Tax reform is on Washington’s lips again – but means different things to different people. This week we asked NAPA Net readers what they thought would happen if Congress took away the pre-tax advantage of 401(k) savings.
This is no idle question. To many in Congress that deferral (not a deduction!) of taxes is nothing more than a big pot of money to spend on other things (including, for some, the reduction in the federal deficit). And there have been academic studies that purport to show that those preferences – the ability to defer paying taxes on 401(k) contributions until they are withdrawn from the plan – don’t matter in determining participation rates. Though other researchers have questioned whether those studies are actually representative of what American workers might do if those preferences actually disappeared – and what that might mean to retirement security.
But what do NAPA Net readers think?
The vast majority of this week’s respondents thought the elimination of the pre-tax contribution in 401(k)s would have a negative – and in many cases – a very negative impact. The most common response – 46% – was that many would quit saving (altogether), and another 5% thought that most would quit saving, while about 1 out of 10 thought that some would.
But then, another 22% thought that many would save less, and another 3% thought that some would save less. As one reader explained, “Many would save less. They would invest enough to get the match and tell themselves they would invest any incremental savings in their brokerage or savings accounts, but not actually do so. It would also send a message to the public that would be perceived as, “The government is not concerned about my retirement preparedness, and if they aren't concerned, why should I be?” Another said, “They would start saving at an older age and many would not do it in a 401(k).”
The rest either thought it wouldn’t matter much, or wouldn’t matter much in the long run. One reader noted, “Short term, not much change. I believe the problem would be getting new people to begin saving in plans and when they change jobs starting up again.” Another echoed the short-term message: “It would be disruptive to the business initially. But if we promoted the Roth advantage, and the need for retirement savings, those that save would still be likely to save up to the match; may see a slight reduction in savings because of the loss of the tax benefit.” Another opined, “If Roth and its tax-free distributions are left alone then it won’t matter much. If just after-tax is available, then logical participants will still save to max match. However, under current rules things do get a bit weird in that after-tax funds can be withdrawn w/o penalty so would there be ‘put it in, take it out’ unless those rules are also changed.”
But, as one reader noted (and several others commented), “Who is to say the tax advantages of the Roth 401(k) would remain untouched as well? Without the tax advantage ‘carrot’ offered by 401(k) and Roth 401(k), workers become less likely to save.”
Limits Less?
What if Congress were to cap – or reduce the current contribution limits? Nearly 60% said that highly compensated workers (most likely to be impacted by those limits) would save less, while another 16% thought participants generally would save less (more than one response was permitted). About 10% thought there would (mostly) be no real impact.
That said, the most striking finding was that just over half (53%) said they thought that plan sponsors would be less likely to setup and maintain these plans if the limits were capped. “Smaller plans where only the owner is reaching the limit are most likely to be impacted,” noted one reader.
“The total value flows into plans would be reduced,” said one reader, “impacting economies of scale, resulting in a combination of higher fees, greater consolidation, less choice, larger funds, and less investment differentiation.”
“Savings would continue but the ability of workers to save adequately for retirement would be diminished. The older working force (45-50+) tend to hit their savings stride and try to make up lost ground in their later working years by maxing out their deferrals. Reducing or capping is detrimental,” noted another.
Or, as one reader explained, “The level of the cap would determine the level of the reaction. Cap it at $6k and you can guess what happens next.”
WWPSD?
Building on that outcome, we asked readers what plan sponsors would likely do if the pre-tax advantage of 401(k) savings was eliminated. Just over half (57%) said that many would be less inclined to maintain and setup these plans, while 22% said some would be less inclined. The rest didn’t think there would be much impact, or that it would be limited to certain size plans.
As one reader noted, “Small plans would be less inclined and in many cases would terminate plans since the owner would have much less personal benefit/incentive relative to the hassle of maintaining it.” Another echoed, “Employer reaction would be in large part determined by the actions of other employers.” Still another noted, “Small employers would not set up the plans. Larger employer would still have them unless employees rated the benefit as not useful and preferred other benefits.” Joining that chorus was the reader who said, “Smaller plans (which were designed to favor ownership) would likely be the most impacted.”
Do Lawmakers ‘Get it’?
The real question, of course – certainly the one that might matter most in the months to come – is whether or not lawmakers understand all of this. And among this week’s respondents, the clear answer is – they don’t. In fact, two-thirds said that plainly. Perhaps more damning is the sense of 22% that lawmakers understand, but don’t care about that result (or, as one reader said, “some who are enlightened do”), or the 7% who said they understand, but don’t actually believe those outcomes will occur. As one reader noted, “I am not sure people in our business understand the impact and many a Congressperson has voted on bills he/she did not understand.” Another explained, “They don't understand the small employer and impact it would have on qualified plans.”
The remaining one-in-eight said while lawmakers understand the potential for these impacts, they have other priorities. “It is just another example of Washington double talk,” noted one reader. “Out of one side of their month, legislators are trying to encourage people to save (because they fear the impact that poor, older citizens will have on entitlement programs) and out of the other side of their mouth, they are salivating over the immediate tax revenue that they can glean from taking away a pre-tax benefit or by taxing the very people who ‘do the right thing’ and save for their retirement.”
Or, as another put it, “I think most lack the foresight and knowledge to predict how plan sponsors would react.”
Other Reader Comments
We had lots of comments to this week’s reader poll – here’s a sampling:
- “Take away the employer contribution deduction also, if they want to really get rid of the tax advantages of qualified plan.”
- “Tax reform sounds good, but all the special interests (banking/real estate to keep the homeowners deduction; business incentive write-offs, etc.) will come out of the woodwork.”
