Once again, some of the most popular retirement savings tools are under the congressional microscope. Policy makers are gearing up for the tax-reform effort expected after the presidential election and asking what seems to be a simple question: Can 401(k) plans, 403 (b) plans, individual retirement accounts and other tax-deferred accounts be streamlined while getting more traction among people with lower incomes? And can we squeeze some additional tax revenue out of the plans in the process?
You may be thinking, “Why are retirement accounts being scrutinized now?” The bottom line is that Congress is looking for ways to raise revenue. The government has estimated it will lose $136 billion in revenue this year to tax-deferred retirement plans. Every dollar that is excluded from income this year will most likely be included in income in a future year. However, the future tax revenue doesn’t show up in the typical 5-10 year budget windows the federal number crunchers use. So what proposals to increase tax revenue, or boost retirement savings, are on the table? There are several:
- IRAs that would automatically enroll workers with no access to a workplace retirement plan, creating a means to save through regular payroll reductions.
- Capping retirement-plan contributions at $20,000 a year or 20% of compensation, whichever is less — including employer contributions. Currently, the limits are 100% of compensation or $50,000 a year.
- Replacing exclusions and deductions for retirement savings with an 18% tax credit, deposited directly into an individual’s retirement savings account.
- Accelerating “automatic enrollment” of workers in retirement-savings plans, along with their default savings rate, and automatically increasing workers’ savings rates each year.
- Simplifying the paperwork involved for small employers’ adopting existing types of plans, with the goal of increasing access for more workers.
Sixty-six percent of full-time workers participate in workplace retirement plans with almost three-quarters of them making less than $100,000 a year. However, the larger number of plans with different rules and eligibility criteria has led some policy makers to question whether the plans have left workers confused and less likely to use them. The old adage is that the more ice cream flavors you offer, the more people choose vanilla.
In the recent Retirement Confidence Survey for 2011, one in four full-time workers saving for retirement said they would reduce, or totally eliminate, their retirement savings plan contributions if they could no longer deduct them from their taxes. Doing away with tax-deferrals for workers could lead some employers to drop their plans as well. Principal Financial Group last year found that if workers’ ability to deduct any amount of their 401(k) contributions from taxable income were eliminated, 65% of the plan sponsors surveyed would have less desire to continue offering their 401(k) plans. At the very least, the increasing focus on retirement savings is a reminder that tax treatment of the accounts, once considered permanent, is anything but.