The Obama administration and many in Congress — hungry for revenue to reduce the federal deficit and the outstanding federal debt — might be tempted to look for unusual financial sources, including pension programs.
Others in Washington, including the president's own National Commission on Fiscal Responsibility and Reform, already have done so, suggesting 401(k) and other defined contribution plans as new sources of federal revenue.
A lot of money could be raised from retirement programs. But such moves should be off the table.
“Today, these pension tax incentives are the second largest tax expenditure (of the federal government), and the associated income tax revenue losses are estimated to amount to approximately $105.1 billion in fiscal year 2011,” according to a Government Accountability Office report. Broken down, the total consists of $62.9 billion for defined contribution plans and $42.2 billion for defined benefit plans.
That total reaches $134 billion, when the federal government revenue forgone from Keogh plans ($15 billion) and from individual retirement accounts ($13.9 billion) is included.
Proposals generally call for lowering the maximum tax deductible contribution to defined contribution plans.
But they are a bad idea.
First, DC plans aren't tax avoidance schemes; they are tax deferral programs. Taxes deferred now in the programs will be paid as assets are distributed when participants retire.
Some participants pay taxes now on their contributions, exercising their preference to move to Roth 401(k)s at companies that offer the choice, or Roth IRAs. Therefore, the defined contribution program isn't necessarily entirely tax deferred.
Second, proposals to limit the maximum tax-deductible contribution to 401(k)s come at the same time some members of Congress and the Department of Labor are trying to get participants to save more.
The president's commission, co-chaired by former Sen. Alan Simpson and former White House Chief of Staff Erskine Bowles, in its report, “The Moment of Truth,” proposed capping a participant's tax-preferred contributions to the lower of $20,000 or 20% of income annually.
A Congressional Budget Office report, “Reducing the Deficit: Spending and Revenue Options,” includes proposals lowering the contribution maximum for 401(k) and 457(b) plans and individual retirement accounts.
The CBO suggested lowering the annual contribution limit for 401(k) and similar defined contribution plans, now at $16,500 for participants under age 50, and up to $4,500 more for participants age 50 and older.
The CBO proposal would reduce contribution limits, regardless of a participant's age, to $14,850.
For IRAs, whose annual maximum contribution limit is $5,000 for those under 50 and $6,000 for those 50 and older, the proposal would place the limit at $4,500.
The idea would require all contributions to employer-based plans, including 457(b) plans to be subject to a single contribution limit.
In addition, the proposal would suspend the indexing of contributions for inflation, now done for all the plans and IRAs, for five years.
The proposals from the president's commission and CBO are based on a static income model and would harm participants as income rises, affecting their ability to contribute more to their defined contribution plans. Eliminating the catch-up contribution for participants age 50 or older would affect those nearing retirement who have fallen behind.
The moves would increase federal revenue steadily every year from 2012 through 2021, amounting to a cumulative $45.9 billion for the entire period, the CBO report said.
These proposals are attractive because they raise revenue without raising taxes.
President Barack Obama, at his news conference July 15, referred to the Simpson-Bowles commission's broad range of fiscal proposals in general, saying they are under consideration. He didn't refer specifically to the contribution cap.
At the same time some are calling for a decrease in retirement plan contributions, two bills in Congress, and a separate DOL proposal, seek to encourage more contributions by providing guidance for participants about their likely future retirement income from their plans.
Democratic Sens. Jeff Bingaman and Herb Kohl, and Republican Sen. Johnny Isakson introduced legislation designed to help ensure 401(k) participants don't outlive their retirement savings. Their Lifetime Income Disclosure Act, S 267, introduced Feb. 3, would require 401(k) plan sponsors to inform participants of the projected monthly income they could expect at retirement based on their current account balances, according to a joint statement by the senators. Their bill is pending in the Senate Committee on Health, Education, Labor and Pensions.
HR 677, also titled Lifetime Income Disclosure Act, introduced by Rep. Rush Holt, D-N.J., on Feb 11, is pending in the House Subcommittee on Health, Employment, Labor and Pensions.
It's a challenge to reconcile calls to limit contributions because they are too high with proposals to encourage contributions because they are too low.
Limiting the contribution ceiling will have no impact on bolstering the retirement security of those lower-level income earners, or expanding pension coverage.