- “There is a need to either reestablish DB plans or mandate forced savings in order to head off a future of broke retirees. Forced savings (for example requiring all Americans to save at least 10% of earnings) would have been unthinkable not long ago, but now that we have forced health insurance, it’s in the realm of possibilities. Forced savings could reduce the consumption component of GDP but increase the investment component. Increased flows to investment would either inflate investment values as we've seen in the last several years, or could increase investments in the form of new ventures.”
- “Many of the employees that the industry is trying to reach are low wage earners. What helps them is the minimal impact to their take-home pay because of the reduction in federal income taxes. If they are forced to choose between paying bills or saving, the choice is obvious. Higher income participants are impacted also. A personal example: in order to continue to save the max and take care of an aging parent, the tax savings is a huge determination on the amount of savings. Should that be taken away, the savings amount would have to drop in order to continue to care for the parent. Since the government is also looking at property tax exemptions, should the discontinuance of either or both, would reduce the savings amount to zero. It’s a three-legged stool; take away one leg and the whole thing falls. (The parent is living with the caregiver. Taking away these tax exemptions could possibly cause the parent to need assistance from Medicaid. So the government has to increase payouts. Nonsense.)”
- “With all the advantages of 401k we still struggle to get participation rates up. Why punish those who are actually doing a good job saving by taking away a benefit?”
- “Until government can stop their uncontrolled spending, they will continue to look for ways to bridge their income and spending gap to the detriment of the public at large. We know American workers do not begin saving soon enough or set their deferral rates high enough to save adequately for retirement. But within our own shop we are moving the needle through education and one-on-one guidance. If government takes away the positive message of tax advantage savings, we all lose. If private citizens are not given the ability and incentive to manage their own retirement savings program, we must protect their future through public programs... and we all know how well the government has handled that one (can you say Social Security insolvency?).”
- “The fight needs to be ‘sold’ using truth versus acting like a lobbyist. The economic impact is the key and not the current tax deduction. What happens if an entire generation of workers become largely dependent on Social Security and Medicare (only)? Will workers continue working past their ‘expiration dates’? How does that stymie younger workers’ career paths? President Carter raised the issue of having a national retirement policy almost 40 years ago yet we still operate via the patchwork method. (P.S. He was also right about having an energy policy, but I digress!)”
- “We’ve known about this looming issue for decades and very few legislators have been willing to have an honest conversation with the American people. Most workers ‘get it.’ The rate of Social Security and Medicare contributions has not been indexed and given the increasing numbers how receive the benefit, it probably needs to be. Entitlement plan contributions and program design need to be updated. Also, many workers do not fully realize the value of a ‘pre-tax’ benefit or in general, how it works. The tax code is so complicated to them and they really only want to know how much money they will get back each spring when they file their taxes. Then, when it comes time to retire, they are shocked that the IRS is going to subject them to a mandatory withholding (and that their pre-tax distributions are subject to taxation). The next thing you know they think it is a plan sponsor rule (taxes) that they are being subjected to. It’s too bad that employees couldn’t opt in for a higher Social Security savings rate during their working years, that goes into an individual account that they cannot take a withdrawal from (loan or distribution), so that they have some retirement income stream for life. Sounds like the Bush era proposal perhaps.”
- “This concept of putting the retirement issue into a box and making savers pay for non-savers is about the dumbest thing this industry has ever allowed to happen. Unfunded retirement is a problem for the country — employers, consumer brands, etc.... not just the savers. We need to make the conversation bigger and Washington needs to support that effort.”
- “Tax reform is a large topic and target depending upon your political persuasion. To focus on retirement plan taxation without also addressing other tax preference, including a complete overhaul of the tax code, is dangerous, foolish and likely to go nowhere. At best it will create massive unintended consequences, like the ACA. The result: even more bureaucracy than today. Leave the current system in place until a new system can be created; enact the ‘new’ system all at once.”
- “They need to put together a policy on what they want the average American to have at retirement and come up with a pathway to get them there. It is not going to happen with IRAs. And they should not tweak them every time they review the budget.”
- “Consideration should be given to two classes of employees... those who are W-2 vs. self-employed. Small businesses are getting crushed by taxes, healthcare and the new wage labor laws.”
- “DC is clueless about these issues. I met with a young Senate staffer and the guy had NO clue how retirement plans worked or why so few folks contributed.”
- “As with most items considered for reform, they are trying to reconcile the need for easy revenue vs. the need for a retirement program that works for millions... of voters!”
- “Trying to get the highly paid people to pay more taxes now is just going to result in ‘the little guy’ not having any benefit at all. It’s tax deferred, people! They're going to pay taxes eventually, so just be patient.”
- “I believe that people are either savers or spenders. Regardless of compensation or tax incentives, savers will always figure out a way to stash away a nut or two for tomorrow. Spenders will always spend more than they make, live for today, and complain that they will never be able to retire. If I just had a crystal ball, I’d be able to tell who’s doing it right!”
- “Heaven help us all. The only thing I can think of is these lyrics from the Beatles: 'Should five percent appear too small, be thankful I don't take it all. ’Cause I’m the taxman, yeah… I’m the taxman. If you drive a car, I’ll tax the street. If you try to sit, I’ll tax your seat. If you get too cold, I’ll tax the heat. If you take a walk, I’ll tax your feet.'”
Thanks to everyone who participated in this week’s NAPA Net reader poll!
Got a question you’d like to run by your fellow readers? Want to get a real-world perspective on an issue? Feel free to post it in the comments section below, or email me directly (and anonymously) at [email protected].
