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‘Blank Slate’ seen as threat to retirement saving

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Deferring taxes on money saved for retirement could be a thing of the past, if Sen. Max Baucus, D-Mont., chairman of the Senate Finance Committee, and Orrin Hatch, R-Utah, ranking member, have their way.

The “blank slate” approach they propose for reforming the tax code will eliminate all tax deductions, no matter how worthy, and force the defense of any measure by advocates who wish to see them retained.

The senators cited the Joint Committee on Taxation as saying that pension and retirement savings tax breaks alone, if added back into a newly reformed tax code, could amount to $2 trillion over 10 years, and “would, on average, raise each of the seven individual income tax brackets by between 1.3 and 2.2 percentage points from what they would be under the blank slate.”

But according to Brian Graff, executive director and CEO of The American Society of Pension Professionals & Actuaries, some of the tax enticements to save for retirement aren’t, strictly speaking, deductions.

They are instead tax deferrals, which “power (employer-based retirement plans). … Reducing the incentive would hurt these plans. Eliminating it would destroy retirement security for working Americans,” Graff said.

Retirement savings incentives fall into three different categories: tax credits, tax deductions and tax deferrals.

Among these are tax credits for contributors to a 401(k) plan or IRA (the Retirement Savings Contributions Credit or Savers Credit), and tax credits for employers who provide retirement plans (and who may be able to get a credit for part of the setup costs for eligible plans); tax deductions for contributions to a traditional IRA, as well as tax deductions for employer contributions to employee retirement plans (and even trustees’ fees, if employee contributions don’t cover them); and deferral of tax on contributions to a 401(k) plan (contributions are not taxed until distribution).

Tax deferrals end up being collected some years down the road — albeit likely at a lower rate; at least, that’s the intent.

But if the money is to be taxed now instead, lawmakers need to consider the loss of the deferred tax, according to Judy Miller, director of retirement policy at ASPPA. “I hate to see this deferral treated like they can raise revenue now without losing revenue later,” she said in a recent report.

The mix of tax credits, deferrals and deductions does, in fact, amount to a hefty chunk of change for the government. According to a recent Congressional Budget Office report, this mix costs the Treasury some $137 billion in fiscal 2013. They are, said the report, the third-highest annual tax expenditure.

Rob Austin, senior consultant at Aon Hewitt, said that given the national debt, “it’s not a surprise that retirement plans are being discussed on Capitol Hill” as potential targets for tax reform.

But while there’s been a lot of talk about a mass movement of employers killing retirement plans if tax benefits are eliminated, Austin says that’s unlikely. That’s because most employers don’t offer 401(k) or retirement plans for their tax benefits, he said. Instead, they offer them to help retain good employees. “If you take away taxation benefits, I don’t think there will be a sizeable move of employers to (eliminate retirement plans); they need them for employee retention,” he said.

Amid the outcry against eliminating tax breaks for employer retirement plans, a study released earlier this year suggests that such an action might not make much difference.

The study looked at Danish data on savings and retirement, because the Danes have much more detailed information available and also have a pension system similar to that in the U.S.

The researchers, Raj Chetty and John N. Friedman of Harvard, Soren Leth-Petersen and Tore Olsen of the University of Copenhagen, and Torben Heien Nielsen of the Danish National Center for Social Research, divided savers into two main categories: “active” and “passive” savers.

Approximately 85 percent of Danes fell into the “passive” category, having less money and responding less to government actions. The other 15 percent had more money to begin with, and more actively took advantage of government policies that encouraged savings.

According to the results, tax breaks did very little to stimulate retirement savings. Savings increased only about a penny for every dollar spent by the Danish government on tax breaks.

Active savers responded to tax breaks by shifting around the money they saved to take advantage of the breaks, rather than saving more. Passive savers, on the other hand, did little. What did make a substantial difference was automatic saving of an employee’s pay, which did benefit passive savers.

Still, savings incentives of any kind don’t work if employees don’t make enough to live better than paycheck to paycheck, a point raised by numerous consumer advocates. Instead, about 80 percent of savings incentives, according to the Tax Policy Center in Washington, end up benefiting those who make $100,000 or more — the top fifth of wage earners.

For the record, Baucus and Hatch are not specifically calling for the elimination of tax breaks for retirement savings.

Indeed, the likelihood of a “blank slate” approach succeeding at all has been criticized by no less a personage than Bruce Bartlett, who served under President Ronald Reagan and the first President Bush. He wrote that it would be impossible to eliminate a number of deductions because of their overwhelming popularity, adding, “Even special tax breaks that members of both parties denounce and that are clearly perverse have proven impossible to repeal.”

Instead, Bartlett said, “(Baucus and Hatch) ought to be willing to exercise some judgment and put forward a specific proposal of tax expenditures they think are worthy of abolition in order to clean up the tax code and lower rates.

“That’s what Ronald Reagan did in 1985, which led to enactment of the Tax Reform Act of 1986.”

Bartlett has a point. With Congress so unable to agree on anything, how on earth would a complete abolition of all tax breaks get passed?

See also:

The new 2013 taxes: The good, the bad and the ugly

10 life insurance tax facts you need to know

2013: The year of the RMD tax bubble


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