Retirement security requires planning, commitment and investment over many years. Employer-sponsored retirement plans provide a framework for those efforts, thanks to many features and protections that make them attractive to employees and employers. But quite apart from the essential role that retirement plans play ensuring income security, is an indisputable fact: they constitute a large pool of investment capital in our country, which is indispensable to economic growth. According to the Federal Reserve Flow of Funds Accounts, as of the 4th quarter of 2013: households owned retirement assets totaling $19.6 trillion, excluding Social Security. For comparison’s sake, corporate equities totaled $13.9 trillion in that same period. Reducing incentives for these plans could erode their value to the detriment of both the retirement security of an aging population and an economy that has yet to adequately create jobs. It is against this background that the comprehensive tax reform draft (“Draft”) unveiled recently by House of Representatives Ways and Means Committee Chairman, Dave Camp (R-MI), deserves attention.
Chairman Camp is to be applauded for recognizing that tax code changes are needed to allow individuals and businesses to prosper. But given the imperative to help Americans achieve retirement security and the reality that ultimately entitlement programs need to be reformed, any action that unintentionally diminishes employer-sponsored and individual retirement savings should be avoided. The Draft needs to be examined closely because it will be a benchmark document in the forthcoming tax reform debate; and could be a source of revenue-raising ideas outside that context as well.
The overall thrust of the Draft’s retirement provisions is twofold: to push more savings into after-tax vehicles, and to reduce the value of tax benefits for high earners. The proposed changes would expand the availability of Roth vehicles, thereby taxing contributions up front but allowing earnings to grow tax-free. Total annual pre-tax deferrals for a participant in all but the smallest employer plans would be limited to one-half the applicable maximum allowed deferral (with additional contributions required to go into a Roth account). In other words, at the current maximum $17,500 contribution level, no more than $8,750 could be on a pre-tax basis. Of course pushing more savings to after-tax vehicles gets “scored” as a revenue raiser within the 10-year budget window. However, as tax-free distributions are made, it would reduce government revenue.
The Draft also locks current contribution levels for employer-based plans by suspending inflation adjustments until 2024. These adjustments are important not just for protecting against ongoing inflation but inflation later upon retirement due to the compounded growth on the amounts contributed. In addition, the inflation adjustments help people stay on a trajectory to save more. The Camp Draft would also impose a 10% surtax to certain income above $400,000 for single filers ($450,000 for joint filers). Consequently, some plan contributions would be double-taxed – when they are made and, again, when distributions are paid to retirees – thereby reducing their immediate tax value.
The voluntary employer-sponsored retirement system has been driven by its popularity with, and commitment from, employers and employees. This is demonstrated by the system’s success, which relies upon tax incentives to encourage the establishment and growth of plans. In turn, these plans have allowed workers across the income spectrum to accumulate 5 trillion dollars in defined contribution plan assets, alone. This has relieved and will continue to relieve pressure on entitlement programs.
A dramatic reduction of tax incentives for 401(k) plans could cause employers and employees to sense that the commitment to retirement saving is not shared by policymakers and that the system is not as stable as they once thought. It may be difficult for policymakers to convince people they are better off, overall, even if the changes are accompanied by a reduction in income tax rates. The argument that high-level savers and high earners will simply shift savings elsewhere misses an important point. Employer-sponsored retirement plans offer enormous value to savers, the government and the economy. They offer structured, routine and consistent savings mechanisms across the income spectrum and, of course, allow employer contributions as well. Employer involvement permits asset pooling, cost efficiencies and access to a wide range of investment choices.
Finally, as noted above – but often overlooked by policymakers – retirement plan contributions are tax deferred, not tax exempt. Not only is tax revenue collected when benefits are paid, but because savings compound over time, a significantly greater stream of future taxable revenue is produced. Retirement security takes long-term planning, commitment and investment. And building capital to make possible a thriving economy depends upon growing retirement assets. Employers and workers have been able to meet these dual challenges thanks, in large part, to enlightened public policy. A retirement wave in the near future and economic imperatives require continued commitment from all three stakeholders.