Why the Tax Reform Crew May Target Your Retirement
The nearly $584 billion in retirement plan tax breaks is tempting
I’ve long assumed that improving Americans’ retirement security would become a legislative priority in Washington D.C. For one thing, the population is aging, including the massive baby boom generation. For another, the glaring flaws in America’s patchwork quilt of retirement savings plans is obvious, especially for private sector workers. And yet, the tax reform crew seems to have targeted retirement plans as prey.
Even though there are straightforward policy fixes that would improve the tattered retirement system, Washington seems determined to make it worse.
Tax Reform and Your Retirement
The reason? Tax reformers are on a hunt for revenue to defray government revenue that will be sapped by lowering income tax rates and capital gains tax rates (especially for higher-income households) and eliminating the estate tax.
It may be tough for legislators to ignore the nearly $584 billion in estimated lost tax revenue from defined contribution plans like 401(k)s over the 2016 to 2020 time frame.
“Unfortunately, many retirement policy decisions have been made on the basis of tax considerations, rather than retirement security considerations,” says Jeffrey Brown, dean of the College of Business at the University of Illinois at Urbana-Champaign and a long-time pension expert.
Altering the Rules for 401(k)s and IRAs
One proposal making the rounds on Capitol Hill: Congressional Republicans and the Trump Administration are contemplating turning traditional 401(k)s and Individual Retirement Accounts (IRAs) into Roth 401Ks and Roth IRAs. (This idea was first hatched by former Republican Rep. Dave Camp in 2014.)
Traditional 401(k)s and IRAs are funded with pretax dollars and their retirement distributions are taxed as ordinary income. In sharp contrast, Roth contributions are made with aftertax dollars and withdrawals from those accounts aren’t taxed. Tax writers like making this switch because it would boost government coffers upfront.
Top Democrats on the Senate Finance Committee — Sens. Sherrod Brown, Ron Wyden, Debbie Stabenow, Ben Cardin and Bob Casey — on Sept. 14, however, warned the White House and Congressional Republicans against changing the rules on retirement plans.
"At a time when working families are already struggling to get ahead, reducing or taking away tax-deferred retirement savings options could have significant long-term consequences," they wrote. They added that tax reform should increase working families' take-home pay, encourage savings, grow jobs and the economy, reward companies that invest in American workers and their communities and maintain sound fiscal policy," but that "so-called rothification of retirement savings fails that test on all counts."
A recent Politico story said the “Big 6” — Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Senate Majority Leader Mitch McConnell, House Speaker Paul Ryan, Senate Finance Committee Chairman Orrin Hatch and House Ways & Means Committee Chairman Kevin Brady — are working together to hammer out details of a tax reform plan.
The details of such a shift, laid out in the House Ways and Means Committee draft Tax Reform Act of 2014, are sobering, however.
More Complexity for Retirement Plans?
That retirement plan overhaul would have lead to a more complex and confusing mix of pretax and aftertax contributions in 401(k)s. Employer contributions would be made with pretax dollars and employees could choose to put up to half their contributions in pretax dollars or elect to make all their contributions with Roth aftertax dollars. Got that?
Little wonder that Alicia Munnell, head of the Center for Retirement Research at Boston College, concluded her analysis of the proposal with this scathing line: “This seems a crazy way to make pension policy.” No kidding.
Trump Administration and Retirement Security
It’s worth noting that the Trump administration has already been dismantling several initiatives designed to bolster retirement security, without offering better alternatives. The Administration is trying to stymie or stop state-run retirement savings plans for employees without access to employer-sponsored retirement savings plans. It has only partially implemented the Obama administration rule that would make financial advisers adhere to the gold-plated fiduciary standard when offering retirement savings recommendations. And it eliminated the MyRA, the Obama administration’s program encouraging low-income workers to save retirement.
The Need to Help Americans Save
So far, the tax reform ideas bubbling up aren’t about offering new or better tax incentives to encourage people to save for retirement. Those could be useful given the sad state of retirement saving today.
Some 41 percent of people ages 55 to 64 have no money in savings plans such as 401(k)s or IRAs. They typically work for small businesses that don’t offer employer-sponsored plans. And among those in that age group with some retirement savings (usually through an employer), the median sum set aside is about $104,000, according to the Government Accountability Office. That’s the equivalent of a monthly income from an inflation-protected lifetime annuity of $310, or $3,720 a year.
But there actually are many well-thought out proposals for establishing universal retirement savings plans.
Universal Retirement Savings Plans
For instance, Meir Statman, a finance professor at Santa Clara University and author of Finance for Normal People: How Investors and Markets Behave, draws on the experience of other countries to advocate for mandatory defined contribution retirement savings accounts. The Auto-IRA proposal of former Deputy Assistant Secretary of the Treasury J. Mark Iwry (now at the Brookings Institution) and David John of the Brookings Institution and the AARP Public Policy Institute, would make savings more automatic and accessible for workers not covered by an employer-sponsored retirement account.
Teresa Ghilarducci, an economist at the New School for Social Research and Hamilton James, president of Blackstone, the money-management behemoth, want to see Guaranteed Retirement Accounts that would require any employer without a 401(k) participate in, and contribute to, a government sponsored retirement savings plan.
A Simpler Retirement Account
Even less sweeping ideas could make a big difference.
For example, John Friedman, an economist at Brown University, calls for replacing the multitude of retirement savings accounts people accumulate over the course of their career with one account: a Universal Retirement Savings Account.
Too many Americans are financially ill-prepared for retirement. At a minimum, legislators should do no additional harm to the retirement system in their quest for tax cuts. But it would be far better if Washington focused its political capital solving a real problem: Ensuring retirement security for all Americans.