While the 979-page document introduced by U.S. House Ways and Means Committee Chairman Dave Camp (R-Michigan) does not include taxation of retirement contribution amounts and benefits caps President Obama suggested in earlier budget proposals, there are similar or new provisions industry groups say will result in double taxation and discouraging retirement plan benefit offerings.
Under current law, the limits on contributions to qualified retirement plans are indexed for inflation. The Camp proposal would freeze these increases in the contribution limits for 10 years. Therefore, individual elective deferrals to qualified retirement plans would be capped at $17,500 (or $23,000 for individuals eligible to make catch-up contributions) for the next decade. This provision would raise more than $63 billion in the next 10 years to pay for tax reform, according to an analysis by the Association of Pension Professionals & Actuaries’ (ASPPA) Congressional Affairs Manager Andrew Remo.
The Camp proposal would subject all elective deferrals into qualified retirement plans above 50% of statutory limits ($8,750, or $11,500 for individuals eligible to make catch-up contributions) to Roth tax treatment—taxing them up front, rather than upon distribution. In addition, the proposal would require all employers with more than 100 employees to amend their plan documents to allow employees to make Roth contributions (if Roth contributions are not already permitted). Encouraging Roth savings accelerates the revenue flowing into government coffers in the short term, raising $143.7 billion over the next 10 years to pay for tax reform, Remo says.
Camp’s proposal would place a 25% cap on the rate at which deductions and exclusions (including those relating to retirement savings) reduce a taxpayer’s income tax liability. This is similar to a provision included in President Obama’s past budget proposals (see “Savings Cap Could Affect up to 5% of Participants”). Should this proposal become law, it would subject individuals in the new 35% tax bracket to a 10% surtax on all contributions made to a qualified retirement plan—that is, both employer and employee contributions. (Obama’s proposed cap did not apply to employer contributions.)
“The result of the 10% surtax is double taxation of plan contributions. It totally ignores the fact that these contributions are tax deferrals, not a permanent exclusion, and will be subject to ordinary income tax when they are withdrawn after retirement,” says Brian Graff, ASPPA’s executive director and CEO, in a statement. “Should this proposal become law, a small business owner could pay a 10% surtax on all contributions made to a qualified retirement plan today, then pay tax again at the full ordinary income tax rate when they retire.”
Graff adds: “Penalizing small business owners for contributing to a plan is going to make them think twice about sponsoring a plan at all, and their employees could lose their workplace retirement plan as a result. Double taxation is hardly what we hoped to see in any tax reform proposal.”
Graff also expresses concern about the impact of the proposed freeze on contribution limits until 2023. “After all, the cost of living in retirement is not going to be frozen,” he points out. “On top of the double taxation mistake, this is a real blow to employer-sponsored retirement plans, and to American workers’ retirement security.”
Graff says ASPPA is very disappointed to see these provisions, and would have accepted the proposal if the reduction to retirement savings tax incentives was limited to requiring 401(k) contributions above 50% of the contribution limit to be Roth only. “Unfortunately, that is not the case, and we must strongly oppose this tax reform proposal given its negative impact on American workers’ retirement security,” he concludes.
The Plan Sponsor Council of America (PSCA) also issued a statement saying several provisions in Chairman Camp’s proposal will diminish the retirement savings opportunities for working Americans. “The requirement that employee contributions above a certain amount to a 401(k) or similar plan be made on a Roth basis will add complexity and increase administrative costs,” the council notes.
In addition, it expresses concern that rules that limit top earners’, often small business owners, ability to claim a full deferral for contributions made to their savings account will reduce the willingness to offer a plan to their employees, and the repeal of the small employer pension plan startup credit removes a valuable incentive to owners considering establishing a plan for their workers.
“Additionally, eliminating inflation adjustments for contribution limits for ten years provides another reason for a business owner to decide against offering a plan. Many workers will also be affected by the limit freezes,” ASPPA continues.
The Camp tax reform proposal also makes changes in other areas, according to Remo’s analysis, including elimination of new Simplified Employee Pensions (SEPs) and Savings Incentive Match Plan for Employees (SIMPLE) 401(k) plans going forward—existing SEPS and SIMPLE 401(k)s could continue to exist, modification of retirement plan distribution rules, and changes in the rules governing individual retirement accounts (IRAs) to encourage Roth savings and combat leakage.
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