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Financial Planning > Tax Planning > Tax Reform

Say Uncle

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Limits on retirement plans and other tax issues won’t be on the table in the package of budget cuts and tax hikes that must be negotiated by Aug. 2 as part of a deficit reduction plan aimed at justifying a hike in the current federal debt limit.

But that is where the good news ends. In public comments and congressional testimony, the current deficit concerns lead industry officials to predict that all current tax-advantaged products will be forced to justify their continued existence, most likely in 2013.

For example, in testimony before a House subcommittee on the issue June 14, James Klein, president of the American Benefits Council, warned members of Congress that a move to a capped tax credit that provides a reduced tax benefit could discourage plan sponsorship.

He added that if sponsorship declines and more employees are forced to save on their own, they would not receive the many protections and benefits associated with employer-sponsored plans (from ERISA protection to fiduciary oversight –especially of investments and fees–to employer contributions).

Klein also said in testimony before the Subcommittee on Health, Employment, Labor and Pensions of the House Education and the Workforce Committee that the current pre-tax treatment of retirement savings is a powerful incentive for individuals.

He said that it is viewed by taxpayers “as the core of our retirement savings regime and allows them to save more on a paycheck-by-paycheck basis than would be the case with after-tax contributions.”

This financially efficient approach is particularly important for low- and middle-income families trying to make the most of scarce dollars.

“The payroll tax savings on employer contributions provides another significant advantage for modest-income households, as does the deferral on gains that spares families from annual tax bills on their accumulating savings,” Klein said.

And current incentives efficiently produce retirement benefits, Klein said.

“Repeated analyses have shown that for every dollar of federal tax expenditure devoted to tax-preferred workplace retirement plans, four to five dollars in ultimate retirement benefits result,” he said.

William Sweetnam, co-chair of the policy and legislation group of the Groom law firm, agreed that changes are coming–and that limits on retirement plan benefits for executives will be discussed.

“I would anticipate seeing proposals to further cut the tax benefits of insurance products,” Sweenam said.

However, he said, the insurance industry has an effective advocacy system in place. “I’m sure that every Congressman or woman knows at least one or two insurance brokers who will be telling the congressman or woman about the value of maintaining the current tax provisions regarding insurance,” Sweetnam said.

At the same time, he said that if there are cutbacks in Social Security, like pushing back the retirement age or means testing with regard to Medicare, higher income people will need to save more for retirement and cutting the opportunities for high-income people to save for retirement would be a “double-whammy” on the upper middle class.

“The retirement plan industry will need to point out this mixed message in terms of tax and retirement policy,” Sweetnam said.

He noted that the National Commission on Fiscal Responsibility and Reform, headed by Erskine Bowles and Alan Simpson, have suggested a limit on all contributions to retirement accounts equal to the lesser of $20,000 or 20% of income and that limit will effectively only apply limit executives’ retirement accounts.

“You may see efforts to trim the expanded benefit limits that were enacted in 2001 under the theory that only top executives and business owners benefit from those increased limits,” he said.

However, “if retirement benefit limits are decreased, there is the increased likelihood that small businesses may not sponsor retirement plans since the small business owners do not receive enough benefits to make the costs of setting up these plans worthwhile,” Sweetnam cautioned.

He said that small business groups and those that provide small business retirement plans “are trying to get Congress to understand the interrelationship between limits for high-income individuals and access to plans for low-income employees.”

He said that Congress cannot get into the details of fundamental tax reform until it addresses the debt limit increase, which is now the subject of tense discussions.

At the request of Republican leaders in the House and Senate, President Obama stepped into the negotiations in late June.

The Aug. 2 date is considered important because under projections made by Treasury Secretary Timothy Geithner, that is when the U.S. is likely to run out of money.

The government has been depending on tax receipts and the refunding of maturing debt, as well as contributions to Social Security and other long-term programs, to pay government bills since the U.S. ran up against the current debt limit in early May.

“While there is likely to be some price, budget-wise, with getting the Republicans to agree to increase the debt limit, Congress has not laid down an appropriate foundation to address tax reform,” he said.

“That foundation will probably be addressed either later this year or early in 2012,” he said, noting that he understands that the Obama administration’s Treasury Department is working on a tax reform proposal as is the Republican staff on the House Ways & Means Committee.

He also suggested that Senate Democrats will also pull together a proposal.

“I see there being a lot of debate on the competing tax reform proposals, especially during the Presidential campaign,” Sweetnam said.

“However, I don’t think that Congress will be able to compromise during an election season to get tax reform. That is why I believe that Congress will not get down to the serious task of developing tax reform until 2013,” Sweetnam said.

President George W. Bush played a key role in crafting tax cuts in 2001, and also led the teams that provided guidance for Health Savings Accounts and Health Reimbursement Arrangements, the preliminary guidance regarding executive deferred compensation arrangements under Section 409A and the regulatory and legislative proposals regarding cash balance pension plans.

In addition, Mr. Sweetnam was part of the Bush administration’s task force to restructure the defined benefit plan funding system–which resulted in the Pension Protection Act of 2006.

Regarding specific products that may be on the table, Sweetnam said he has not seen any documents indicating what the administration may have in mind other than the proposals to reduce the tax benefits of corporate-owned life insurance and bank-owned life insurance contained in the budget proposal for 2012 released by the administration in May.

The administration reiterated its support for those proposals in a letter in May that responded to a request from 32 members of both parties of the House Ways and Means Committee to back off.

“I believe that policy makers will look at each tax expenditure to see how effective the expenditure is and whether it is worthwhile to maintain, particularly if the revenue raised from curtailing the tax expenditure will make it possible to lower tax rates,” Sweetnam said.

“The tax exclusion for life insurance products, therefore, should be subject to that same review and companies that offer those products will need to show that there are good policy reasons to maintain the current tax status of the products,” Sweetnam said.

Asked if non-qualified deferred compensation plans might be on the table for cutting, Sweetnam said that, “Interestingly, NQDC is not that big of a tax expenditure–companies don’t take a deduction until the NQDC is paid to the employee and the employee includes that amount in income.”

He said that from a tax expenditure viewpoint, NQDC is not much different than the payment of regular compensation–a deduction to the company at the time that the executive pays tax on the compensation.

“Now some on the left believe that the government should not be subsidizing large executive salaries and would like to limit the deduction on compensation above a certain amount–this was done a number of times in the last few years and you may see this issue raised again,” he said.

“However, it might be difficult to get Republicans to agree to these deduction limits,” Sweetnam said.


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