Tue, November 15, 2011
As the Congressional Supercommittee considers ways to cut the federal deficit, one element of their proposal might be a change in retirement savings tax policy.
Because the “supercommittee” has a relatively short time in which to come up with a plan, they’re expected to focus on selecting deficit-reducing ideas that have already been developed by others. Among the tax breaks in the current IRS code, retirement program incentives are an enticing place to find ways to increase federal revenue. According to the General Accounting Office, annual tax breaks for defined contribution plans like 401(k)s exceed $60 billion annually, with another $40 billion in incentives for defined benefit plans (like pensions). Adding in tax breaks for Keogh plans ($15 billion) and IRAs ($14 billion), about $134 billion a year in federal revenue is foregone in order to encourage Americans to save for their retirements.
Consequently, there are a number of existing proposals to reduce the deficit by reducing or eliminating tax breaks for retirement plans. The bipartisan National Commission on Fiscal Responsibility and Reform (a.k.a. Simpson-Bowles Commission), in its report, “The Moment of Truth,” suggested that annual pretax contributions be capped at the lower of $20,000 or 20% of income.
The Congressional Budget Office has proposed lowering the maximum contributions amounts to IRAs, 401(k)s, and 457 plans for workers over 50. The Brookings Tax Policy Center is encouraging a plan that would eliminate retirement contribution tax breaks.
One problem with all of these plans is that retirement experts believe that most workers should be saving more, not less, for retirement. A study done last year by the Employee Benefit Research Institute (EBRI) concluded that half of all Baby Boomers and Gen-Xers are unlikely to have enough income in retirement to cover basic expenses and health care costs. A study published this month by EBRI examined two proposals to reduce retirement plan incentives and found that if the plans were enacted, workers are likely to reduce the amounts saved for retirement.
At this juncture, we can only guess whether such proposals might be enacted. The supercommittee has a deadline of November 23rd by which it must make its recommendations. There are so many areas up for grabs – mortgage deductions, capital gains taxes, limits on itemized deductions, changes in Social Security, etc. – that such a change will be only a small part of a larger picture.
Even after the supercommitte makes its recommendations, the final outcome of any proposal is uncertain. Both houses of Congress must vote on the supercommittee’s proposals by December 23rd, and Congress is likely to run the clock out.
Under current law, employer contributions to 401(k)s and pension plans are deductible expenses, within certain limits. Over the last 30 years, there has been a massive shift from pension plans to 401(k) plans, as the latter relieve employers from the obligation to pay defined benefits in the future. If there is a significant change in tax policy related to retirement plans, there could be new shifts in the retirement benefit plan landscape.
In anticipation of possible cuts to retirement contribution limits are imminent, workers would be wise to maximize 2011 retirement plan contributions if they can afford to, just in case such breaks are cut back or eliminated as a result of deficit-cutting. In many 401(k) plans it’s possible to change your plan contributions at any time during the year, though some limit the frequency with which adjustments can be made.
Changes to retirement plan rules, if made, would probably not take effect in 2012 because all of the entities involved with retirement plan administration will need time to adjust software, publications, and anything else with the old limits present.
If retirement plans manage to dodge the supercommitte bullet, you can always decide to reduce next year’s retirement savings if necessary.