The President’s Plan to Cap Retirement Saving Benefits
By Ben Harris :: April 12th, 2013
The president’s FY 2014 Budget would limit tax benefits for workers with high-balance retirement saving accounts. Although critics call the plan a blow to workers’ retirement saving, I consider the plan a smart way to roll back the billions in tax breaks that go to investors who don’t need tax incentives to save for retirement. (As a recent senior economist with the President’s Council of Economic Advisers, my support for this provision might not come as a surprise, but note that I didn’t work on this proposal during my tenure at the White House.)
Under current law, annual defined-benefit distributions are limited to $205,000 per plan. The president’s proposal extends the limitation to defined-contribution accounts like 401(k)s and IRAs and recognizes that, unlike in the past, individuals may have multiple pensions. If the combined value of a worker’s retirement accounts exceeds the amount necessary to provide a $205,000 annuity, they can no longer receive tax benefits for retirement saving. As under current law, the maximum benefit level would be indexed to the cost-of-living and would be sensitive to interest rates, which determine the price of an annuity. This year, the cap would affect individuals with defined-contribution account balances exceeding about $3.4 million.
The absence of a cap on defined-contribution accounts allows some high-income workers to shield large amounts of saving from tax. A worker and his employer can contribute up to $51,000 each year to a workplace retirement account (a worker can contribute up to $17,500 on their own) and a worker without a retirement plan can generally contribute $5,500 annually to an IRA. Limits are higher for workers over age 50, and contributions can be made regardless of an account’s balance. The president’s plan would disallow new contributions if account balances exceed the limit, although balances could still grow tax-free.
One analysis estimated that the cap would apply to only one in a thousand current account holders aged 60 and older and would eventually affect just one in a hundred current workers later in their careers. While there are caveats with the analysis—the data are for 2011 and do not include defined-benefit pensions—the point remains that the proposal would affect few workers now or in the future.
Wouldn’t the president’s limit discourage saving? Probably not. Research has found that tax incentives for retirement saving have only miniscule impacts on overall net saving—contributions to retirement accounts mostly represent saving that would have happened anyway.
Besides, whether the president’s limit would reduce incentives to save is the wrong question. We should be asking whether it’s worth nearly $10 billion in tax breaks over the next decade—the amount of revenue this provision would save—to encourage wealthy, mostly elderly households to save perhaps a little bit more. The answer, especially for those who think the tax code is too riddled with tax expenditures, is that it’s not.