This is the second in our series of articles on the issues that, beginning in 2017, the new Administration and the new Congress may consider, if they choose to make retirement policy a priority. In this article we discuss contribution policy.
In our prior article in this series, we identified three critical DC policy challenges: (1) getting adequate contributions into the system; (2) investing those contributions efficiently; and (3) distributing DC benefits in a way that adequately allows for longevity risk (the risk that a participant might outlive her retirement savings). As we discussed in that article, challenge (1) breaks down into two sub-challenges: getting American workers covered by an (automatic enrollment) workplace retirement savings plan, and getting plan participants to make adequate contributions. It’s the latter issue – “adequate contributions” – that we will discuss in this article.
This issue is a little more complicated than it might seem. As a general matter, policymakers, both Democrat and Republican, believe that retirement savings are a good thing and should be encouraged. And in that regard, perhaps the fundamental policy tool is tax incentives. After all, 401(k) plans are named after a section of the Tax Code.
Some Democrats, however, believe that current retirement savings tax incentives unfairly favor higher-paid/higher-tax bracket individuals. And, in an era of tight budget constraints, both Democrats and Republicans are concerned about the cost – in tax revenues – of retirement savings tax incentives.
So discussions of policies intended to increase contributions are also enmeshed in disputes over the fairness of the current Tax Code and concerns about the budget.
Moreover, most agree that the critical challenge is increasing the contributions of lower paid employees, for whom current 401(k) tax benefits may not be that significant. One (perhaps somewhat simplistic) way to think of our current situation is that we already have higher-paid, tax-motivated individuals on-board and making adequate contributions to the 401(k) system. We now have to find a way to get lower-paid employees to make adequate contributions. And there is a general consensus (with a minority dissenting view that we’ll discuss) that the best way to do that is auto-enrollment and auto-escalation – defaulting participants into plans at an adequate savings rate.
Thus, we begin the “contribution” discussion with proposals to “improve” current auto-enrollment/auto-escalation rules.
Improved 401(k) design-based safe harbor
The Pension Protection Act of 2006 is generally recognized as broadly encouraging the use of auto-enrollment, critically, by creating an auto-enrollment design-based safe harbor, allowing a plan to avoid nondiscrimination testing if (among other things) it provides for auto-enrollment at a minimum amount and provides certain minimum employer contributions.
The 10 percent cap on automatic increase contributions in the PPA safe harbor has been criticized as too low, and there is concern that the minimum automatic contributions it specifies have been taken by some as, in effect, maximums. There is bipartisan support to modify the safe harbor to address these issues. (See for instance, Senate Finance Committee Chairman Hatch’s (R-UT) 2013 Secure Annuities for Employee Retirement (“SAFE”) Act.)
The Bipartisan Policy Center’s June 2016 Report of the Commission on Retirement Security and Personal Savings goes even further: it recommends a new 401(k) safe harbor that provides for automatic enrollment (with an opt-out) for all participants (including current participants), re-enrollment every three years, automatic escalation and no required employer contribution for employers with less than 500 employees.
Given this bipartisan support, if Congress is able to address 401(k) retirement policy, some sort of reform of the 401(k) safe harbor is a distinct possibility.
Keeping money in the system
Another angle of attack for policymakers concerned about the adequacy of employee contributions is to reduce the amount of leakage from the system. There are, generally, three types of “leakage” – hardship withdrawals, loan defaults (typically associated with termination of employment) and cash-outs at termination of employment. That last one – cash-outs at termination – represents two-thirds of the leakage from the system. And some have noted that limiting hardship withdrawals or loans may actually reduce participant contributions, e.g., for lower-paid participants concerned that they may need, for a “rainy day,” money they might otherwise contribute to a 401(k).
There have been proposals to ease the rules that often result in the distribution (aka “leakage”) of unpaid loan balances when a participant terminates employment. For instance, the 2015 Shrinking Emergency Account Losses (SEAL) Act (S. 324), sponsored by Senators Michael Enzi (R-WY) and Bill Nelson (D-FL), would give participants until their tax return due date (for the year of distribution) to rollover the unpaid balance of a loan that has been distributed in connection with termination of employment or plan termination.
