House Democrats contemplate abolishing 401(k) tax breaks

Powerful House Democrats are eyeing proposals to overhaul the nation’s $3 trillion 401(k) system, including the elimination of most of the $80 billion in annual tax breaks that 401(k) investors receive.

House Education and Labor Committee Chairman George Miller, D-Calif., and Rep. Jim McDermott, D-Wash., chairman of the House Ways and Means Committee’s Subcommittee on Income Security and Family Support, are looking at redirecting those tax breaks to a new system of guaranteed retirement accounts to which all workers would be obliged to contribute.

A plan by Teresa Ghilarducci, professor of economic-policy analysis at The New School for Social Research in New York, contains elements that are being considered. She testified last week before Mr. Miller’s Education and Labor Committee on her proposal.

At that hearing, the director of the Congressional Budget Office, Peter Orszag, testified that some $2 trillion in retirement savings has been lost over the past 15 months.

Under Ms. Ghilarducci’s plan, all workers would receive a $600 annual inflation-adjusted subsidy from the U.S. government but would be required to invest 5% of their pay into a guaranteed retirement account administered by the Social Security Administration. The money in turn would be invested in special government bonds that would pay 3% a year, adjusted for inflation.

The current system of providing tax breaks on 401(k) contributions and earnings would be eliminated.

“I want to stop the federal subsidy of 401(k)s,” Ms. Ghilarducci said in an interview. “401(k)s can continue to exist, but they won’t have the benefit of the subsidy of the tax break.”

Under the current 401(k) system, investors are charged relatively high retail fees, Ms. Ghilarducci said.

“I want to spend our nation’s dollar for retirement security better. Everybody would now be covered” if the plan were adopted, Ms. Ghilarducci said.

She has been in contact with Mr. Miller and Mr. McDermott about her plan, and they are interested in pursuing it, she said.

“This [plan] certainly is intriguing,” said Mike DeCesare, press secretary for Mr. McDermott.

“That is part of the discussion,” he said.

While Mr. Miller stopped short of calling for Ms. Ghilarducci’s plan at the hearing last week, he was clearly against continuing tax breaks as they currently exist.

SAVINGS RATE

“The savings rate isn’t going up for the investment of $80 billion,” he said. “We have to start to think about … whether or not we want to continue to invest that $80 billion for a policy that’s not generating what we now say it should.”

“From where I sit that’s just crazy,” said John Belluardo, president of Stewardship Financial Services Inc. in Tarrytown, N.Y. “A lot of people contribute to their 401(k)s because of the match of the em-ployer,” he said.Mr. Belluardo’s firm does not manage assets directly.

Higher-income employers provide matching funds to employee plans so that they can qualify for tax benefits for their own defined contribution plans, he said.

“If the tax deferral goes away, the employers have no reason to do the matches, which primarily help people in the lower income brackets,” Mr. Belluardo said.

“This is a battle between liberalism and conservatism,” said Christopher Van Slyke, a partner in the La Jolla, Calif., advisory firm Trovena LLC, which manages $400 million. “People are afraid because their accounts are seeing some volatility, so Democrats will seize on the opportunity to attack a program where investors control their own destiny,” he said.

The Profit Sharing/ 401(k) Council of America in Chicago, which represents employers that sponsor defined contribution plans, is “staunchly committed to keeping the employee benefit system in American voluntary,” said Ed Ferrigno, vice president in the Washington office.

“Some of the tenor [of the hearing last week] that the entire system should be based on the activities of the markets in the last 90 days is not the way to judge the system,” he said.

No legislative proposals have been introduced and Congress is out of session until next year.

However, most political observers believe that Democrats are poised to gain seats in both the House and the Senate, so comments made by the mostly Democratic members who attended the hearing could be a harbinger of things to come.

ADVICE AT ISSUE

In addition to tax breaks for 401(k)s, the issue of allowing investment advisers to provide advice for 401(k) plans was also addressed at the hearing.

Rep. Robert Andrews, D-N.J., was critical of Department of Labor proposals made in August that would allow advisers to give individual advice if the advice was generated using a computer model.

Mr. Andrews characterized the proposals as “loopholes” and said that investment advice should not be given by advisers who have a direct interest in the sale of financial products.

The Pension Protection Act of 2006 contains provisions making it easier for investment advisers to give individualized counseling to 401(k) holders.

“In retrospect that doesn’t seem like such a good idea to me,” Mr. Andrews said. “This is an issue I think we have to revisit. I frankly think that the compromise we struck in 2006 is not terribly workable or wise,” he said.

Last Thursday, the Department of Labor hastily scheduled a public hearing on the issue in Washington for Oct. 21.

The agency does not frequently hold public hearings on its proposals.

E-mail Sara Hansard at [email protected].

Related Topics: Defined Contribution Plans, Taxes