Could Obama's retirement proposal hurt savers?
President Obama's plan to bar millionaires from using retirement plans as tax shelters could block 1 in 10 Americans from saving at some point in their careers, and hit young people the hardest, experts say. They contend the plan could also add a stultifying level of complexity making retirement plan contributions, discouraging millions from using tax-favored accounts.
"Most people hear this affects millionaires, so they think it has nothing to do with them," said Jack VanDerhei, research director at the non-partisan Employee Benefits Research Institute. "But this proposal is incredibly complex and is likely to impact millions of people over time."
The rule is part of a package of proposals that aims to levy higher taxes on the rich, while providing more tax breaks to middle-income families with children. Though there's little criticism of the proposed tax breaks, the additional levies on wealthy filers have triggered a firestorm of protest from both large and small businesses and business owners, who would likely be on the hook for much of the cost.
But the biggest criticism of the proposed cap is that its likely to hit a far wider swath of Americans than advertised.
The government describes the proposal as a loophole closer that would stop individuals from saving in tax-favored retirement accounts once they had more than $3.4 million socked away. Experts estimate that less than 1% of Americans now have retirement plans that exceed the $3.4 million limit, but the limit is misleading. The actual dollar amount that would cause retirement contributions to be restricted varies based on the participant's age and market interest rates, experts contend. In fact, the proposal doesn't close tax breaks -- it simply subjects all retirement savers to one rule that now governs only defined benefit pension plans (the type of pension that pays set monthly benefits for life).
Specifically, defined benefit pensions are restricted from providing a final annual benefit of more than $210,000 to a 62-year-old. Each year, the professionals who administer these pension plans must calculate how much they need to set aside today to deliver the promised benefits in the future, given the age of the beneficiaries and prevailing market investment returns.
At today's historically low interest rates, a 62-year-old could have as much as $3.4 million set aside before running afoul of this rule. But in a more normal interest rate environment, this saver would bump into the rule with $2.6 million in savings, according to the American Benefits Council. And a 35-year-old could be barred from saving in retirement accounts once he had accumulated just $325,000. A 40-year old would be hit at $470,000 in savings.
If interest rates were to rise above their historic norms, critics of the White House plan say young savers could be barred from contributing to tax-favored retirement accounts when they had accumulated far less, making it harder to put money aside.
Worse, the rule would demand that individual savers do some complex math each year before adding any money to retirement savings.
Specifically, before contributing to a tax-favored retirement account, individuals would need to gather information on how much they had accumulated in all types of tax-favored accounts -- IRAs, 401(k)s, 403(b)s, 457 plans, SEPs and Keoghs. Then they would have to add that money together, project ahead to determine what this amount might be worth in the future, given current market interest rates and compound investment returns, and figure out how much of an annual pension benefit that projected savings would produce if annuitized over an average lifespan.
Only after wading through that complex and cumbersome process could the saver figure out how much he or she could contribute to tax-favored retirement accounts.
At that point, if he or she wanted to save through a company 401(k) plan, the saver would be required to report the result to his or her employer, who could then start deducting the appropriate contributions from pay.
Unfortunately, employers also have complex rules they must comply with when administering 401(k) plans. So if some workers at a company are limited by the new rule, it could impact other workers, who would otherwise not be affected, experts say.
"It's just completely impractical," said Lynn Dudley, senior vice president at the American Benefits Council. "That's a huge burden to place on a saver, particularly when we're already grappling with complexities in our tax code and health care system. I don't think anyone wants to do this."
VanDerhei predicts that the rule would add so much complexity to administering small plans that many employers would simply stop offering them.
"Given the incredible problem we have with getting people to accumulate enough to supplement their Social Security, it seems strange that policies would be modified to put arbitrary constraints on the amount people could save," VanDerhei said.
