President Donald Trump has stated that his tax reform and tax cut plan leaves 401(k) plans untouched, but that doesn't mean Congress will agree.
Whenever Congress starts to get serious about reforming taxes and balancing the budget, the tax concessions granted to retirement plans become a target.
When defined benefit plans were the predominant form of private-sector retirement saving, they were the targets, as when in the 1980s Congress limited the size of the annual benefit amount that could be paid from a tax-qualified pension plan.
Now, according to reports, with tax reform again being planned in Congress, and additional revenue needed to reduce the federal deficit, 401(k) plans have been discussed as a target.
Employers that sponsor 401(k) or other defined contribution plans, and unions representing workers covered by those plans, must rise up and nip this idea in the bud. The 401(k) retirement plan is for most employees the only way they can save significant amounts for retirement.
If Congress fiddles with the rules, it risks jeopardizing the retirement structure of the nation and harming the quality of life in retirement for millions.
One possible change being discussed in Washington, according to the reports, is reducing the dollar amount that can be contributed to a 401(k) on a tax-deferred basis each year. This would reduce the utility of the 401(k) plan to higher-paid employees.
Another idea is to remove the tax deferral from 401(k) contributions and make withdrawals after retirement tax free. This is similar to Australia, where contributions to defined contribution plans are taxed at a 15% rate but withdrawals after retirement are not. However, in Australia, companies are required to contribute to the plans, an amount that will soon increase to 12% of pay.
Given that the U.S. already has a retirement income shortage that some experts call a retirement income crisis and a Social Security system that also is in financial trouble, the last thing any government should want is to risk damaging the retirement income saving system. Unfortunately, many in government see the tax deferral of retirement savings only as a giant leakage of tax revenue. They do not see the contributions to retirement plans as contributions to the nation's savings, and hence to financing essential investment. Defined contribution plans provide fuel for investment through the capital markets.
In 2016, according to the Federal Reserve, corporate defined contribution plans added $393 billion to the nation's savings, with total assets of $5.742 trillion at the end of the year.
In the mid-1980s when Congress went after the retirement system for additional revenue, it harmed the system.
A 1986 law restricted the amount of the actual pension that could be accumulated on a tax-deferred basis by corporate top management. Top management was virtually cut out of the tax-deferred DB plan and lost interest in it. A 1987 law made DB plans more expensive and volatile when it restricted corporate funding to 150% of the accumulated benefit obligation on a termination basis and shortened the period over which liabilities had to be funded.
Both contributed to the demise of corporate defined benefit plans and to their replacement by defined contribution plans.
A restriction on the amount contributed to a defined contribution plan on a tax-deferred basis could hurt corporate top management's interest in sponsoring defined contribution plans, just as the 1986 law hurt sponsorship of defined benefit plans.
Likewise, replacing the tax deferral of annual contributions with tax-free withdrawal after retirement likely would harm retirement income accumulation. If companies were taxed on any contributions they made to DC plans, those contributions would likely cease.
If employees could not make their contributions to the DC plans on a tax-deferred basis, fewer would participate in the plans. The fact that the contributions are partly subsidized by the government is a great selling point to persuade employees, especially lower-income employees, to set aside money for the future.
Either reaction to changes in the rules for defined contribution plans would be dangerous for the economy in both the short run and the long run.
Anyone with an interest in the welfare of defined contribution plans, future retirees and the U.S. retirement system, must let Congress know loud and clear that DC plans are not a pot of gold waiting to be plundered, and that attempting to do so likely would bring about damaging unintended consequences.
The search for additional revenue must go in different directions.
