One of my favorite short stories is Ray Bradbury’s “A Sound of Thunder.” For those who haven’t read it (or who perhaps think that the fairly awful 2005 film of the same name does the story justice), the story takes place in the future when, having figured out time travel, mankind has found a way to commercialize it by selling safaris back in time to hunt dinosaurs. Not just random dinosaurs, mind you — cognizant of the potential implications that a change in the past can ripple through and affect future events, the safari organizers take care to target only those that are destined to die in short order of natural causes.
Furthermore, participants are cautioned to stay on a special artificial path designed to preclude interaction with the local flora and fauna — until, of course, one of the hunters panics and stumbles off the path. Upon returning to their own time, the group finds that subtle — and not so subtle — changes have occurred. When leaving the path, the hunter apparently stepped on a butterfly, whose untimely demise, magnified by the passage of time, produced changes much larger than one might have expected from its modest beginnings.
Cap on Retirement Savings
The recently released White House budget proposal for 2014 includes a plan to raise $9 billion over 10 years by imposing a retirement savings cap for tax-preferred accounts. While initial reports focused on the aggregate dollar limit of $3 million included in the text, it soon became clear that that figure was merely a frame of reference for the real limit – the annual annuity equivalent of that sum, $205,000 a year in 2013 for an individual age 62. [1. With the publication of the final budget proposal, we also learned that the calculation of the threshold also includes defined benefit accruals. While our current analysis did not contemplate the inclusion of defined benefit accruals, it seems likely that the number of individuals affected will change. The White House budget proposal is online here.]
While such things often fall more within the purview of actuaries than advisors, as you might expect, there are a number of variables that influence annuity purchase prices. As a recent EBRI analysis outlines, if you look only as far back as late 2006, based on a time series of annuity purchase prices for males age 65, the actuarial equivalent of the $205,000 threshold could be as low as $2.2 million — and a higher interest rate environment could result in an even lower cap threshold.
At the same time, the passage of time — which normally works to the advantage of younger savers by allowing savings to accumulate — tends to increase the probability that younger workers will reach the inflation adjusted limits by the time they reach age 65, relative to older workers. The Employee Benefit Research Institute’s Retirement Security Projection Model (RSPM) allows us to estimate what the potential future impact could be. Utilizing a specific set of assumptions, [2. The specific assumptions involved taking age adjustments into account in asset allocation, real returns of 6% on equity investments and 3% on nonequity investments, 1% real wage growth, and no job turnover. This particular analysis was focused on participants in the EBRI/ICI 401(k) database with account balances at the end of 2011 and contributions in that year. The assumptions used in modeling a variety of scenarios are outlined here.] EBRI finds that 1.2% of those aged 26 to 35 in the sample would be affected by the adjusted $3 million cap by the time they reach age 65, while 4.2% of that group would be affected by the cap of $2.2 million derived from the discount rates in 2006 cited above.
While the EBRI analysis offers a sense of the impact that variables such as time, market returns and discount rates can have, there are other potential “ripples” we aren’t yet able to consider, such as the potential response of individual savers — and the employers that make decisions about sponsoring retirement plans — to such a change in tax policy. Think about your current clients. What would their response to such a change be?
Only Part of the Big Picture
Like the hunters in Bradbury’s tale, the initial focus is understandably on the here and now — how today’s decisions affect things today. However, decisions whose impact can be magnified by the passage of time are generally better informed when they take also into account the full impact [3. As with all budget proposals, most of the instant analysis focuses on the numbers. The objective in this preliminary analysis was simply to answer the immediate question: How many individuals might be affected by imposing such a cap on retirement savings accounts? Of necessity, it does not yet consider the administrative complexities of implementation and monitoring such a cap, nor does it take into account the potential response of individual savers and their employers to such a change in tax policy — all of which could create additional “ripples” of impact. The latter consideration is of particular importance in considering the implications of tax policy changes to the current voluntary retirement savings system.] they might have in the future.
Footnotes
