Don't monkey around with IRAs

Mar 9, 2014 @ 12:01 am

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The tax reform proposal put forward by Rep. Dave Camp, departing chairman of the House Ways and Means Committee, has many good features, but it has one really bad one: the proposal to eliminate tax-deductible

IRA contributions.

His proposal would leave workers not covered by a company-sponsored retirement plan with only the Roth individual retirement account as a way to save for retirement. The Roth IRA, of course, provides no immediate incentive to employees to postpone consumption to save for retirement, as the regular IRA does.

To be sure, the employee saving in a Roth IRA will pay no taxes on the money when it is withdrawn and spent in retirement, but a dollar spent today is far more enjoyable for most people than a dollar to be spent far in the future.

At the end of 2012, the latest year for which data are available, U.S. workers had salted away $164 billion in IRAs for retirement.

An old economic dictum says: When you tax something, you get less of it, and when you subsidize it, you get more of it. The tax-deductibility of contributions to regular IRAs acts as a subsidy — an incentive to save.

Removing that subsidy will reduce saving at a time when the U.S. savings rate, after increasing during the financial crisis and recession, has slipped to 4.3% of income. The country doesn't need another incentive not to save.

ECONOMIC GROWTH

During the 1970s, the savings rate was more than 12% much of the time, and even during the early 1980s, it reached double digits regularly. These savings fueled U.S. economic growth.

A lower savings rate will likely reduce future economic growth.

The elimination of the tax-deductibility of regular IRA contributions no doubt will discourage many workers from saving for retirement, meaning that they will be even more reliant on Social Security than many now are.

The Camp proposal is designed to increase revenue now to offset the negative effects on revenue of other changes in his tax reform proposals, such as reducing the number of tax brackets to just three and the reduction of the top tax rate to 35% (after a 10% surcharge).

FUTURE PRICE

But the price would be paid in the future as those with Roth IRAs — probably high earners — retired and took their money out tax-free, reducing income tax revenue. That part of Mr. Camp's tax reform proposal is shortsighted.

As he has acknowledged, his overall reform proposal is unlikely to move forward in an election year, and he is retiring at the end of this term. But his otherwise well-thought-out reform plan, scored as revenue-neutral and as stimulating economic growth by the Congressional Budget Office, might well serve as a starting point for anyone who picks up the tax reform baton in the next Congress.

Therefore, financial planners and investment advisers who guide those saving for retirement should let their representatives and senators know that messing with IRAs is a poor idea, and be prepared to fight against this or a similar proposal in the future.

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