Proposed Retirement Savings Cap Reduces Tax Benefits

Back in the spring, President Obama released his budget proposal for the country. It had no chance of passing. The Democrats didn’t seem to want it and the Republicans sure didn’t want it. It was more a statement of the world as he’d like to see, if only he had a working magic lamp.

 Since its introduction, one of the proposals that has been getting a lot of (mostly negative) financial press is the establishment of a cap on retirement savings contributions. Here’s how it works.

Every year a calculation is made to see what it would cost to purchase a $205,000 per year joint and 100% survivor annuity. While the annuity payment would not increase for inflation, that beginning number of $205,000 would. Currently the cost of that annuity is about $3.4 million.

This means $3.4 million would be the maximum amount a family could have in the combination of all their retirement accounts and still be allowed to contribute to those accounts. These include IRAs and 401(k)s as well as the value of a pension your employer might provide. The idea is to take away any tax breaks after you have what the government thinks is “enough” retirement savings.

I think you can imagine one area of contention with this proposal. Why does the government get to decide how much is a reasonable amount of retirement savings? Well, it gets to decide a lot of things concerning taxes. If my memory is correct, it is the government that came up, makes the laws for, and enforces the tax laws. So yes, they can decide how much you can save tax-qualified. It does not limit how much you can save. You can still save billions of more dollars; you’ll just have to pay taxes on the income and capital gains.

Nevertheless, I do have problems with some aspects of this plan. First, while $205,000 per year seems like a lot of money, it is a non-inflating amount. Assuming modest inflation, the purchasing power could be cut in half in 20 years.

In my less than humble opinion, the proposed amount of savings can reasonably support an inflation-adjusted income stream of around $140,000 per year. The figure may be lower than some come up with, but it needs to survive the kinds of severe markets like the recent financial crisis. Also the calculation that came up with the current $3.4 million figure is affected by interest rates. With interest rates very low, the cost of an annuity is very high. As interest rates rise (which we all expect to occur sometime down the road), the amount you can accumulate without creating tax issues will go down.

Employers won’t like any of this either. The bosses and higher-paid executives will have their ability to save in their own plans curtailed. There will be the additional burden of having to report the value of all retirement plans on an employee-by-employee basis. My guess is that the availability of those plans for the rank-and-file employee will diminish, resulting in less retirement saving all around.

Change the rules and you change behaviors…and not always in a good way.

 
This article was published under the title "Savings cap has problems" in the Wichita Falls Times Record News on June 9, 2013.