Some want to boost the deferral limit – others want to do away with it
Retirement industry advocates sparred today in testimony before a congressional committee examining the tax treatment of defined-contribution plans
In particular, panelists at the hearing before the Senate Finance Committee clashed over the tax-deferred status of investments made in 401(k) plans.
“The purpose of the retirement income system is to promote an adequate retirement, not to promote tax sheltering through 401(k)s,” said participant William G. Gale, a co-director of the Urban-Brookings Tax Policy Center at the Brookings Institution.
Individuals can contribute up to $16,500 each year on a tax-deferred basis to a 401(k) and $5,000 to an individual retirement account, and employers can contribute up to $49,000 toward 401(k)s.
Mr. Gale pitched a proposal that would replace the current tax deferral for contributions with a flat-rate refundable credit deposited into the investor's account. He had two different versions of the proposal: one used a 30% matching contribution, which would be revenue neutral, while the other was an 18% matching rate, which would not harm those in the 15% income tax bracket.
But Judy Miller, chief actuary at the American Society of Pension Professionals and Actuaries, said that today's tax incentives are working well and noted that higher contribution limits would encourage participation. Current tax incentives transform what would have been a bonus to the employer into a savings contribution for the business owner and workers, she noted. Reducing the tax advantages of 401(k)s would discourage small-business owners from setting up a plan in the first place, Ms. Miller said.
She added that if less cash goes into 401(k)s now, less money will go toward taxes when retirees eventually make withdrawals, she added. “Retirement incentives are a deferral; the income is taxed at normal income rates when it's distributed,” Ms. Miller said. “Reduced contributions today mean less tax revenue tomorrow.”
Mr. Gale insisted, however, that higher-income individuals reap the biggest benefits from the tax treatment of 401(k)s. They make bigger contributions, he noted, and since they're in a higher tax bracket, they reduce the taxes they owe by a larger amount, compared with those who are in low- or middle-income brackets.
That argument resonated with panelist Karen Friedman, executive vice president and policy director of the Pension Rights Center.
“When you look at tax subsidies, ask yourself what they're doing,” Ms. Friedman said at the hearing. “The government is spending $123 billion to encourage employers to set up plans, and two-thirds of that goes toward the highest-paid employees, who don't need those incentives.”
Instead, Congress should weigh a proposal that would encourage low- to middle-income workers to save, she said.
The group called for a series of short-term reforms, including expanding the saver's credit so that lower wage earners receive it in the form of a check that can go into a retirement account. Longer-term reforms ought to aim for workers and employers to share responsibility for contributions, mandate universal coverage through a system that supplements Social Security and secure lifetime income for retirees, Ms. Friedman said.
The tax-deferred growth of retirement savings has been a hot topic of late, as the bipartisan deficit reduction commission searches for ways to plump up government coffers.
The commission has proposed capping retirement savings deferrals at $20,000 per person each year.
