Advisors to Congress: Don't Axe Retirement Plan Tax Benefits to Cut Deficit--Update

American Benefits Council warns against possible Congressional desire to remove favorable tax treatment of DB and DC plans.

Retirement officials are worried that Congress, in its efforts to reduce the federal deficit, will look to pilfer the tax expenditures for employer-provided retirement plans—which totaled $112 billion in fiscal year 2011, James Klein, president of the American Benefits Council, said in testimony before the House Subcommittee on Health, Employment, Labor and Pensions on Tuesday.

In its scramble to find ways to reduce the deficit, “some in Congress may overlook how these plans provide retirement savings incentives to workers at a significantly lower cost than the additional dollars needed to expand corresponding public programs,” Klein said. “Because members of the Education and Workforce Committee inherently understand the value of the employer-sponsored retirement system, you are especially well positioned to be a voice within the budget debate on the need for tax policy to support, not erode, employer plans and retirement savings.”

William Sweetnam, co-chair of Washington-based Groom Law Group's Policy and Legislation Group, who was previously the benefits tax counsel in the Office of Tax Policy at the Treasury Department, told AdvisorOne in an email message that in deciding how to close the budget deficit, “Congress will be looking at cutting all government spending--including reducing tax expenditures.” One of the biggest tax expenditures, he said, “is the current exclusion from taxable income of contributions and earnings on employer-based defined benefit pension plans and defined contribution plans”--like 401(k) plans.

“If employers don’t want to see reduced limits in the amount of contributions and benefits that can be provided under a retirement plan, they will need to make a good argument that the tax expenditure for these plans is a worthwhile government expenditure,” Sweetnam said. “One way to do that is to show how many employees will lose access to retirement plan benefits if the limits on benefits for these plans are reduced.”

Indeed Brian Graff, executive director and CEO of the American Society of Pension Professionals and Actuaries (ASPPA), says new research from the society shows that proposals to scale back or eliminate retirement savings incentives in 401(k) plans not only “endanger the ability of low- and moderate-income workers to enjoy secure retirements but are based on faulty math.”

ASPPA says its analysis shows “the real cost of retirement savings incentives to be 55% to 75% lower than claimed by budget hawks, meaning that proposed cuts will not save nearly as much as advertised even as they jeopardize the future of 401(k)s and other retirement plans.”

When evaluating the cost of the tax deferrals associated with defined-contribution plans such as 401(k) and Keogh plans, the congressional Joint Committee on Taxation (JCT) and the Treasury Department’s Office of Tax Analysis (OTA) both use current cash-flow analysis, ASPPA explains. “Since workers withdraw money from these plans only in retirement, the taxes paid show up outside the 10-year timeframe used in cash-flow analysis, and therefore are ‘scored’ as lost revenue, rather than deferred revenue,” Graff explains.

These tax deferrals differ from tax credits or deductions, Graff says, such as those for medical expenses or mortgage interest, since the taxes deferred ultimately are paid. “The faulty analysis dramatically exaggerates the real cost of the tax incentives for retirement plans,” Graff says. “In fact, using present-value analysis--which economists typically use for long-term analysis--economist Judy Xanthopoulos and tax attorney Mary M. Schmitt have calculated that present-value estimates of the five-year cost of retirement savings tax expenditure are 55% lower than those of the JCT and 75% lower than those of the OTA.”

 

Who Would Be Affected?

Sweetnam of Groom Law Group's Policy and Legislation Group, when asked by email (after this article was originally published) to expand on the proposal, said "There have been no specific detailed proposals advanced yet.  However, in the President's National Commission on Fiscal Responsibility and Reform (headed by Erskine Bowles and Alan Simpson), they suggested a single limit on deductions toward all retirement plans( DBs, DCs, IRAs and SEPs) of the lower of $20,000 or 20% of income -- which is a reduction for higher income individuals.  So they will not eliminate all the tax benefits of these plans; they will reduce them in some manner."\

In addition, Sweetnam said it would be individual taxpayers "that will lose the tax benefits with any of these proposals." For example, he said individual taxpayers could be limited on the amount of pre-tax contributions to 401(k)s, IRAs and SEPs  which would reduce the amount of the deduction. "If under reform the amount of benefit that can be provided under a DB plan is limited, individuals will either receive more taxable income to make up for the lost DB benefits or DC contribution or just receive a lesser amount of retirement benefit," according to Sweetnam. "Companies will not be affected because they get a deduction for compensation regardless of whether it is paid directly to the employee or it is put into the plan."

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