Obama budget to cap retirement deductions

The retirement- and investment-related tax proposals in President Barak Obama's fiscal 2014 budget are bargaining chips in the administration's battle with Republicans, Washington insiders say.

As a result, they can't be discounted as dead on arrival, even though they are drawing criticism from the industries they target.

Perhaps the most striking proposal is a limit on tax-favored accumulation of all private retirement assets, including defined benefit and defined contribution plans. The budget would allow an annual benefit of $205,000 at age 62, resulting in a cap of $3.4 million at current interest rates.

While there were few additional details, the Office of Management and Budget estimates that the account cap would raise $9.3 billion over 10 years.

Derek B. Dorn, a partner in the Washington law firm of Davis & Harman who represents plan sponsors and service providers, cautioned against taking the ideas too lightly, since Mr. Obama gave up some ground on other fiscal issues such as growth in entitlement spending.

“The president stakes out some compromise positions, so we should take this proposal more seriously than past versions, which were often deemed dead on arrival,” said Mr. Dorn.

Mr. Obama's top economic adviser, Gene Sperling, agreed, saying in a press briefing that the budget package hits “a fiscal sweet spot” that shows the country is serious about dealing with its fiscal problems.

The president's proposed budget repeats many revenue-raising ideas familiar to professionals in the retirement and investment industries.

Still, the package unveiled April 10 followed through on the theme of limiting tax advantages for more affluent taxpayers. That was behind the call to reduce the value of tax deductions, including retirement contributions, to 28% of income.

ESOPs on the table

The budget proposal also eliminates the tax deduction for employee stock ownership plans, which drew some criticism.

“It's baffling to hear the administration preach about creating jobs and then take away a proven policy that sustains jobs,” J. Michael Keeling, president of the ESOP Association, Washington, said in a statement.

The White House budget also proposes giving the Pension Benefit Guaranty Corp. the authority to raise premiums to address its funding shortfall, a change that Director Joshua Gotbaum has pushed since joining the PBGC in 2010.

Another portion of the budget proposes a savings of $20 billion over 10 years by increasing the amount federal employees contribute to their pension plan, the Federal Employees Retirement System, Washington. People hired after 2012, who contribute 3.1% of pay, would contribute an additional 1.2% over three years. Federal employees hired before 2012 contribute 0.8%.

The budget also revives a proposal to eliminate the carried interest deduction paid by general partners in private equity and other partnerships. Carried interest, the president's proposal said, “creates an unfair and inefficient tax preference” for such partnerships, especially as that advantage has grown in recent years. Private equity lobbyists said they were not alarmed, given that the idea has become a perennial non-starter in Washington.

Recognizing a greatly expanded regulatory and enforcement workload that includes oversight of investment advisers at the Securities and Exchange Commission, the White House budget calls for adding 676 staff positions, an increase of 15%, for examinations, enforcement and risk-based oversight programs.

Calculating retirement income limits

Mr. Obama's $205,000 annual retirement income limit is calculated for someone age 62, to mirror the current IRS limit for qualified defined benefit plan annuities. Current law prevents anyone getting a benefit above that amount under a qualified defined benefit plan; benefits above that level are paid from non-qualified plans and are taxable. At today's interest rates, a $205,000 annual benefit (for 100% joint and survivor) works out to a maximum permitted accumulation of $3.4 million, the administration calculates.

But when the interest rates used to determine those annuity levels start rising, the $3.4 million cap can be much lower, and hit workers at an earlier age.

While the mechanics of adjusting for interest-rate changes would still need to be worked out, Mr. Sperling defended the idea of a formula capping retirement tax benefits. “Once you have an amount sufficient to retire at that number, you shouldn't get a tax break,” he told reporters.

But officials of organizations representing plan sponsors fear a monetary cap will chill the incentive for employers to offer such plans, especially small-business owners whose tax rates would also increase under other provisions of the budget proposal. “I'm worried about who will calculate the right amount you need, and that it lessens the interest in a qualified plan,” said Lynn Dudley, senior vice president of policy for the American Benefits Council in Washington.

There is also concern about how such a dollar-capped account would be administered.The new approach requires plan sponsors and IRA trustees to report each participant's account balance at the end of the year, and makes any excess contributions taxable as ordinary income. Investment earnings and cost-of-living increases would be excluded from the calculations.

“It would certainly add another layer of complexity on the part of the plan sponsor,” said Scott Macey, president and CEO of the ERISA Industry Committee in Washington. “There are all types of limits now. This is just an unnecessary burden. I'd hate to see us drive retirement policy on a few aberrational situations.”

Worry over PBGC authority

Defined benefit plan groups were also unhappy with the White House granting the PBGC the authority to set, and raise, premiums. Mr. Gotbaum said in an e-mailed statement that without the change, “PBGC will be faced with requesting a taxpayer bailout or shutting down.”

But Mr. Macey and others worry the change “puts too much discretionary authority” in the agency's hands.

Despite their initial alarm at the White House proposals, advocates for pension plan sponsors and service providers are confident that any public consideration of the ideas will calm things down. The $3.4 million cap, for example, “would have a hard time” gaining congressional approval, said Ms. Dudley.

For attendees at the Defined Contribution Institutional Investment Association's Washington meeting April 11, “the clear consensus of the experts we heard from was that the direct and unintended consequences of these proposals will take us in the wrong direction in meeting the public policy imperative we face of getting people to save more for retirement,” said Executive Director Lew Minsky.

Brian Graff, executive director and CEO of The American Society of Pension Professionals & Actuaries, Arlington, Va., agreed that the “outrageous” idea will lose steam under scrutiny. “I'm optimistic that members of Congress will see this as an attack on small business,” said Mr. Graff in an interview.

“From an administrative standpoint, it's a nightmare,” Ed Ferrigno, vice president of Washington affairs for the Plan Sponsor Council of America, said in an interview. “You don't want to pit plan sponsors against the participants. This is the philosophy of class warfare.”