There have also been proposals to streamline the current rollover process, which has been criticized by, among others, the Government Accountability Office (see its report 401(K) Plans: Labor and IRS Could Improve the Rollover Process for Participants).
And, finally, there has been private sector work on the establishment of a clearinghouse, which is likely to require some regulatory action.
Tax issues: “fairness” and tax credit proposals; caps on benefits or deductions; and possible impact of corporate tax reform
As we noted at the beginning, tax incentives are a fundamental part of our current retirement savings system. Both Presidential candidates and the House Republicans have produced proposals for comprehensive reform of the current tax system. And there are a number of tax-related issues/proposals that may affect retirement savings policy.
Fairness, tax credits and the Saver’s Credit
The “fairness” of the tax system generally is under attack by both Democrats and Republicans. Some Democrats have, in the past, singled out the 401(k) system as having “upside-down” tax incentives. (See, for instance, the 2014 New York Times Op-Ed by former head of President Obama’s National Economic Council Gene Sperling, A 401(k) for All, and the 2005 paper Making the Tax System Work for Low-Income Savers by William Gale (Brookings Institution), Mark Iwry (currently U.S. Treasury Deputy Assistant Secretary (Tax Policy) for Retirement and Health Policy) and Peter Orszag (President Obama’s head of the Office of Management and Budget from 2009-2010).)
These critics have floated the idea of converting the current 401(k) tax exclusion (which operates more or less like a deduction) to a refundable tax credit. Less radically, Democrats have proposed expanding the Saver’s Credit (which generally provides a tax credit for contributions to qualified plans and IRAs by certain low income taxpayers), by increasing the income limits and making it refundable. (See Congressman Neal’s (D-MA) proposed Retirement Plan Simplification and Enhancement Act of 2013 and the Retirement Improvements And Savings Enhancements Act Discussion Draft recently circulated by Senate Finance Committee Ranking Member Wyden (D-OR).) Republicans generally remain opposed to more tax credits, especially (as envisioned by Democrats) refundable credits.
Caps on benefits or deductions/exclusions
There have also been proposals to limit retirement savings tax incentives for higher income individuals. Recent Administration budgets have included both: (1) a $3.4 million cap on “accumulated amounts within the tax-favored retirement system;” and (2) a 28% cap on “the tax value of certain deductions and exclusions, including employee contributions to defined contribution retirement plans and individual retirement arrangements.”
The 28% cap on deductions/exclusions would, generally, have a much greater effect on retirement savings system than $3.4 million benefits cap. It (the 28% deduction cap) has generally been identified with Democrats, although something like it was a feature of then Chairman of the House Ways and Means Committee Dave Camp’s (R-MI) 2014 tax reform proposal. Former Secretary of State Clinton has also proposed a cap on deductions, although it is not clear that it would apply to retirement savings.
Effect of corporate tax reform on the retirement savings tax benefit
While expanding tax credits for retirement savings is unlikely in the context of a divided government, there is some bipartisan consensus that we need to “do something” about corporate tax reform. As we discussed in our article Corporate tax reform and retirement savings tax policy, one issue that will certainly be in play in discussions of how to reform corporate taxation will be how to tax corporate earnings at the corporate level. And those discussions are likely to also consider the taxation of dividends and capital gains at the shareholder level. All of which will have a (perhaps significant) knock-on effect on retirement savings tax policy:
Increases/decreases in taxes at the corporate level will reduce/increase returns to all savers, regardless of whether they are saving inside a plan or outside a plan.
Increases/decreases in taxes on individual savers (e.g., an increase/decrease in the tax on dividends or capital gains) will make saving inside a plan more/less attractive.
Given how highly politicized the discussions of/arguments over the current tax system are, unless one party runs the table (wins control of the White House, the Senate and the House), fundamental tax reform is unlikely. Of all the tax reform proposals, the “most bipartisan” and thus the most likely to move in the next Congress is “doing something about the corporate tax.” There is, however, as yet, no consensus as to what that “something” should be, and reaching a consensus will probably be difficult.
Finally, we should note that it is conceivable that lawmakers will look to change the 401(k) tax deal not as a matter of retirement savings policy but simply as a way to raise revenues for other purposes.