Advisers worry about future of retirement savings incentives
Despite emerging unscathed from an initial review by a House committee, tax incentives for retirement savings could be…
Despite emerging unscathed from an initial review by a House committee, tax incentives for retirement savings could be curbed or eliminated as part of comprehensive tax reform and deficit reduction, worried investment advisers said last week.
Last Tuesday, Democrats and Republicans on the House Ways and Means Committee expressed support for provisions of the tax code that allow workers to put money into 401(k) and individual retirement accounts on a tax-deferred basis.
But the special treatment is under pressure as Congress takes the first small steps toward tax reform. The bipartisan mantra for reform is to lower rates and broaden the base.
Doing so likely would require slashing many popular tax deductions, credits and exemptions, along with the special tax breaks for retirement programs such as 401(k) plans and IRAs. Collectively known as tax expenditures, they have the effect of lowering federal tax revenue.
Robert Reynolds, chief executive of Putnam Investments, remains concerned that lawmakers don't understand that retirement savings programs create a tax deferral, not a tax exclusion.
“VERY GUARDED’
The distributions retirees eventually take will be taxed as ordinary income, though presumably at a lower rate.
“As long as you consider retirement savings a tax expenditure, which it is not, I'm very, very guarded,” Mr. Reynolds said. “You don't rest until tax reform is in place and the tax deferrals for retirement savings are protected.”
The latest threat comes from a tax reform plan offered in the budget written by Rep. Paul Ryan, R-Wis., that the House approved last month.
He would streamline the six tax brackets to two and lower the top rate to 25%, from 35%.
The proposal would require the elimination of many tax expenditures but doesn't identify which ones.
The retirement savings incentives are among the biggest in the tax code. Defined-contribution plans are expected to cost the government $375.9 billion and IRAs $86 billion over the next five years, according to the congressional Joint Committee on Taxation.
But last Tuesday, lawmakers on the tax-writing Ways and Means Committee appeared reluctant to jettison them.
“You do not have to eliminate all expenditures to get to that [25% top rate] level — not at all,” Chairman Dave Camp, R-Mich., told reporters after the hearing.
That doesn't assuage investment advisers.
“To say they won't [eliminate retirement savings incentives] is naive,” said Heidi Davis, a financial adviser at Columbia Financial Planning LLC.
“Just because it sounds as if it's gone for now doesn't mean it's gone for good,” she said. “It's an idea; it's a possibility.”
The tax breaks are crucial to encouraging their clients to save, advisers say.
Employer-sponsored DC plans hold about $4.5 trillion in assets, and IRA accounts total about $4.7 trillion in assets.
RETIREMENT CRISIS
“The country has a retirement crisis,” said Harry Armon, president of Arcap Partner LLC. “Without the incentive to save on taxes today, there's no impetus for people to put money into a retirement savings plan — and if they don't, they'll spend it.”
One of the most important parts of the current tax treatment of retirement savings is the provision that allows people over 50 to contribute up to $22,500 annually to a 401(k) plan — $5,500 more than the $17,000 limit for everyone else —and $6,000 annually to IRAs — $1,000 more than the $5,000 limit.
Ms. Davis said that the accelerated savings path is crucial to her clients, many of whom have spent most of their working lives raising children and putting them through college.
“Every client I have who's 50 needs to catch up,” she said.
The retirement tax breaks are much more important than other big tax expenditures such as the mortgage deductions, according to advisers, and they are urging Congress to leave those breaks alone.
“You can pick and choose,” said Frank Armstrong III, president and founder of Investor Solutions Inc.
“Taxes influence behavior,” he said. “Right now, we have to get people to save, not buy houses or other consumer goods.”
Even if Congress doesn't eliminate retirement savings tax deferrals, it might limit them as it looks for ways to pay for tax reform and reduce the burgeoning federal deficit. The presidential deficit commission in 2010 suggested capping retirement contributions at $20,000 or 20% of income, whichever is higher.
UNDERMINING INCENTIVES
That idea doesn't sit well with Mr. Reynolds, as he said it could undermine the incentive for small-business owners to set up DC plans.
Currently, the maximum 401(k) contribution per employee is $50,000, if an employer also contributes.
“I'm afraid that smaller companies would eliminate [the plans], rather than take on the cost,” Mr. Reynolds said.
The 20% ceiling hits low-income people, according to James Holtzman, an adviser at Legend Financial Advisors Inc.
“It's going to hurt the people who are working hardest to save,” he said. “It just doesn't make any sense.”
The ranking Democrat on the House Ways and Means Committee echoed advisers' concerns about retirement savings tax deferrals' being in the cross hairs of tax reform.
“My objection is that Republicans came out with a figure of 25% [top tax rate] without talking about the consequences of how to get there,” Rep. Sander Levin, D-Mich., told reporters last week after the hearing. “It undermines the notion that you can get rid of [tax] preferences without getting rid of important policy.”
Paul Auslander, chairman and chief executive of American Financial Advisors and president of the Financial Planning Association, summed up what many advisers think about nixing retirement savings deferrals.
“If it's not the stupidest thing that ever happened out of Washington, I can't think of one,” he said.
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