With the Democrats in control of both houses of Congress, they are now in a position to move legislation. In what follows we discuss, briefly, the procedural issues that may limit what legislation may be viable, and then consider a variety of proposals that indirectly (e.g., changes in tax rates and deductibility) or directly (e.g., changes to the multiemployer pension system and to 401(k) plans) affect retirement policy that Democrats may consider giving priority.
Procedural limitation – the budget reconciliation process
Administrations have, for some time, used the budget reconciliation process to move tax legislation when they have 50 but less than 60 votes “on-side” in the Senate. Under Senate rules, a budget reconciliation bill needs only simple majority (e.g., 50 votes plus the Vice President sitting as President of the Senate) to pass. Thus, it is not subject to the Senate’s rule requiring 60 votes to close off debate and force a vote.
This special rule only applies to legislative provisions that affect revenues or spending. Generally, the Senate Parliamentarian will determine what sorts of proposals will be allowed/not allowed in a reconciliation bill. A critical question with respect to, e.g., multiemployer bailout or automatic retirement plan legislation will whether it qualifies as affecting revenues or spending.
There is, generally, only one budget reconciliation bill per year.
Because of these limitations, in this article we focus primarily on tax-related legislation (broadly understood).
Biden tax proposals directly affecting retirement policy
In his campaign, President-elect Biden put forward a number of proposals that would directly or indirectly affect retirement savings policy.
“Equalizing the tax benefits of defined contribution plans”: The Biden campaign advocated “equaliz[ing] benefits across the income scale.” This was generally understood to mean substituting something like a (possibly refundable) tax credit for, e.g., the current tax exclusion. (Such a proposal might include a refundable tax credit of, e.g., 25% of the amount deferred instead of the current income reduction to which the taxpayer’s top marginal tax rate generally applies.) Many have suggested that this approach – despite its visceral appeal, especially to Democrats – is unlikely to prove workable. A more practical alternative may be simply to increase the Saver’s Credit (see below).
Tax incentives for small businesses plan formation: The Biden campaign called for tax credits for small businesses to start qualified retirement plans. There is some bipartisan support for such an effort, and last year, House Ways and Means Committee Chairman Neal (D-MA), with the co-sponsorship of Ranking Member Brady (R-TX), included such a proposal in his Securing a Strong Retirement Act proposal.
Proposals that affect the “economics of saving”
Many of President-elect Biden’s broader tax proposals will have an effect on the economics of saving in, e.g., a 401(k) plan – how much “cheaper” it is to save inside a plan than outside a plan.
As a useful background to this discussion, please see our 2016 article on the Trump and Clinton tax proposals(many of which are, in some version, included Biden’s proposals). Also useful are articles we have posted on The value of retirement benefits and tax policy, Capital gain and dividend taxes, and The effect of tax reform on retirement savings – corporate tax.
President-elect Biden’s proposals include:
Increasing taxes on income in excess of $400,000 from 37% to 39.6%. Generally, as tax rates go up, the value of the tax benefit of saving in a 401(k) plan also goes up (relative to non-plan savings). This marginal increase in the 401(k) tax benefit for high paid/high tax individuals could, however, be eliminated by the “deduction cap” discussed below or the equalization proposal discussed above.
Taxing capital gains at ordinary income tax rates on income above $1 million. As with income taxes, an increase in the capital gains tax paid by high paid/high tax individuals would increase the tax benefit of saving in a 401(k) plan vs. non-plan savings. Here, the size of increase (nearly doubled from a current level of 20% to 39.6%), and the resulting tax incentive, is much greater and more significant. This benefit is even larger in the case of high earners in professional partnerships that may be contributing hundreds of thousands of dollars in a year to a cash balance or similar plan.
Capping the deduction/tax benefit of itemized deductions at 28%. The most important question at this point is, will this cap apply to, e.g., 401(k) contributions? If it does, it would generally significantly decrease the value of the 401(k) tax benefit for taxpayers with marginal tax rates in excess of 28%.
Phasing out the qualified business income deduction income above $400,000. Many viewed the Trump Tax legislation’s 20% deduction from individual income tax for qualified business income from a partnership, S corporation, or sole proprietorship as creating a disincentive for some small businesses to establish or continue to maintain tax qualified plans. The elimination of that deduction for income above $400,000 would, under this logic, increase the incentive for small plan formation.
