Set aside for a moment the fight in Washington over raising the debt limit. In his budget blueprint for 2014, President Obama has proposed a number of tax and other reforms that would mean big changes in how retirement is financed.
At some point after the debt crisis is resolved, the House and Senate are likely to take up the following proposals, all of which would have lasting effects on anyone saving for retirement.
1. Automatic Enrollment in IRAs
The president’s 2014 budget would require employers in business for at least two years that have more than 10 employees to offer an automatic IRA option to employees.
Contributions would be made to an IRA on a payroll-deduction basis. If an employer already offers a plan, it wouldn’t have to comply with this regulation, but if its current plan excludes certain segments of its employees from participating in the plan, the employer would have to begin to offer the automatic IRA to those excluded employees, according to an assessment by KPMG.
Obama included this provision in the 2014 budget because he wanted to turn the tide on a rising retirement crisis in the United States. According to a Treasury report, the number of U.S. workers participating in an employer-sponsored retirement plan has remained stagnant for decades at no more than about half the total workforce.
The administration has seen that automatic enrollment efforts can be very effective in raising the number of people participating in workplace retirement plans and believes that by forcing small companies to offer automatic enrollment in an IRA, the number of people saving for retirement will rise.
Under the proposal, employers could help their workers save without having to make contributions to the plan or having to comply with the Employee Retirement Income Security Act. All they would have to do is make their payroll systems available to transmit employee contributions to an employee’s IRA.
Employers with fewer than 100 employees that offer an automatic IRA could claim a temporary credit for expenses associated with the arrangement of up to $500 for the first year and $250 for the second year. They also could be entitled to an additional credit of $25 per enrolled employee, up to a maximum of $250 for six years.
If employers adopted a new qualified retirement, SEP or SIMPLE plan, they would receive a tax credit for their startup costs that would be doubled from the current maximum of $500 per year for three years to a maximum of $1,000 per year for three years.
The Obama budget would eliminate the stretch IRA that allows beneficiaries to stretch the proceeds from an inherited retirement account over their lifetime. Instead, non-spouse beneficiaries of retirement plans and IRAs would have to take full distribution of their inheritance within five years of the account holder’s death.
The only exceptions would be disabled or chronically ill individuals, someone who is not more than 10 years younger than the participant, or an IRA owner or a child who has not reached the age of majority. Those individuals would be allowed to take distributions from the deceased person’s retirement plans over the life or life expectancy of the beneficiary beginning in the year following the death of the participant.
If the beneficiary was a child at the time of the participant’s death, they would have to take a full distribution within five years of coming of age.
If beneficiaries are forced to take distribution of large sums of money early, they will be taxed at a higher rate than they would be if they could leave the funds in the participant’s account and take money out gradually.
The president’s proposed cap on retirement savings has garnered the most attention this year. The cap would raise about $9 billion for the federal government over the next 10 years by prohibiting taxpayers from taking advantage of the pre-tax deferral in their 401(k) or defined contribution pension plans after they cross a $3.4 million threshold.
According to the Employee Benefit Research Institute, only a small percentage of IRA and 401(k) investors would be affected by the cap. In 2011, only 0.06 percent of total IRA account holders had $3 million or more in their accounts, and only 0.0041 percent of 401(k) accounts had that much money in them at the end of 2012.
The $3.4 million cap would allow an account holder to generate an annuity of $205,000 a year.
Small-business owners would be the biggest losers in this proposal, according to Judy Miller, director of retirement policy at the American Society of Pension Professionals & Actuaries.
That’s because company-sponsored retirement plans are the only way small-business owners can generate tax-deferred savings.
Workers might be hurt, too, even those with nowhere near $3.4 million in their accounts.
Brian Graff, executive director and CEO of ASPPA, said he is concerned that “without any incentive to keep the plan, many small-business owners will now either shut down the plan or reduce contributions for workers. This means that small-business employees will now lose out not only on the opportunity to save at work but also on contributions the owner would have made on the employee’s behalf to pass nondiscrimination rules.”
4. Social Security COLA
The president also proposed changing the way inflation is measured to shrink cost-of-living adjustments for retirees receiving Social Security benefits. The use of a chained consumer price index for Social Security and other programs, like Supplemental Security Income and veterans pensions, would reduce government deficits by $230 billion over 10 years. A chained CPI is a lower measure of inflation, which would reduce Social Security and other benefits by $130 billion.
The AARP Public Policy Institute spoke out about the use of a chained CPI back in 2012, saying the proposed changes would have a detrimental effect on the economic wellbeing of older and disabled Americans and their family members who receive the benefits of Social Security.
On the surface, a chained CPI seems like a good idea. It would reduce the annual COLA by small amounts every year. The problem is, it would hit the oldest and most vulnerable beneficiaries the hardest.
Those in favor of a chained COLA believe that the inflation measure used for the current COLA overstates inflation because it doesn’t fully account for the way that people substitute different goods and services when prices change. They argue that future COLAs should be based on a more accurate measure of inflation, the chained consumer price index.
AARP asserts that these cuts would have a catastrophic impact on older Americans who are the least able to absorb cuts to their benefits because they rely on Social Security for their income and have higher out-of-pocket medical expenses. They also have a higher poverty rate than younger Americans.