From the July 2011 issue of Investment Advisor • Subscribe!

Retirement Plans’ Perilous Future

Between threats of cutting tax benefits and crackdowns on non-compliant plans, for the retirement industry ‘stakes are higher than they ever were’

Retirement planning 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 (ABC), said in testimony before the House Subcommittee on Health, Employment, Labor and Pensions (HELP) on June 14.

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, says 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 says, “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 says. “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 ASPPA 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 time frame 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, 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 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.”

Impending Enforcement
Retirement planning officials take note: In case you hadn’t noticed, the Obama administration is ramping up enforcement efforts to combat the large number of retirement plans that it says are non-compliant with retirement planning rules and regulations.

The Department of Labor (DOL) has stated that 77% of 401(k) plans are non-compliant “in some form,” said John Carl, president of the Retirement Learning Center, which is sponsored by Columbia Management, the investment manager owned by Ameriprise Financial, at the SPARK Institute’s national conference in Washington on June 14.

While 2009 was a bad year for the economy, Carl said, it wasn’t so bad for the DOL—the department managed to add 997 employees that year—with 70% of those employees added to its enforcement division. The DOL’s Employee Benefits Security Administration (EBSA), for instance, saw a 28% budget increase in 2009, and EBSA added 29 enforcement personnel.

Carl also said that at the end of 2010, the Internal Revenue Service’s (IRS) employer plan division disclosed its list of “plan sponsor audit targets”—U.S. companies owned by foreign entities; 403(b) plans; and small business owners.

For the retirement planning industry, “the stakes are higher than they ever were,” Carl said. “Lots of enforcement folks are running around kicking the tires.”

While the current administration is focused on enforcement initiatives, like previous administrations, it’s also pushing an agenda to address how unprepared most workers are for retirement.

Carl listed some statistics that demonstrate why the administration is concerned:

  • 54% of workers report less than $25,000 in total savings and investments; 27% have less than $1,000;
  • Half of U.S. workers do not have access to employer-based retirement plans;
  • Only 54% of small businesses (those with fewer than 100 employees) offer a retirement plan;
  • Plan participation rate is 75% for those with access to a plan; and
  • The average account balance of the typical retiring defined-contribution plan participant is $144,000.

To combat its retirement planning concerns, the administration is pushing a pretty sizable agenda—including expanding the definition of who’s considered a fiduciary. Carl said that while there should be a “more level playing field so consumers know what they are getting when it comes to advice,” referring to the DOL’s regulation amending the definition of fiduciary under the Employee Retirement Income Security Act (ERISA), “I’m not sure it should be a Title 1 ERISA” fiduciary standard. The fiduciary standard “should be something [the retirement planning] industry can comply with without mass change.”

The administration’s retirement planning agenda, according to Carl, includes:

  • Auto IRA
  • Plan startup tax credit
  • Target date analysis
  • Plan fee transparency
  • Lifetime income options in DC plans
  • Investment advice proposal
  • Increased IRS and DOL enforcement and compliance assistance
  • Expanded definition of ERISA investment advice fiduciary
  • Social Security reform
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