Insight: "Cliff" deal's retirement plan revenue boost questioned
NEW YORK (Reuters) - One modest way that U.S. lawmakers were able to offset the impact of delaying spending cuts in the deal to avert the "fiscal cliff" was through a retirement plan provision that is supposed to raise $12.2 billion over 10 years.
The only problem is that some retirement and fiscal policy experts doubt whether enough people will take advantage of the provision, which allows workers to move their money from one kind of plan to another, for the government to be able to raise that much money.
And if it does, they argue it will only be robbing from future taxation revenue - which might even reduce the government's tax take over the long run.
"It's worse than fake," said Robert Greenstein, the founder and president of the left-leaning Washington think tank, the Center on Budget and Policy Priorities, in a blog post. "Every dollar of that $12 billion is revenue that the federal Treasury would have collected in subsequent decades. And, the resulting revenue loss in later decades will be substantially greater than $12 billion — probably several times that amount."
Alicia Munnell, director of the Center for Retirement Research at Boston College amplified that sentiment, saying, "It was simply a last-minute ploy to close a funding gap."
The change concerns the conversion of more traditional 401(k) retirement plans into the so-called Roth 401(k) plans, which were named after William Roth, a Republican senator, who was a relentless campaigner for lower taxes. He died in 2003.
Unlike mainstream 401(k) contributions, which are tax deferred until money is withdrawn, Roth contributions are taxed up front.
The estimate of an additional $12.2 billion in revenue hinges on the idea that there would be enough people willing to convert and pay taxes on the money they were moving over immediately (as well as on future contributions), rather than paying taxes on income from a traditional plan in retirement.
Among the people who would be tempted to convert are those who expect their tax rate to be higher in retirement, perhaps because of their income and asset mix or if they think tax rates are going to rise.
But some experts say they don't think enough people will benefit for the conversions to be numerous enough to raise that kind of money.
"I don't think it will raise those revenues in the long run, because I don't think it's going to deliver the benefit for individuals that people think it will deliver," said Jeffrey Levine, a certified public accountant and retirement specialist with Ed Slott and Company in Rockville Center, New York.
Suggestions that the provision would not deliver the estimated revenue were challenged by Don Stewart, spokesman for the Senate Minority Leader, Republican Mitch McConnell. The deal to avert the fiscal cliff deal was hashed out between McConnell and Vice President Joe Biden.
Stewart said in an email response to questions that he's "not sure what's a gimmick about people paying taxes now on money rolled over at today's rates vs. 20 or 30 years from now at whatever rates might be at that time...
"There was bipartisan agreement on this provision to give people more flexibility in their retirement planning," he said noting that the congressional Joint Committee on Taxation was the one that came up with the $12.2 billion estimate.
The JCT estimates that revenue from the change will slowly build from $293 million in 2013 to $1.72 billion in 2022. The JCT did not respond to inquiries.
The White House did not immediately respond to requests for comment on the allegation that the measure was a gimmick.
Certainly, it would only take a small portion of the people with $3 trillion in traditional 401(k) plans to switch money into a Roth 401(k) for the estimate to be reached. Judy Miller, director of retirement policy for the American Society of Pension Professionals & Actuaries, said that assuming an average tax rate of 25 percent only $48 billion would need to move - something she sees as very achievable.
Before this deal, workers could roll their traditional 401(k) plan money into a Roth 401(k) only if they changed jobs, retired, or reached age 59-1/2. The legislation to avert the fiscal cliff, the American Taxpayer Relief Act of 2012, permanently lifts those restrictions.
However, many employers don't offer Roth 401(k) plans and when they do many employees don't use them.
Of the roughly 7,000 retirement plans surveyed by Plansponsor Magazine, 48 percent offered Roth retirement plans in 2012, up from 38.2 percent in 2011. Participation in these plans remains extremely low, though. Another survey by the Plan Sponsor Council of America reports that 17.4 percent of participants made Roth contributions when they had the option.
"I expect more companies to offer the provision, but I don't expect many people to take advantage of it," says Robyn Credico, defined contribution practice leader at Towers Watson, an employee benefits consulting firm.
One reason for the low participation in Roth plans is the psychological pain of paying taxes earlier than is necessary. It doesn't usually make sense to do a conversion while someone is in their high-earning years.
"Roths are confusing, workers don't understand the consequences of them and if you are 25 and you are trying to guess tax rates 40 years from now, it's hard," Credico says.
Even if Roth conversions spike and more money flows to the U.S. Treasury, it does so at the expense of taxes expected down the road, when these people would be withdrawing from tax-deferred accounts in retirement. And because the only people likely to transfer to Roths are those who perceive it would save them money, it is even possible the change could become a long-term revenue loser.
The two groups that such a move could most clearly benefit would be wealthy taxpayers and younger taxpayers with a long time horizon to earn back in the Roth account, with its tax-free income for retirees, the taxes that conversion would initially incur, said Paul Gevertzman, a partner at accounting firm Anchin, Block & Anchin.
In the past, Gevertzman said, his clients who were in either or both of those groups and had the option to convert to a Roth account, rarely did so.
Investors with a large 401(k) account need a lot of cash to pay the tax bill for a Roth conversion, said John Sweeney, executive vice president at Fidelity Investments. In addition, the income from a conversion can kick you into a higher tax bracket that adds to your overall tax bill.
"You'll probably see people making conversions in increments, not one fell swoop," Sweeney added.
Although it is a short-term fix, this is not the first time Congress has used retirement account rule changes to help close a financial hole.
In 2006, Congress paid for an extension of low capital gains and dividend taxes in part by removing income limits that had precluded higher earners from converting assets in traditional individual retirement accounts (IRAs) to Roth IRAs; the hope was that it would spur conversions that would result in higher taxes.
An analysis from the congressional Joint Committee on Taxation at the time found that the benefits would be front-loaded, with the change raising $5 billion in its first four years, and then losing $9 billion over the following six years.
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