401(k) break at risk as policymakers mull retirement shift

WASHINGTON Tue Sep 13, 2011 8:13am EDT

The Capitol dome in Washington, August 2, 2011. REUTERS/Jonathan Ernst

The Capitol dome in Washington, August 2, 2011.

Credit: Reuters/Jonathan Ernst

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WASHINGTON (Reuters) - U.S. retirement programs could look different if a grand deficit-cutting bargain is struck in upcoming negotiations.

On Thursday, the powerful Senate Finance Committee will explore "Tax Reform Options: Promoting Retirement Security." Despite the sleepy title, the hearing will be one of the first outward signs of something that's been actively discussed privately all over this city in recent weeks and months: How to tweak retirement to make 401(k) plans more efficient, keep Social Security afloat and save some money for the federal Treasury.

Among the ideas being floated are a replacement of the 401(k) deduction with a tax credit that would offer bigger benefits to lower earners, changes in the withdrawal choices that workers face when they retire and a shift in the way Social Security benefits are calculated. That is on top of the increase in the retirement age that has been mentioned several times in recent months.

A variety of economic pressures and demographic trends have come together to put these new ideas on the table. There's also some disillusionment within the Obama Administration and among people with close ties to the administration with the way the 401(k) system is operating. The Social Security program is projected by its own trustees to exhaust its trust fund in 2036. The so-called "retirement deficit" - the difference between what Americans have saved for retirement and what they should have saved - has been put at $6.6 trillion by Boston College's Center for Retirement Research.

At the same time, Congress and the White House are under pressure to cut federal deficits. And prominent members of both political parties have talked up the idea of loophole-closing, rate-lowering tax reform.

Put all of that together, and it points to changes in the sprawling retirement system. "The kinds of points at which you can get fundamental changes adopted is in the midst of a big deal," says Dallas Salisbury, who has been watching retirement policy closely as head of the Employee Benefit Research Institute. "And President Obama wants a grand bargain."

Of course, it may be that no big deal gets struck and retirement plans remain unchanged between now and the 2012 election. In that case, expect some of these themes to continue surfacing after the heavy campaigning is done.

"Any time they are looking at spending and revenue over the next 40 or 50 year, these issues will be on the table," Salisbury predicts.


The tax break for defined contribution retirement plans will cost the Treasury $212.2 billion between 2010 and 2014, according to the Joint Tax Committee. But the vast amount of that benefit - as much as 80 percent - goes to the top 20 percent of earners, according to estimates from the Tax Policy Center, a nonpartisan, but liberal-leaning, think tank.

For example, a person in the 35 percent tax bracket saves $35 in taxes every time he puts $100 in his 401(k), for a net cost of $65. Someone in the 15 percent bracket pays $85, after tax, for the same $100 contribution. The Pension Rights Center, which has favored traditional defined benefit pensions and other programs aimed at lower-income retirees, advocates rolling back the current $16,500 annual 401(k) tax-deferred contribution limit to the $10,500 level it was at before the Bush tax cuts, its director, Karen Ferguson, has said.

One way to address both the cost and the disparity is to change the deduction into a credit. William Gale, of the Brookings Institution, will present a plan like that to the Senate committee on Thursday. His plan would eliminate the deduction entirely and replace it with a federal match that would be deposited directly into workers retirement accounts. A match of 30 percent would be revenue neutral, he says.

If lawmakers instead opted to approve an 18 percent match, it would leave low-bracket workers unharmed, but would raise $450 billion in tax revenues over 10 years.

Gale's proposal is significant because he has close ties to current and former Obama Administration officials. An earlier version of the Gale plan was coauthored by Peter Orzsag, who was President Obama's first budget director and who continues to editorialize in favor of killing the deduction.

But those proposals would leave higher-income workers with less incentive than they currently have to stash money into a tax-deferred retirement account. "Quantitatively speaking, these proposals would appear to reduce prospective retirement well-being," says EBRI's Salisbury. He's raised the idea - that he says dates back to the mid-1990's - of putting all tax-favored savings (for items like retirement and college) into a single account that gave savers more flexibility.


Mark Iwry, deputy assistant Treasury secretary for retirement and health policy, and another former Gale colleague, has voiced concern about the fact that workers may not be getting enough information about how much lifetime income their 401(k) account balances can support. And it's hard for individual retirees to understand how much they can afford to pull out of their tax-deferred accounts without running short in later years.

