The limit would be the amount needed to buy an annuity that pays a retiree the maximum allowed under a defined benefit plan. That is now $205,000 a year, which would translate to a balance limit of $3.4 million for someone who is 62, according to the administration. The formula would factor in not just defined-contribution plans, like 401(k) and individual retirement accounts, but also defined-benefit plans, or pensions.
The $3.4 million threshold seems to be a fairly large number that would affect few people. It would also raise relatively little money in taxes, about $9 billion over 10 years. But it has caused consternation in the $17.9 trillionretirement world, in part because that limit may not be as high as it initially seemed and could end up affecting a lot more people.
Looking at the initial White House numbers, the Employee Benefit Research Institute said that extrapolating from its database of 24 million people with 401(k) accounts from 60,000 plans and 20.6 million I.R.A.’s, just 0.1 percent of those 60 or older at the end of 2011 had balances exceeding $3 million. (What is difficult is saying how many people are affected, because some have multiple retirement accounts.)
Those numbers rose when the institute projected the percentage of young workers, now between 26 and 35, who would be affected by age 65. Making assumptions about returns, inflation and job stability, up to 1.5 percent of workers would eventually hit the limit if it were $3 million calculated at 65.
When more realistic interest rates were used, those in late 2006, for example, it would have taken only $2.2 million to buy an annuity that would pay out $205,000 a year in retirement. This would increase the number of current 401(k) accounts affected to nearly 3 percent. For younger workers, at the 2006 interest rates, 5.2 percent would be affected by age 65. That is higher but still not an overwhelming number of people.
But the number potentially affected grew considerably when the institute looked at the fine print of the White House budget proposal, popularly known as the Green Book. There the Treasury Department said the amount needed to buy that annuity worth $205,000 a year at 62 would be calculated at the end of each year and apply to everyone’s contributions for the next year, regardless of age.
“For a taxpayer who is under age 62, the accumulated account balance would be converted to an annuity payable at 62, in the form of a 100 percent joint and survivor benefit using the actuarial assumptions that apply to converting between annuities and lump sums under defined benefit plans,” it said.
Translation, according to the institute: If you’re young and don’t have anywhere near millions socked away for retirement, you still could be hurt by the limit, and right away. Jack VanDerhei, research director at the institute, said the proposed limits could affect a lot more people because, simply put, the younger you are, the less money it takes to buy an annuity that would pay out $205,000 a year starting at age 62.
At current rates of 4 percent, which are historically low, a 31-year-old with $1 million in his retirement accounts would bump against the cap to buy that annuity. However, if the assumed rates (used to calculate the future value of an account today) were 6 percent, then a 33-year-old with $500,000 in her retirement accounts would hit the cap, meaning no more tax-deferred savings that year.
In an extreme case, a rate of 8 percent would mean a 25-year-old with $131,806 in a retirement account would hit the cap, though not many 25-year-olds have that kind of nest egg.
Under these assumptions, Mr. VanDerhei said that from 11.3 percent of accounts under current rates to 20.1 percent at an 8 percent rate could be affected. If defined-benefit plans were factored in, he said, the percentage affected would go even higher.
The picture that Mr. VanDerhei’s calculations paint from the Treasury explanations are far bleaker than the White House proposal made them seem. But who should be worried about these proposals and why?
First, it is important to note that these proposals probably will face stiff opposition. Any discussion of retirement savings that suggests “taking away tax-advantaged investing and capping investment amounts is detrimental to the system and society as a whole,” said Robert L. Reynolds, president and chief executive of Putnam Investments and one of the people considered responsible for popularizing the 401(k) plan.
“Right now elderly poverty is at an all-time high,” Mr. Reynolds said. “If that tells government anything, it’s we should do more to encourage saving for retirement.”
Those who support the cap on the tax deferral say that large retirement plans function like tax shelters, and they cite Mitt Romney’s multimillion-dollar retirement plan. Jared Bernstein, former economic adviser to Vice President Joseph R. Biden Jr., made the argument on his blog that without the tax deferral the wealthiest Americans would still save, so giving them a tax break was a wasted expenditure. But most Americans should be worried about not having enough money to retire comfortably, not a limit on the tax deductibility of their contributions.
According to a report published early this month by Deloitte Consulting, 401(k) balances hit a record high in 2012, with an average amount of $85,000. The report added that only 12 percent of the companies that sponsored 401(k) plans said they believed that their employees were financially ready for retirement.
BrightScope, a company that rates 401(k) plans, put the average balance lower, at $60,000. Brooks Herman, the company’s head of research, said that of the 58 million Americans with 401(k) plans he could only find a couple of hundred with balances over $3 million.
For small-business owners and their employees, the limit on retirement plans would present another concern. “If you’re a small-business owner and you have the ability to save but you know you’re going to be capped, are you going to provide the same benefit to all your employees?” Mr. Reynolds asked. “That may cause small-business owners to say, ‘I can’t do enough savings so I’m not going to have a plan.’ ”
To make matters more confusing, employees and their employers could contribute one year and then not for several years depending on many factors, like how the portfolio performed, the I.R.S.’s rate or cost of living adjustments. Mr. VanDerhei said he could imagine large companies and many medium-size ones having the human resource departments to figure this out, but he said many small businesses might be tempted to forgo setting up or continuing 401(k) plans.
Even if this proposal never comes to pass, many advisers were worried about the signal it was sending. Richard Scarpelli, co-head of advanced planning at UBS, said he had initially dismissed the proposal as irrelevant given its unlikelihood of passage until he saw how angry it made people, including his wife, a certified public accountant. Mr. Scarpelli said he was concerned that it was sending the wrong message about saving for retirement, particularly to a majority of people for whom the cap will never come into play.
Just floating a proposal like this is damaging to investors psychologically and a distraction from the bigger issues concerning retirement, said Tim Steffen, director of financial planning at Baird, a wealth management firm.
“Let’s be clear, $205,000 a year is a lot of money, and most people are not going to have it in retirement,” Mr. Steffen said. “But they’re asking, ‘Why is the government telling me what is the right amount I should have saved for retirement?’ ”
One fear is that this proposal is just the first step in changing the tax treatment of retirement savings across the board. Mark Luscombe, principal federal tax analyst at CCH, a publisher of research and software for tax lawyers and accountants, pointed to the Tax Reform Act of 1986, which instituted an excise tax of 15 percent on withdrawals that exceeded $112,500 a year. The tax was repealed in 1997, with lawmakers concluding it was unnecessary “and may also deter individuals from saving.”
Much the same argument is being made today.
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