Remember the proposal by Professor Teresa Ghilarducci? She wanted to repeal employer-provided defined contribution plans and instead have the government make annual $600 contributions to a government-run retirement account maintained for workers. Well, guess what? There is a new idea from some other nutty professor types that is getting some attention on Capitol Hill. And yes, this one would completely undermine 401(k) plans as well.
It’s actually not a new proposal. It was first released in 2006 by the Brookings Institution, a liberal think tank. The authors of the proposal are William Gale, a Brookings economist, Jonathan Gruber, an economics professor at MIT, and Peter Orszag, who was a Brookings Economist at the time but then became President Obama’s Director of OMB before leaving to go to Citibank. The proposal is going to be presented at a Congressional briefing sponsored by the Senate Aging Committee on September 9. The full proposal can be found here.
So what is it? In a nutshell, the proposal would completely eliminate the deduction for employee contributions to any defined contribution plan and any employer contributions to such plans would be current taxable income to the employee (and subject to FICA tax as well). The tax revenue generated from this would be used to fund a new government matching program for qualifying savings. Employee and employer contributions to a DC plan (and individual contributions to an IRA) would qualify for a 30 percent government matching contribution, which would be contributed to the employee’s account (or IRA). (The details for how this would happen are conveniently not disclosed.)
The government matching contribution, however, would be limited. Specifically, the matching contribution would only apply to annual contributions up to the lesser of $20,000 ($5,000 in the case of an IRA) or 10 percent of adjusted gross income (as opposed to pay although for most workers the numbers will be very close).
The proposal is surprisingly unclear on the taxation of distributions. But, it appears that investment earnings would be subject to tax on distribution. Further, a footnote in the paper bizarrely states that the taxation of the government match when distributed “would need to be decided.” However, the proposal would provide that the default distribution for amounts relating to the government match would be an annuity. By the way, all of the current law nondiscrimination tests (e.g., ADP tests) continue to apply.
So what would happen? The net effect of this proposal is very similar to the President’s Deficit Commission proposal to cap defined contributions at the lesser of $20,000 or 20 percent of pay. Hundreds of thousands of small business retirement plans would terminate. Say goodbye to pretty much every profit-sharing plan. Why bother to have a plan that generally is designed to allow for savings in excess of $20,000 for small business owners and senior managers? There would be no benefit to it. For some reason, the proposal assumes contributions in excess of $20,000 would continue. Why would anyone lock up their money without any tax (or other) incentive? Thus, middle income workers would lose their employer plan and only have an IRA as an option and their savings rates would suffer as a consequence.
Any remaining small business retirement plans would severely reduce or most likely eliminate any employer contributions such as matching contributions. For the most part, the only remaining plans would be deferral only 401(k) plans, and only where because of employee demographics there is no problem with nondiscrimination testing. There simply would not be enough incentive for small business owners to do otherwise. Besides, the government would now be offering the match instead.
Amazingly, the authors of the proposal address this risk by saying, “… even if employer match rates decline substantially (which we do not expect to occur) the overall effects of the reform may still be beneficial.” Wow, “may be beneficial,” assuming there are no substantial reductions in matching contributions when they have taken away any incentive for most businesses to continue to provide matching contributions. It’s like they’re treating the retirement security of tens of millions of American workers as some kind of science experiment.
So bottom line: employees either lose their plans or their employers match. But hey, who cares about details when you live in the ivory tower?
Ironically, this proposal was issued as part of Brookings’ “Hamilton Project,” named after our nation’s first Treasury Secretary. From what I have read about Hamilton, I am pretty sure he is spinning in his grave over this one.
–Brian H. Graff, Esq., APM, ASPPA Executive Director/CEO
Opinion published in The 401(k) Wire September 8, 2011
Category: Washington Update