Brookings proposal to cap 401(k) tax incentives draws fire from ASPPA

A Brookings Institution proposal to limit the retirement tax incentives for higher income individuals has drawn criticism from the American Society of Pension Professionals & Actuaries (ASPPA). The proposal was contained in a report, 15 Ways to Rethink the Federal Budget, which is part of the Hamilton Project, a Brookings initiative designed to come up with policy solutions to reduce the federal budget deficit.

One of the proposals put forward in the Brookings report would be to “cap the rate at which deductions and exclusions related to retirement saving reduce a taxpayer’s income tax liability at 28 percent.” This change would reduce the benefit associated with contributions to 401(k) plans, IRAs, and other qualified retirement plans for higher income taxpayers whose tax rate exceeds 28%. The proposal is expected to raise $7.5 billion per year.

According to the Brookings report, current savings incentives embedded in the tax code are “particularly poorly designed” when it comes to the goal of encouraging savings among low- and moderate-income households. The majority of such benefits go to upper-income households, said Brookings, “not only because they simply have more income to potentially save, but also because, on the margin, households in higher tax brackets achieve greater reductions in their tax liabilities for each tax-deductible dollar.”

“[S]tudies of households’ responses to retirement tax incentives,” said Brookings, “suggest that the (mostly high-income) individuals that do alter contributions in responses to changes in the return on these investments tend to simply offset these adjustments with changes in other forms of saving.”

Proposal amounts to double taxation, says ASPPA

Brian Graff, ASPPA CEO and Executive Director, was sharply critical of the Brookings proposal. “Because the tax incentive for retirement savings is a deferral, not a permanent exclusion,” Graff contended, “the proposal would more accurately be described as double taxation of contributions to retirement savings plans for anyone with a marginal tax rate of over 28%.”

“You won’t expand coverage by penalizing small business owners for offering a 401(k) plan,” said Graff. “Retirees already pay ordinary income tax on distributions from retirement savings plans. If this proposal went through, a small business owner in the 39.6% bracket would pay an 11.6% tax on contributions made to the 401(k) plan today, and pay tax again at the full rate when they retire.”

The Brookings report “acknowledges that individuals subject to this double taxation may decide to put their savings somewhere other than in the 401(k) plan,” said Graff. “What it fails to acknowledge is when that double-taxed person is a small business owner and it no longer makes sense for the owner to have a 401(k) plan, that owner probably won’t offer a 401(k) plan to the employees, either,” he concluded.

Source: Brookings, The Hamilton Project, “Proposal 6: Better Ways to Promote Saving Through the Tax System,” February 26, 2013; ASPPA press release, February 26, 2013.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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