President Barack Obama again proposes a limit on the value of all tax deductions, defined contribution exclusions and individual retirement account (IRA) deductions to 28% of income. The budget also proposes an overall cap of the amount that could be held in tax-deferred accounts, of $3.4 million, an amount that would theoretically provide an annual retirement income of $205,000 using a formula based on current interest rates. The amount could be lowered if interest rates rise.
Alicia Munnell, director of the Center for Retirement Research at Boston College, doesn’t like the idea of the cap. “I think it’s cumbersome,” Munnell tells PLANADVISER. “If it’s capped at an amount that would provide some income, it’s such a negative signal,” she says.
Suggesting that there should be a limit on retirement savings is counterproductive, Munnell feels. The goal of avoiding disproportionate savings for those with higher incomes is worthy, but capping is not the way to achieve that.
“We already have limits on the amount that can go in every year,” points out Judy Miller, director of Retirement Policy at the American Society of Pension Professionals and Actuaries (ASPPA). “To have limits on the amount your investments can earn is just wrong.”
These limits unfairly penalize people who invest well, Miller tells PLANADVISER. She expresses concern that if you remove the incentive for small-business owners it could result in some plans being shut down and people losing coverage.
A key point, Miller says, is that the tax incentive for retirement is a deferral: it is a one-year event, she emphasizes. “When you have the 28% tax, you’re taxing those things twice,” she says. “That’s just unfair. It’s horrible tax policy.”
An Upside-Down Benefit?
When Democrats talk about an upside-down tax benefit, Miller says, it is particularly frustrating to examine the limits on contributions and benefits, and see that it is more progressive than the progressive tax rate. “The retirement benefit is actually allocated more favorably to people with incomes under $50,000,” she says.
Retirement savings is not top heavy, Miller feels. Capital gains, on the other hand, is an upside-down tax benefit, which disproportionately benefits a very small percentage of the population. According to Miller, a scant 2% of the population receives 85% of the capital gains tax preference.
Munnell says she is sympathetic to the idea of an upside-down system in need of reform, but she says a credit would be more effective than a deduction, and could work as an incentive. “If you gave both rich and poor a credit of 25% they would each get the same incentive per dollar, and richer people would get more,” she says. “The credit would get rid of the more-per-dollar distortion.”
The budget also eliminates using the “chained CPI (Consumer Price Index), created by the Bureau of Labor Statistics as an alternative consumer price index. Using the chained CPI would reduce the rate of cost of living increases for Social Security.
Taking the chained CPI out of the budget is positive, Munnell feels. “Social Security needs to be fixed, and people interested in fixing it should propose a comprehensive package,” she says. “To toss out a less-than-palatable option by itself doesn’t seem very constructive.”
ASPPA disapproved of the limits on contributions in last year’s budget, and, Miller says, there is no reason for the organization to change its opinion now.