Oct 04, 2011

Deficit Reduction and Retirement Plans, How do They Relate?

Estimates prepared by the Joint Committee on Taxation rank employer provided retirement plans as one of the highest tax expenditures in the federal budget ($105.8 billion). In light of our current budget deficits, these retirement plans become attractive targets for a Congress searching for revenue. It is important to point out that unlike other tax deductions, qualified plan deductions are not “tax expenditures” but deferrals of taxation since retirement savings become taxable upon distribution. That said, in the tax reform debate just beginning, two proposals would affect the current system of retirement plans.

At the September 15, 2011 Senate Finance Committee hearing the Brookings Institution proposed eliminating the 401(k) tax deduction, which they says favors high-wage workers, and replacing it with a flat-rate tax credit that would put money directly into workers' retirement accounts. Under their system, neither employers nor employees contributions to a 401(k) plan would be tax-deductible. In addition, any employer contributions to a 401(k) plan would be treated as taxable income to the employee (just as current wages). All qualified employer and employee contributions would be eligible for a tax-credit, given to the employee, and deposited directly into the retirement savings account. The Brookings Institutions proposed a 30% credit (this being revenue neutral) or an 18% credit.

The National Commission on Fiscal Reform and Responsibility’s report issued in December or 2010 offered a proposal that would eliminate all retirement tax preferences. In addition, it would cap defined contributions at the lesser of $20,000 or 20% of pay. Note: for the last three years, the defined contribution cap has been $49,000 or 100% of pay.

An analysis of both these proposals by the Employee Benefit Research Institute (“EBRI”) has found that the highest-income worked would be most affected. But they also found that the lowest-income workers would be negatively affected and many workers reported they would reduce their contributions or stop saving in a company sponsored plan if the current system were ended. For those making under $50,000, the percentage of full-time workers currently saving for retirement who stated they would stop if they could not make a deduction ranged from a low of 32% (income $25,000-$35,000) to a high of 57% (income $15,000-$25,000). In research done by the American Society of Pension Professionals and Actuaries (“ASPPA”), 38% of all active participants in a 401(k) and Profit Sharing Plan make less that $50,000 and 35% make between $50,000 and $100,000. The participation rate is 21% for incomes of greater than $100,000 and under $200,000 and only 5% for those earning greater than $200,000.

Stay tuned, as it is still early in the process. We know from prior rounds of tax reform that retirement plans are easy targets. In 1993, the maximum amount of compensation considered in a retirement plan was $235,840. A year later, the IRS lowered the maximum plan compensation limit to $150,000. Note: For the last three years, the maximum plan compensation limit has been $245,000.

Miriam “Missy” G. Matrangola, Esquire, QPA, QKA is founder and president of Atlantic Pension Services, Inc., a third party administrator firm located in Chester County, Pennsylvania. Atlantic Pension Services is an independent, non-producing TPA firm excelling in retirement plan design and administration since 1992. Missy can be reached at