The recent debt ceiling deal which staved off the threat of default for the time being has brought increased attention to the U.S. national debt issue and has set December 23rd of this year as a deadline by which Congress must approve some $1.5 trillion in deficit reductions.  Combining this with a sluggish national economy and deep-seated political divisions has set the stage for a major showdown on tax reform in Washington.

As the debate around the deficit reduction turns to tax reform, the tax expenditures (deductions) for private retirement plans (while generally overstated) have not gone unnoticed.  Tax deductions for defined contribution retirement plans are estimated by the Joint Committee on Taxation to cost the Treasury $212.2 billion between 2010 and 2014.  This large number makes retirement savings expenditures an attractive target for policymakers looking to trim the deficit.

It is important to note that the Joint Committee on Taxation estimates do not tell the whole story.  Tax expenditures for retirement savings are treated in those estimates as tax breaks.  In the case of pre-tax retirement plan contributions, they are not so much “tax breaks” as they are “tax deferrals” which will end up being taxed upon distribution.  This misclassification means that the amount of lost revenue to the Treasury is drastically overstated in these estimates. According to an American Society of Pension Professionals and Actuaries study, the cost is really as much as 77% lower than the Joint Committee on Taxation estimates.  Unfortunately for the uninformed, a simple reading of the numbers makes retirement tax expenditures look much larger than they really are.

The Proposals:

Several notable proposals aimed at reducing the budget deficit have recently surfaced that would roll back some of the incentives behind employer-sponsored retirement plans.  In fact, on September 15 the Senate Finance Committee sought to explore some of these proposals in its hearing entitled “Tax Reform Options: Promoting Retirement Security.”  The following are a few of the more significant proposals that have been discussed.

The first type of proposal is aimed at the annual contribution limits to defined contribution retirement plans.  Under one of these proposals, maximum contributions would be limited to the lesser of $20,000 or 20% of an employee’s compensation. This is a significant curtailment of the current contribution limits which cap contributions at the lesser of $49,000 or 100% of compensation.

Another proposal which has been floated by the Brookings Institution, would replace the current deduction with a tax credit in the form of a matching contribution from the federal government.  According to the Brookings Institution, a 30 percent match under this proposal would reduce the tax benefits for upper income earners while increasing the benefit for lower income earners yet remaining revenue neutral to the federal government.

Perhaps the most supported proposal would be to change the way cost of living adjustments (COLAs) are computed.  Under this proposal, the COLAs which are used to set annual contribution limits would be linked to the “chained Consumer Price Index (CPI),” a different, and slower-growing, measure than the current CPI being used.  While effective in reducing tax expenditures, this proposal would undoubtedly harm retirement readiness by decreasing both employer and employee contributions.

Closing Thoughts:

While dealing with the ever-increasing national debt is a serious issue and is rightly a top priority in Washington, it is important that policymakers not try to fix it by dismantling or eroding America’s already successful private retirement system.  The unfortunate effect of each of the proposals described above would be to discourage business owners from establishing and maintaining retirement plans for their employees.  Current law already imposes strict nondiscrimination and coverage rules on contributions which are aimed at ensuring that workers of all income levels receive a fair share of benefits.  Reducing the contribution limits or eliminating the tax deduction would undoubtedly serve to reduce the existing tax incentives for business owners leading to undesirable results.  Without attractive tax incentives, business owners and decision makers may be inclined to reduce their employer matching or profit sharing contributions or even make the decision to stop offering a retirement plan altogether.  This would serve to undermine the goal of promoting retirement savings for American workers.  Current policy strikes a good balance between employer and employee incentives and has helped millions of Americans successfully prepare for retirement.

As I mentioned in our summer edition of the Translator, TSC now has a blog; RetirementVoice.com, which has been up and running since June 22, 2011.

Through RetirementVoice.com we hope to expand our efforts to advise our clients, retirement plan sponsors, and financial advisers of current events in the retirement plan field as they happen.

Our post of September 16, 2011 entitled “Straightening Out the Facts on the 401(k)” is one in which we commented on an article in the Minneapolis Star  Tribune that attacked the 401(k) plan as an inadequate vehicle for retirement readiness. We adamantly disagreed.

Despite the 30% drop in the stock market in 2008, 401(k) plans have enabled participants to accumulate retirement savings in excess of $3 trillion. While some would like to treat the 401(k) as the evil stepchild of the traditional pension plan, it has encouraged millions of Americans to accumulate trillions of dollars that will provide a much needed supplement to their social security benefits once they have reached retirement age.

We cannot turn back the hands of time, nor should we want to; the private sector pension plan is a thing of the past for most employees.

As a wise man once said; “If it is to be, it’s up to me”. We all must take charge of our own retirement benefits. Through proper planning and guidance from retirement plan specialists it is possible to achieve a successful retirement plan. It is up to plan sponsors, plan trustees, financial advisers, and retirement plan consultants to continuously encourage all employees to participate in their company’s retirement plan.

Gary Zurek, President

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Are you ready for retirement? Statistics show that a significant number of people are not preparing for retirement.

Four facts on retirement readiness:

1. Generations differ on how the stock market affects them.
2. The 401(k) retirement plan is not broken.
3. Retirement planning is similar to running in a Mud Run.
4. An annual 401(k) Health Check is highly recommended for healthy retirement.

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