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Obama Budget’s Retirement Savings Cap Targets Wealthy

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With the release of its 2016 spending blueprint on Monday, the Obama White House officially signaled its intent to raise taxes on the wealthiest Americans, in part by placing limits on retirement savings.

The proposed budget, which allots $4 trillion in spending for fiscal year 2016, proposes to cap tax-deferred saving in 401(k) and Individual Retirement Accounts at about $3.4 million. 

That amount of savings generates more than $200,000 in income annually when annuitized, an amount that should be sufficient for most, according to the Obama administration’s rationale behind the proposal. 

The vast majority of Americans would never feel the cap. In 2011, only one out of every 1,000 Americans had more than $3 million in their retirement accounts, according to the Employee Benefit Research Institute. That said, many in the industry oppose the cap, especially in light of concerns over the likelihood of rising interest rates.

“Politically, it is convenient to target people who have saved $3.4 million,” said Jim Klein, president of the American Benefits Council. “But the devil is in the details when you look at the impact on younger workers and the inevitability that interest rates will rise over the coming decades.” 

The problem is that 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. In other words, the cap would drop, subjecting any higher amounts to more taxation while leaving the saver with less.

In defending its proposed limit, the White House budget said that, “while tax-preferred retirement plans are intended to help middle-class workers prepare for retirement, loopholes in the tax system have let some wealthy individuals convert these accounts into tax shelters.”

In further making their case, the White House and Department of Labor noted that as many as 78 million working Americans — about half the workforce — do not have a retirement savings plan at work. Fewer than 10 percent of those without plans at work save in a retirement account on their own, the administration said.

The cap – an idea that Obama proposed last year as well – is a relatively small gambit in the budget’s larger effort to raise revenues by increasing capital gains taxes, inheritance taxes, and taxes on foreign revenue streams of U.S. multinational companies. 

Investment Company Institute President and CEO Paul Schott Stevens said his organization “strongly opposed” any limits on retirement-savings incentives.

“Policy changes of this kind are simply wrongheaded. … The administration’s proposals would penalize workers trying to set aside a nest egg for retirement, discourage employers from offering retirement plans, and add unnecessary complexity to retirement savings.”

A recent ICI survey found Americans overwhelmingly oppose changing tax incentives for retirement savings. 

The ICI also expressed its opposition to another proposal in the budget: an auto-enroll IRA program that the administration asserts would give 30 million workers access to workplace plans. “We oppose mandates on employers,” the ICI said.

The Insured Retirement Institute, on the other hand, applauded Obama for including “sensible solutions for expanding access to retirement plans, such as auto-IRAs, for American workers who do not have a workplace plan available to them.”

“Policies like this can go a long way toward helping Americans plan for their future financial security,” IRI President and CEO Cathy Weatherford said.

Under the proposal, any employer with more than 10 employees that does not offer a retirement plan would be required to automatically enroll their workers in an IRA. Auto-IRAs would let workers opt out if they choose. The DOL noted that auto-IRA proposals have been endorsed by “independent scholars across the ideological spectrum,” including those affiliated with AARP, the Brookings Institution and the Heritage Foundation.

The auto-IRA proposal would provide employer a $3,000 tax credit.

The president also proposed tripling the “start-up” credit, so small employers who begin to offer a retirement plan would receive a tax credit of $4,500. And small employers who already offer a plan and add auto-enrollment would get an additional tax credit of $1,500.

The budget also contains a proposal to make retirement plan available to part-time workers. 

Under current law, only 37 percent of part-time workers have access to a retirement plan. The budget proposes part-time workers logging at least 500 hours of service for three years should be eligible for enrollment in savings plans, extending access to about 1 million individuals. Employers would not be required to provide matching contributions. 

Also, states setting up their own automatic IRA enrollment programs would have greater latitude to do so under federal law. The budget would give the Department of Labor a “waiver authority” to allow a limited number of states to move ahead with their own automatic enrollment programs. 

Also, a rule prohibiting the Department of Defense from auto-enrolling service members in the government’s Thrift Savings Plan would be lifted. Each branch of the military could decide which members to auto-enroll, based on pay grade and who would be most likely to benefit. 

“The nation needs to do more to help families save and give them better choices to reach a secure retirement,” the White House said. 

Republican Rep. Paul Ryan, chairman of the House Ways and Means Committee, suggested Obama would have a fight on his hands on at least some of his proposed reforms, calling the savings cap “envy economics.”