Obama's Budget Proposal Would Cap Retirement Accounts

By Stephen Miller, CEBS Apr 11, 2013

President Barack Obama's proposed federal budgetfor fiscal year 2014, released on April 10, would cap tax-advantaged retirement savings for individuals at roughly $3.4 million next year. The White House estimates that the limit on tax-preferred accounts would generate $9 billion over 10 years.

The administration seeks to limit the deduction or exclusion for contributions to 401(k) and 403(b)-type defined contribution plans, defined benefit pension plans and individual retirement accounts (IRAs) for an individual who has total balances or accrued benefits under those plans that are sufficient to provide an annual income of $205,000—the current annual maximum payout allowed for defined benefit plans—payable through an annuity commencing at age 62. At current interest rates, about $3.4 million would be needed to purchase such an annuity. The proposal would be effective for taxable years beginning after Dec. 31, 2013.

A Fluctuating Cap

The retirement plan savings cap and the annual retirement-income threshold to which it's tied would fluctuate over time based on interest rates and inflation.

According toa new analysis from the nonprofit Employee Benefit Research Institute (EBRI), just under one percent (0.9 percent) of those with 401(k) account balances at year-end 2011 would be affected by a $3 million cap, adjusted for inflation, by the time account holders reach age 65, assuming no change in asset allocation over their future career, real returns of 6 percent on equity (stock) investments, 3 percent returns on nonequity investments and 1 percent real wage growth. In addition, 1.2 percent of those currently ages 26 to 35 would be affected by an adjusted $3 million cap by the time they reach age 65.

Interest rates have been kept at historic lows in recent years as part of the U.S. Treasury's monetary policy aimed at stimulating the economy. If interest rates rise back to their 2006 level, the limit on tax-preferred savings tied to the purchase of an annuity producing $205,000 annually could fall as low as $2.2 million. At that level, EBRI projects that nearly 3 percent of 401(k) accounts would be affected. A higher interest rate environment would result in an even lower savings cap. Complicating future estimates, however, would be a likely inflation-adjusted increase in the $205,000 maximum payout.

Fairness Issues Raised

Inremarks introducing his budget, President Obama did not specifically mentioned the retirement savings cap but noted, "These measures will only become law if congressional Republicans agree to meet me in the middle by eliminating special tax breaks and loopholes so millionaires and billionaires do their fair share to cut the deficit."

However, some critics of the cap argued that small business owners and employees would be disproportionately affected.

“If a small business owner has saved $3 million in his or her 401(k) account, they won’t be allowed to save any more—and will have to pull out and pay tax on any balance over that amount,” said Brian Graff, CEO and executive director of the American Society of Pension Professionals and Actuaries (ASPPA), in a released statement. “Without any further incentive to keep the plan, many small business owners will now either shut down the plan or reduce contributions for workers. This means that small business employees will now lose out not only on the opportunity to save at work, but also on contributions the owner would have made on the employee’s behalf to pass nondiscrimination rules.”

Graff added that “small business can’t use the nonqualified deferred compensation arrangements that provide millions, even billions of dollars in retirement benefits to big corporate executives.”

Similarly, the proposal was called “short-sighted and “confusing” in a statementby Scott Macey, president and CEO of the ERISA Industry Committee (ERIC), representing large employers. “The burden of calculating whether a participant exceeds the $3 million cap would only add an additional layer of complexity in retirement planning and would unfairly burden participants, as well as plan sponsors,” Macey said.

He added, “Policymakers should keep in mind that most monies saved in retirement accounts are tax deferrals, and will eventually be subject to taxation. There are also complex rules which limit the amount that highly compensated workers can contribute to retirement plans, as well as detailed rules that assure comparable treatment of all participants in plans.

According to the Society for Human Resource Management's2013 Guide to Public Policy Issues,SHRM believes “tax incentives should be used to expand retirement savings. Provisions that encourage savings, such as increased contribution limits and catch-up contributions for older workers, are beneficial.”

The Coalition to Protect Retirement, which represents retirement plan sponsors, said, “It’s harder to reach the amount needed for a comfortable retirement when tax-deferred contributions are limited by law." The coalition advocates that Congress "Keep contribution limits high, encouraging maximum savings and helping individuals create a larger retirement nest egg, faster.”

Stephen Miller, CEBS, is an online editor/manager for SHRM.​

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