Retirement savings tax incentives in danger post election

The odds of reduced tax incentives for retirement savings and further regulatory action on retirement issues increased significantly with the Nov. 6 federal election results.

The largely unchanged balance of power in the White House, Senate and House of Representatives as officials face pressing fiscal problems raises the likelihood of substantial changes and shared pain.

President Barack Obama's re-election also has retirement industry experts preparing for further action on the regulatory front. “With a second Obama administration, we have a pretty good sense of what the regulatory agenda is going to be,” said Bob Holcomb, head of legislative and regulatory affairs at J.P. Morgan Retirement Plan Services, Kansas City, Mo. The top item on that list is a reproposed fiduciary rule from the Department of Labor, followed by a proposed rule on lifetime income projections on plan participant statements.

Outside the regulatory arena, the first order of post-election business is dealing with the fiscal cliff created by expiring tax cuts, potential spending cuts and a federal deficit left unchecked by partisan squabbling. With no political party gaining a stronger mandate from the election, “the message to both sides is that there's got to be some middle ground here,” Barbara Novick, vice chairwoman and head of government relations for BlackRock (BLK) Inc. (BLK), said in a conference call. “We either go over the edge or we don't. Hopefully we don't.”

With a few short weeks left in the current congressional session, the expected scenario is that time-sensitive tax and spending issues are extended temporarily, leaving the real work for the 113th Congress to be seated in January.

Once deficit reduction and tax reform begin in earnest in the new year, the second largest federal tax expenditure — an estimated $105 billion for defined contribution and defined benefit pensions — will have nowhere to hide, and proposals offered by Mr. Obama and several study commissions to cap tax preferences for retirement contributions, especially for higher-income taxpayers, will get serious consideration.

“They obviously are going to be looking for tax revenue wherever possible, and further limits on retirement savings are likely to come up because it's such a big piece,” said Craig Rosenthal, a partner in Mercer's retirement risk and finance practice. This year's MAP-21 highway law, for example, breezed through Congress “because it was a revenue raiser” on two counts, Mr. Rosenthal said. The law allowed for fewer tax-deductible defined benefit pension contributions — so it left more corporate income as federally taxable — and it raised premiums paid to the Pension Benefit Guaranty Corp.

Defined contribution plans could be next. “From a retirement prism, the biggest question out there is, are we going to see all (tax) expenditures take a hit?” J.P. Morgan's Mr. Holcomb said.

Another possible scenario, Mr. Rosenthal said, is greater emphasis on Roth-type retirement plans, because taxes on contributions are paid up front. “They could call it a compromise, where there is more tax revenue upfront but there's still incentive for people to save for retirement. If it's instead of taking an outright cut, I think it's a reasonable compromise,” he said. “We are in the midst of a retirement crisis. It's much better to get something that gets people to save for retirement than nothing at all.”

Cathy Weatherford, president and CEO of the Insured Retirement Institute, Washington, thinks that the importance of encouraging retirement savings will not get lost in the tax debate. “Every policymaker is concerned about retirement security for their constituents. Tax deferment (of retirement contributions, where tax is paid at the time of distribution) is not a tax expenditure, and we've tried to make sure that's been known on the Hill,” she said. Hampering that argument is Congress' method of calculating or “scoring” the lost tax revenue of such tax preferences only with a 10-year time frame, which prevents the later tax collection from being counted toward the revenue score of a tax bill.

Ms. Weatherford also expects the administration to advance the idea of annuities within qualified plans to create lifetime income for retirees. “We have been working closely with DOL to reduce some of the regulatory hurdles to having annuities within qualified plans. We're going to continue to see priority given to that” regardless of whether there are personnel changes within the department, she said.

Plan executives and service providers also will be closely watching how Labor and Treasury department officials address ways to get participants to focus on lifetime income needs. With income projections on participant statements, “the only question is, are they going to mandate them, and how much flexibility is there going to be,” said Mr. Holcomb of J.P. Morgan.

Key administration backers of those ideas —J. Mark Iwry, deputy assistant Treasury secretary for retirement and health policy, and Phyllis C. Borzi, assistant secretary of labor in charge of the Employee Benefits Security Administration — are expected to stay in their posts to advance those ideas. Ms. Borzi has also made her agency's fiduciary rule a priority.

Regardless of those outcomes, “there is no appetite for mandates, even for auto IRAs,” said James Delaplane Jr., the Washington-based principal for government relations at Vanguard Group. In a Nov. 6 keynote address at Pensions & Investments 2012 West Coast Defined Contribution Conference in San Francisco, Mr. Delaplane added: “(You) are more likely to see state-level tax and entitlement changes.”

Key committees

Outside the executive branch, left unchanged by the elections were key congressional committees with jurisdiction over retirement issues. Senate Health, Education, Labor and Pensions Committee Chairman Tom Harkin, D-Iowa, vowed to push his idea of a universal private retirement system with professional money management. His House counterpart, Education and Workforce Committee Chairman John Kline, R-Minn., promises to keep a close watch on the PBGC and Department of Labor regulators for any moves that could drive up employer costs.

PBGC Director Joshua Gotbaum, whose five-year term will outlast Mr. Obama's, would like to shift more of the risks and costs of plan insurance to plans whose sponsors are more likely to get into financial trouble.

Most of the spotlight in the coming months will be on the budget and tax-writing committees. Republican vice presidential candidate Rep. Paul Ryan, R-Wis., is returning as chairman of the House Committee on the Budget, while Rep. Dave Camp, R-Mich., will continue to lead the Committee on Ways & Means and Sen. Max Baucus, D-Mont., will lead the Senate Committee on Finance.

One seat to watch is the Senate Budget Committee chair being vacated this year by Sen. Kent Conrad, D-Neb., whose replacement will be chosen by committee Democrats. Another notable change is the departure of Rep. Barney Frank, D-Mass., as House Financial Services Committee ranking member. Mr. Frank, who will retire at the end of the current term, leaves as his legacy the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Mr. Obama's re-election also means continued implementation of 90-plus regulations mandated by Dodd-Frank, including a common fiduciary standard for allinvestment advisers that is more stringent than the current suitability standard and is similar to one for registered advisers.

Personnel changes are expected at the Treasury Department, where Secretary Timothy Geithner already announced plans to leave. Federal Reserve Board Chairman Ben Bernanke doesn't have to decide on a new term until the current term ends in January 2014, “which means that a market-friendly Fed will continue to be in place,” Peter Hayes, head of BlackRock (BLK)'s municipal bonds group, said during a post-election conference call.Outside of retirement-specific tax changes, Mr. Obama's campaign promise of raising rates on higher-income taxpayers and plans to end the carried interest deduction for private equity general partners also will be back on the table.

George Michaels, CEO of G2 FinTech in Boston, a tax software provider for institutional investors, thinks revenue hunters could also find some money by ramping up enforcement of existing tax rules, including those covering securities transactions often used by hedge fund managers to lower their tax bills. “It's low-hanging fruit and it only really hurts rich people. It's an easy target for them to go after.”

Some of the fiscal compromises could even start in this year's lame duck session of Congress. With 12 senators and 70 House members leaving, “you've got a lot of people thinking about their legacy and what their last act might be,” noted Ms. Novick of BlackRock. “They have nothing to lose.”