Increasing the corporate tax rate from 21% to 28%. As we discussed in our article The effect of tax reform on retirement savings – corporate tax, the 2018 reduction in the corporate tax, from 35% to 21% significantly enhanced the 401(k) retirement savings tax benefit for all savers. That’s because tax qualified retirement plans/trusts are tax-exempt entities and do not pay tax at the “shareholder level.” They do, however, indirectly pay the corporate level tax; that is, the earnings from their investment in a corporation are subject to tax, at the corporate level. (We discuss this issue in more detail in the sidebar.) The President-elect Biden’s proposal to increase the corporate tax would (partially) reverse this result.
Why the corporate tax rate matters to tax-qualified retirement plans
Generally (and oversimplifying), corporations pay taxes at the corporate level; dividends are not deductible; and shareholders pay taxes on (qualifying) dividends at capital gains rates. Thus, there are two taxes on corporate earnings: (1) one at the corporate level; and (2) one at the shareholder level. This is sometimes called the double taxation of corporate earnings.
As tax-exempt entities, tax qualified retirement plans/trusts do not pay the shareholder level tax – tax (2) above. They do, however, indirectly pay the corporate level tax; that is, the earnings from their investment in a corporation are subject to tax, at the corporate level – tax (1) above. In his remarks at a 2016 conference on the issue, Professor Edward Kleinbard (USC Gould School of Law) described this feature of the current system vividly: “the corporation is … a wonderful place to collect tax on those investors who otherwise would be tax exempt without punching them in the nose with the fact that we’re now going to impose tax on them.” (US corporate tax reform in 2017: Exploring the options, American Enterprise Institute, June 7, 2016.)
There are a number of retirement policy proposals currently being considered that might qualify for budget reconciliation treatment. We want to highlight three:
Multiemployer plan/system bailout. Most in Congress agree that many very large multiemployer plans and the Pension Benefit Guaranty Corporation multiemployer insurance fund are near insolvency and that the multiemployer system itself is in crisis. Democrats and Republicans have not, however, been able to agree on what to do about it. Solving these problems is a high priority for Democrats, and they are likely to craft some sort of solution to them that could be included in reconciliation legislation (consider, e.g., the May 2020 House-passed HEROES Act inclusion of a version of the “Butch Lewis Act”). The likely effect on contributing employers of any such legislation are at this point largely dependent on its details.
Neal Securing a Strong Retirement Act: On October 27, 2020, House Ways and Means Committee Chairman Neal (D-MA) and Ranking Member Brady (R-TX) released the Securing a Strong Retirement Act. Highlights of the new proposal include:
- New auto-enrollment/escalation mandate for 401(k) plans
- Solution to some of the technical problems presented by programs providing for 401(k) matching contributions for student loan repayments
- Relaxation of the required minimum distribution (RMD) rules, increasing the required beginning date from age 72 to age 75, providing an exemption for DC/IRA balances up to $100,000, and allowing special treatment for certain annuity provisions
- Establishment of a Retirement Savings Lost and Found agency to assist participants in finding missing benefits and instructing DOL/IRS/PBGC to (finally) provide a definition of when a participant may be treated as “missing” for purposes of ERISA and the Internal Revenue Code
- Simplify and increase the Saver’s Credit, to 50% of the first $3,000 of contributions (to be indexed for inflation), phased out for incomes over $40,000 (single filers)/$80,000 (joint filers). The Treasury Secretary is instructed to promote this credit.
Neal automatic retirement plan proposal: On November 12, 2020, Chairman Neal released a “discussion draft” of a new “Automatic Retirement Plan Act of 2020.” Under the proposal:
- Employers with more than 10 employees would generally be required to maintain an “automatic contribution plan”
- May be a qualified plan, 403(b) plan, IRA, or SIMPLE IRA
- May satisfy with a new, employee contribution-only 401(k) plan, with an $8,000 contribution limit, not subject to nondiscrimination testing
- Sponsors with certain pre-Act plans would be grandfathered
- Failure to maintain an automatic contribution plan would result in an excise tax – $10 per employee per day subject to certain limits
- Would generally exempt employers from compliance with state plan initiatives other than those adopted prior to enactment
As noted above, a critical issue with respect to all of these proposals will be whether they qualify (in the view of the Senate Parliamentarian) for inclusion in budget reconciliation legislation.
The current situation is, obviously, very fluid. We will update this analysis as 2021 progresses.