One approach to solve this would be a requirement that 401(k) sponsors put that kind of information in their statements. A bill proposed by a bipartisan group of senators led by Sen. Herb Kohl, chairman of the Senate Special Committee on Aging, would require that 401(k) statements show how much of an annuity the current account balance would provide.

A step beyond that would be the offering of more annuity and automated-withdrawal plans as alternatives to retiring workers who may believe their only option is to take the lump sum. That's an approach that, unsurprisingly, is favored by the insurance industry. But it also has fans in the Labor Department, which is currently working on some sort of policy encouragement for employers who give their workers flexible retirement income choices.


Though most officials repeatedly say they don't intend to "fix" Social Security by penalizing current retirees, several of the bipartisan, deficit-cutting proposals raised over the last two years have included a swipe at the cost-of-living adjustment that currently pegs benefits to the Consumer Price Index.

This "is one of the few ways to have current retirees contribute to restoring balance in the program," writes Alicia Munnell and William Hisey of the Center for Retirement Research in a new study.

But the most common proposal, which would switch the COLA from the CPI to a different (and slower-growing) measure called the "chained CPI" would set back retirees trying to keep up with the cost of elderly living by as much as 0.57 percent a year, the coauthors estimated. That's because the current CPI already understates the inflation rate that is actually experienced by retirees, and because the chained CPI would further understate that.

"Low-income elderly are not deciding whether to buy a watch or a bracelet," the two said. "They spend most of their income on essential amounts of necessities, like housing, food, health care and transportation."

Munnell and Hisey proposed a one-time delay in the inflation adjustment. That could help save the program money but also set all current beneficiaries back, but not to the same extent as an annual adjustment that understates inflation every year

Like all of the other retirement proposals floating around now, the COLA solution is a moving target. Workers and retirees should continue to watch that space.

(Editing by Lauren Young and Beth Gladstone)

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Comments (19)
JLWR wrote:
I am a baby boomer almost age 62. I have worked and paid taxes since age 19. I got my degree late in life (age52) since I had to pay for my education on my own having just a clerical job. So between paying all my school loans back over the eyars (which I did) I was not able to save for old age until I was 57 when I actually started making money with a good job. I plan to work to age 70 full time and possibly part time for a few years there after so I can pay my own way. But if our government plays around with SS and finds ways to deceive the public and reduce my bennefits (using the bogus CPI), then I am screwed. I cannot possibly work much longer than planned and that is conditional in that my health continues to be good. What are people like myself to do when after 51 years of working and paying taxes and paying back all my school loans, my government turns on me to reduce my SS income and leaves me with nothing but poverty to look forward to and all the while the criminals of Wall Street got mega rich and are running around scott free demanding more tax cuts and even less regulation. As I see it, they are stealing from the good hard workers/tax paying people and leaving us to rot in our old age. I sure did not nor would I have allowed that for my grandparents or parents, but today’s governance is quite a different breed. Today’s leaders are about themselves and getting re-elected. They are not capable of thinking independently but rather groupthink or follow the leader mentality. They only care about making more money, money, money and who they rip off is just a matter of who is most vulnerable or the weakest link. Now my bible tells me that pure religion is taking care of the poor, the weak, the aged, the orphan. So all these so called poltical leaders who claim to be religious are in essence the opposite of what they claim. You’ll know them by their deeds.

Sep 13, 2011 10:57am EDT  --  Report as abuse
snipelee wrote:
This is the camel’s nose under the tent. Soon, as with student loans, our 401k accounts will be “merged” into the elusive “Social Security Trust Fund” and then redistributed by government decree. High-earners will be credited with “less” contribution and low-earners with more. Of course, this will make the system more “fair”…

Sep 13, 2011 2:22pm EDT  --  Report as abuse
Curmdugeon10 wrote:
Yes, it is true that the top earners get the biggest tax break. But that is because half the earners DON’T PAY INCOME TAX at all. I’m sick of hearing that people who do not pay ANY FEDERAL INCOME tax need a check sent to them when someone in another bracket is eligible for a credit to reduce his/her taxes. It’s MADNESS.

Sep 13, 2011 2:53pm EDT  --  Report as abuse
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