The President’s recent budget proposal would impose a new cap on tax-favored retirement benefits.
Annual contributions and accruals under tax-favored plans are already limited, but this would be a complex new limit determined by how much of a pension could be provided by your IRA and your 401(k) accounts and qualified pension plans of ALL of your employers. To the extent you exceeded the amount necessary to fund the maximum annuity in a qualified pension plan, which the budget proposal estimates at approximately $3.4 million today, you would be barred from making any additional contributions or earning any additional benefits.
The proposal may have been a reaction to the huge IRA accumulations Mitt Romney revealed during the election campaign. In fact, Treasury’s Undersecretary for Domestic Finance, Mary John Miller, recently stated that the proposal would affect only a fraction of 1% of the country. However, this ignores the “trickle down” realities of retirement plans.
Here are some comments:
- Most taxpayers and employers aren’t actuaries. Who is going to convert IRA and 401(k) balances into equivalent annuities?
- How are employers supposed to get information about benefits provided by prior and future employers?
- How will investment performance affect the limits? Investment earnings could continue under the proposal without regard to the cap, but what if there is a negative return or an investment’s value sharply declines? What if additional contributions are permitted for a temporary loss, and then the investment rebounds?
- At a time when we should be encouraging employers to provide retirement benefits, imposing complex new obligations on employers may actively discourage plan sponsorship. This will hit the rank-and-file, not just the top executives.
- Much has been written about the fact that many employees are not saving enough to provide an adequate retirement income. Under a system where employers can determine (within Code limits) how much to provide for their employees, current law allows highly compensated employees to receive greater benefits if they provide more for the rank-and-file. The cap will remove this incentive, as executives who have reached the cap and are getting no plan benefits themselves may not want to provide for their employees.
A separate part of the budget proposal has a new deduction limit that includes employee IRA and 401(k) contributions. This could also provide a disincentive for employers to provide more for their employees.
Some practitioners believe that this proposal can’t be enacted and the real goal is to minimize objections to a reduction in the current contribution and accrual dollar limits. Regardless of whether they are right, all of those who would be affected by the proposal – which means all of us – should let the Administration know that this proposal is the wrong retirement policy.