The President’s Plan to Cap Retirement Saving Benefits

By :: 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.

11Comments

  1. Vivian Darkbloom  ::  5:01 pm on April 12th, 2013:

    Actually, the President’s budget proposal attacks retirement savings in excess of $3 million–in other words, the amount of the retirements savings, rather than the retirement benefits so your description is not very accurate. At $3 million in retirement savings, a $205,000 annual pension equates with a 6.5 percent withdrawal rate. As a former senior economist with the President’s Council of Economic Advisors, perhaps you could explain to me why the President’s proposal exempts himself from this proposal—his *defined benefit* pensions are certainly worth more than $205,000 per year in current dollars (or $3 million in defined contributions as the proposal stipulates) the minute he leaves office. It begins when he leaves office at age 55 and gives him about $200,000 per year in inflation-adjusted retirement benefits on top of his medical benefits and other defined benefits as Senator and State Congressman from Illinois. Do you actually think that the $205,000 cut-off which applies to defined contribution plans only is accidental? Why is this proposal limited to defined contributions rather than benefits? Why should the tax code punish savings?

    Is it reasonable to conclude that a $3 million retirement nest egg equates to a $205,000 annual pension at current interest rates?

  2. Christopher Green  ::  11:13 pm on April 12th, 2013:

    Although I do not like this proposal, it could be applied more broadly to make it possible to reduce pensions for public employees. If $205,000 per year is considered excessive for private individuals, why not apply the same standard to public employees? Currently, many public employees are able to get pensions far in excess of $205,000 a year. Reducing already promised pensions is fraught with legal difficulties even though it is bankrupting many states and municipalities. If the federal government were to impose a 100% tax rate on public employees pensions above $205,000 per year and return the revenue to the local governments paying the pensions, then the public employees could pay their “fair share” and prevent city bankruptcy and state defaults. This may be the only way out for states like California and Illinois.

  3. David Umlauf  ::  12:39 am on April 13th, 2013:

    I must disagree with Mr. Harris most vehemently regarding his opinion on the plan to cap retirement savings. It is yet another attempt by this administration to determine for private citizens what is a “reasonable” and appropriate amount of wealth or earnings, punishing frugality and ultimately diminishing the amount of private capital available for investment, diminishing people’s retirement security and, above all, diminishing people’s sense of independence from the federal government.

    Mr. Harris is naïve if he imagines that this will raise any actual revenue. For those of us who have either adequate means or, at least adequate financial sophistication will simply change our behaviors and/or the structure of our assets to avoid additional taxation. Young people, just starting out in the workforce will simply be discouraged from saving.

    This proposal is this generation’s AMT, designed to snare a few relatively rich people today, and ultimately snag, later on everyone who is simply enterprising or frugal.

    Make no mistake, Obama and his claque are less interested in the actual dollars collected than they are in quickening our drive on the road to serfdom.

  4. PC  ::  3:22 am on June 14th, 2013:

    Four issues with the President’s proposal.
    1. Regardless of the specific equity which triggers the cap, it is a frightening breach of the IRA contract to come along and change the terms of the IRA after the fact. Consider the case of people who have contributed to ROTH IRA’s, having made a larger up-front tax payment, in return for the promise that the equity is theirs to grow for retirement tax free. How can anyone justify changing their contract after those people have paid their share up-front, at higher front tax rates, in exchange for the promised no-tax terms of the ROTH IRA?
    2. Simple investment arithmetic shows the fallacy of the President’s cap: investment returns oscillate with years of gains and years of losses. Under the President’s proposal, a gain exceeding the cap is siphoned off through taxation. Then when a subsequent investment loss occurs on the equity left after taxation, the balance of the account will be reduced significantly below the prior balance. With some cycles of compounded years of gains and years of losses, the retirement equity in the account gets “destroyed” well below the cap, because gains and losses cannot receive equal tax treatment under the cap/tax plan. Hence the plan is an “account destroyer”.
    3. The plan dictates how much a person needs in retirement, without taking into account the gender difference for mean lifespan, so the plan forces women to budget a reduced retirement compared with men. Further, through marriage, a retirement account can apply to a single person or to a couple; and the plan can be transferred to apply to a surviving spouse who is a man, or a surviving spouse who is a woman. And the plan can need to take care of a long-lifespan, surviving offspring who in some cases cannot take care of himself. How can the government fairly dictate what is appropriate for all these circumstances which change with spouse and family situation over time?
    4. The sheer concept of government determining what is appropriate for a person’s retirement hopes and lifestyle is deeply offensive.

    Finally, it is offensive that some people cite partial justification that this tax would apply to only a small percentage of the population. This concept and tax is either fair or unfair; and if unfair, then it does not matter how small the number of people subjected to it.

  5. Michael Bindner  ::  5:13 pm on June 26th, 2013:

    The proposal is likely DOA in both houses of Congress.

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