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The problem with Obama's plan to limit retirement savings

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(Bloomberg Business) — The White House releases its 2016 budget today, and among other initiatives aimed at raising tax revenue from the richest of the rich, the Administration is proposing a cap on how much money a person can have in their all of their retirement accounts combined. They suggest a ceiling of more than $3 million per person.

The vast majority of Americans will only ever dream of such a well-padded retirement. Even most of the rich wouldn’t hit Obama’s cap. In 2011, only one out of every 1,000 Americans had more than $3 million dollars in their retirement accounts, according to the Employee Benefit Research Institute. But it is not clear how that number will change in the future. 

The administration says it wants to “prevent additional tax-preferred saving by individuals who have already accumulated tax-preferred retirement savings sufficient to finance an annual income of over $200,000 per year in retirement—more than $3 million per person.” In other words, it reverse-engineered the cap, figuring out how much it would cost to buy an annuity that generates more than $200,000 in annual income. That’s great — today. Annuity prices vary with interest rates because insurance companies buy bonds to finance pay-outs. When bond yields are low, as they are now, annuities are more expensive. Right now a 10-year treasury bond yield is just 2 percent. If it jumps to 5 percent (the rate in 2006), that $205,000 annual annuity would only cost $2.2 million. 

Now, it’s not clear whether the cap will actually vary with interest rates. If it did, and rates did jump to 5 percent, the proportion of retirees affected would grow from 1 in 1,000 to 30 in 1,000, EBRI estimates. In that scenario, those people would suddenly have to pay taxes on their retirementaccounts. If rates went down again, they could contribute more and avoid taxes. That makesretirement planning and the tax code even more complicated than it already is, and opens the door to more loopholes and tax dodges.

Keeping the cap at $3.4 million, or indexed to inflation, may seem more reasonable. But then the cap is arbitrary and hardly has any impact. There’s already a limit on how much people can contribute to these accounts each year ($53,000 for a 401(k), including employer match; $5,500 for an IRA if you are not self employed and under 50). These limits make it nearly impossible to have tens of millions of dollars in retirement accounts anyway. 

The cap will initially only impact a rarefied population. But that population will grow as more people reach retirement with career-old-401(k) plans (defined contribution pension plans did not really catch on until the mid 1990s) and rates rise. There are better ways to reform the tax code and collect revenue from the wealthy. A cap based on current, historically low interest rates, merely adds more complication and little benefit.