Retirement plans at heart of Senate cliff agreement

Deal lifts restrictions on converting 401(k)s to Roth plans, which is a taxable event

Jan 1, 2013 @ 12:26 am

By Mark Schoeff Jr.

The Senate approved an agreement by an overwhelming bipartisan margin at 2:07 a.m. on New Year's Day that would avert the so-called fiscal cliff in part by encouraging investors to roll over 401(k) plans into Roth versions of those accounts.

After several days of negotiations between Senate Republicans and Democrats as well as the White House, the Senate passed the fiscal-cliff legislation, 89-8.

The Senate haggling, which included many stops and starts surrounded by political tension, concluded just before the midnight deadline on Jan. 1 when approximately $600 billion of mandatory tax increases and spending cuts go into effect.

With the country technically having gone over the so-called fiscal cliff, the focus shifts back to the House. That chamber will reconvene at noon on New Year's Day to consider the Senate measure.

“This shouldn't be the way we do things around here,” said Senate Minority Leader Mitch McConnell, R-Ky., who hammered out the Senate bill with Vice President Joe Biden. “But I think we can say we've done some good for this country.”

The retirement-savings provision was included as a way to help pay for a two-month delay in about $110 billion of domestic spending cuts slated to go into effect on Jan. 1. The offset also involved other spending cuts.

Currently, 401(k) plan participants can only roll their money into a Roth 401(k) after three qualifying events: changing jobs, retirement, or reaching age 59 and 1/2. But under the Senate plan, workers with 401(k)s, 403(b)s and similar defined contribution plans would be able to convert to a Roth 401(k) designated in their benefit plan at any time. Lawmakers believe that easing restrictions on the conversions will produce federal funds because participants must pay tax on the money when they put it into the plan. Disbursements paid during their retirement years are made tax-free.

“The conversion is a taxable event,” a Senate Republican aide wrote in an email. “Because of the significant tax benefits of Roth plans, many people are expected to choose to convert their plans to Roth plans. This choice results in new tax revenue today and a significant tax break in the future.”

It would permanently extend Bush administration tax cuts for households making less than $450,000 annually, according to a Senate GOP aide. That level is higher than the $250,000 threshold that President Barack Obama had been advocating.

Other elements of the agreement include a permanent capital gains and dividend rate of 20% for households making more than $450,000 and 15% for those below that level; a permanent extension of the alternative minimum tax exemption; and an estate tax rate of 40% with a $5 million individual exemption.

Estates were taxed at a 35% rate with a $5 million exemption in 2012 and were to reset at a 55% rate with a $1 million exemption as of Jan. 1, if the Bush tax cuts expired. The measure also extended unemployment benefits for the long-term jobless for a year and ended the 2% reduction in the payroll tax.

Details of the agreement have not officially been released. Legislative language was still being written at midnight, and the cost of the measure had yet to be calculated by the Congressional Budget Office.

Sen. Charles Schumer, D-N.Y., said that there was “virtual unanimity” among Senate Democrats to vote for the deal, even though there were many objections to individual provisions.

“You're going to see a strong Democratic vote for this proposal,” Mr. Schumer said after emerging from a Senate Democratic caucus meeting with Mr. Biden. “It's a lot better than going over the cliff.”

Most Senate Republicans also line up behind the proposal.

House Speaker John Boehner, R-Ohio, and other House leaders promised that that chamber would take up the Senate bill. It reconvenes at noon on Jan. 1.

“Decisions about whether the House will seek to accept or promptly amend the measure will not be made until House members -- and the American people -- have been able to review the legislation,” they said in a statement.

Investment advisers had a positive initial reaction to the Senate package.

“It seems that both sides made some pretty significant concessions,” said Tim Steffen, senior vice president and director of financial planning at Robert W. Baird & Co. “They'll be creating another layer of tax rates on top of the system that's already in place.”

Kenneth Klabunde, vice president of City Securities Corp., is happy that the threshold for the snap-back to the pre-Bush tax rates was increased from $250,000 in household income to $450,000. High earners will see their marginal rates increase from the current 35% to 39.6%.

“At 450, it doesn't have nearly as big an effect on my client base,” Mr. Klabunde said. “I view my clients as upper middle class. It strikes me as being balanced.”

He also endorses the estate tax exemption.

“Any estate planner would be thrilled with the $5-million exemption being locked in, regardless of what the tax rate is,” Mr. Klabunde said.

The increase from the current 15% capital gains and dividend rates to 20% sits well, too.

“I'm not disappointed,” Mr. Klabunde said. “I don't see that as a [problem] to go back to a rate we previously thought was reasonable.”

As the Senate scrambled to vote Tuesday morning, the agreement remained mostly a mystery.

The opaque nature of the legislative process frustrates Mr. Steffen. It's not clear, for instance, how many levels of capital gains taxes there will be or whether the $450,000 trigger is calculated based on taxable income or adjusted gross income.

“The devil's in the details,” Mr. Steffen said.

But, like Mr. Schumer, he's happy there's an agreement.

“The best thing is that we know what we're dealing with,” Mr. Steffen said. “It's better than having nothing happen, which would have been bad for everyone.”


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