Tax reform continues to be a hot topic. Last year, the focus was on going over the “fiscal cliff,” while earlier this year the term “sequester” dominated the headlines. As the debate over the deficit and federal budget rages on in Washington, politicians continue to look for creative solutions, including cuts to tax incentives for the $3.5 trillion that Americans hold in their 401(k) retirement accounts. This could mean far-reaching and widespread reform, causing a strain on small business owners and ultimately affecting employees’ retirement plans.
As the economy remains uncertain, the administration’s first budget proposal announced on April 10 proposes significant changes to the current tax rules, which could adversely impact how we save for retirement. These changes include a limit on the tax benefit certain employees receive when they contribute to a 401(k) plan, and a cap on how much they can accumulate in retirement plans and IRAs. The first limit directly impacts tax deductibility, which could likely leave many middle- to high-income families in a situation where their 401(k) contribution is no longer fully tax deductible. Critics have been quick to point out that this would result in “double-dip taxing” for Americans in the 28 percent tax bracket or higher – taxation on at least a portion of their contribution going into their 401(k) account and taxation again as it comes out in retirement.
While supporters of these reforms maintain that they target only the wealthy and would therefore only directly impact a miniscule percentage of the American population, they could have far-reaching and unintended consequences for the rest of us, especially since Social Security is going through changes of its own. Since many of the country’s small business owners fall above the 28 percent tax bracket that would be impacted by these changes, and these same individuals may hit the proposed $3 million cap on retirement plan assets as well, one potential outcome is that they may reconsider the need to sponsor a retirement plan at all. If business owners no longer receive the same tax benefits for their own retirement plans, it is less likely that they will sponsor plans for their employees, as the cost and complexities associated with offering 401(k) plans makes it difficult for employers to support them while still turning a profit.
Social Security benefits remain in jeopardy with this proposal as well, with benefits expected to grow more slowly as a result of the administration’s proposed Chained Consumer Price Index. As this program and employee-sponsored plans are under fire, individual savings will be more important for retirement planning than ever before. However, without the convenience of payroll deduction and the benefit of any potential employer contributions that often come with 401(k) plans, it is safe to assume that many workers will elect not to save for retirement on their own.
If It’s Not Broken, Don’t Fix It
The current 401(k) plan structure may have its flaws, but it is far from broken. Data from the Employee Benefit Research Institute (EBRI) suggests that more than 70 percent of workers who earn between $30,000 and $50,000 annually participate in their employer’s 401(k) plan, while only five percent save for retirement without the benefit of an employer-sponsored plan. Although pending changes in the 401(k) structure would not affect workers in this salary range, it could impact their employers, which may put employees’ availability to a company sponsored plan in danger by proxy. Rather than taking away benefits for business owners who support employee plans, making it less likely they will sponsor these plans in the future, we should be trying to incentivize people at all income levels to save more.
As the future of 401(k) plans and the Social Security program remains up in the air, the responsibility for saving for retirement will continue to fall directly on the shoulders of American taxpayers. Based on EBRI data, we know that if it were not for access to the convenience of saving through their employers’ plans, people would not save much of anything, like their counterparts who don’t have an employer-provided plan. The government should do everything in its power to support retirement savings for employees, which means supporting retirement savings for their employers, especially as Social Security benefits are shrinking. Our federal budget is not the only one to fall upon hard times recently. Making changes that could place the 401(k) plan in jeopardy for business owners and their employees is not progress.
Sean McGarry is the director of retirement plan services at Rockland Trust.
