In addition to limiting itemized deductions for higher income taxpayers, President Obama’s recent budget proposal also includes a cap on the amount that individuals can accumulate for retirement on a tax-deferred basis. For years, taxpayers have been advised to save as much as possible for retirement in 401(k)s and IRAs. The President’s proposal limits the tax-deferred nature of these plans.
The President wants to limit the tax advantage of all retirement plans to the amount needed to buy an annuity of $205,000/year. Under current interest rate and inflation assumptions, this amount is about $3.4 million. See Blake Ellis, Obama: Limit retirement tax breaks for the rich, CNNMoney, April 10, 2013. The proposal combines pensions, 401(k) plans, and IRAs – all forms of retirement savings accounts – in reaching this cap.
While $205,000 is a very nice income for a retiree, why should the President dictate the standard of living for anyone in retirement? Why should $205,000 be the maximum income that people can accrue through tax-deferred savings? What is his philosophical underpinning for this amount, beyond the President’s frequent theme of “the rich have too much”?
“The whole thrust of this recommendation goes against the grain of becoming self-sufficient, taking care of your own finances rather than depending on handouts.”
The intent of President Obama’s cap on tax-deferred retirement plan savings is clearly to bring more money into the tax system sooner rather than later – and, like many of his proposals, his proposal is aimed at the top 1% of wage earners.
One consequence of President Obama’s proposal may be for employers to reduce their support for retirement savings of any type. An April 14, 2013, editorial in Investment News, titled Limiting 401(k) tax advantage is unwise, explains the problem. Defined benefit plans (pensions) decreased each time Congress capped the maximum salary on which employers could make tax-exempt pension contributions. Each reduction led to more defined benefit plans being terminated, and accelerated the move to defined contribution 401(k) plans. Now, 401(k)s will be limited, too.
Moreover, depending on the returns in 401(k) plans over time and the assumptions made about what an inflation-adjusted annuity of $205,000 would cost, the savings cap in the President’s proposal could be as low as $2.2 million. At that level, 6% of young workers could be cut back in their retirement savings before they turn 65. If interest rates increase – which they are likely to do over time – even more young employees could see their ability to save for retirement on a tax-deferred basis limited.
For more analysis, see Could Obama’s Plan To Curb The Boss’ Tax Breaks Hurt Workers’ Retirements?, by Janet Novack, in Forbes, on April 10, 2013, or the Wall Street Journal editorial on April 12, 2013, Now He’s After Your 401(k).
Employers and HR executives should watch the development of the President’s proposal carefully, to determine what the impact is on employees at all levels of their organization.
President Obama isn’t the first politician to advocate limiting tax deferrals on retirement savings. But combined with his other attacks on wealthy Americans, he appears dead set on reducing what top earners can save in any way he can – by taxing more of their income now, and by limiting tax-deferred savings in the future.
I am not entirely opposed to increasing taxes on the top earners, nor even on the middle class. But before we increase taxes further, I think it is important to ask ourselves how much taxation is too much. President Obama has never answered that question. I can’t tell if he has even asked it of himself or his advisors. All he talks about is wanting more from the top 1%.
The President’s answer to how much is too much taxation might define the philosophical difference I have with him and his supporters.
How much do you think is the maximum that the government should take of anyone’s income? Should the government set limits on tax-deferred retirement savings?