-income workers," said Karen Friedman, the executive vice president and policy director of the center, in her Senate testimony.
"These incentives are meant to encourage employers to set up plans and to encourage employees to save," she continued. "However, the incentives end up disproportionately benefiting the nation's most affluent employees, who would almost certainly save for retirement even without tax incentives. Two-thirds of the value of tax expenditures for retirement savings plans goes to households in the top-income quintile."
Friedman's organization would support tax reform to "limit leakage," meaning withdrawing money from plans before retirement.
"The main tax provision to control leakage is a 10% excise tax on certain pre-retirement use of retirement savings, which has served primarily as a steep and unfair additional tax on the poor and the middle class, while doing little to actually control the problem," Friedman said. "Congress could create voluntarily designated 401k's and IRAs that once designated could not be accessed prior to retirement -- and use carefully targeted tax incentives directed at both employees and employers to encourage the use of such lock-down accounts. Moreover, the Saver's Credit itself might be locked down so that the credit amount is not available until retirement."
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