At the beginning of this decade, Democrats were decrying the 401(k) system as providing “upside down” tax incentives favoring higher income, high tax bracket taxpayers over the low paid. Then, in what seemed like an about face, during the 2017 debate over the “Trump Tax Cut,” Democrats resisted Republican efforts to generate revenue by “Rothifying” 401(k)s by acclaiming that system as a “middle class benefit.” Senate Minority Leader Schumer (D-NY) attacked the Rothification idea as a “tax hike on middle-class retirement accounts.”
Now former Vice President Joe Biden is back to attacking 401(k)s, asserting on his website that “two-thirds of the [401(k)] benefit goes to the wealthiest 20% of families” and promising to “equalize saving incentives for middle-class workers … by [e]qualizing the tax benefits of defined contribution plans … across the income scale, so that low- and middle-income workers will also get a tax break when they put money away for retirement.” Most have assumed that this means switching from the current system of tax exclusion of contributions (functioning more or less like a deduction) to a refundable tax credit—where everyone who saves gets the same dollar amount of tax benefit, regardless of income or tax bracket.
Given our current politics, it’s probably too much to expect consistency, from either side, in these battles. Or, for that matter, concern—when the going gets tough—for retirement policy as such, as opposed to retirement-policy-as-a-revenue-raiser. Certainly, the only reason defined benefit (DB) plan funding relief remains part of fourth-round stimulus negotiations is that it raises revenues.
Outside of changes made in major tax and budget legislation, over the past decade the most we have gotten from Congress is the relatively modest sorts of changes that were included in the Setting Every Community Up for Retirement Enhancement (SECURE) Act. And, indeed, many of those weren’t really improvements, just solutions to problems created by the regulators, e.g., authorization of open multiple employer plans (MEPs) and fixing the problems DB sponsors have had with “closed groups,” lifetime income disclosure and an adequate defined contribution (DC) plan annuity safe harbor.
In the agencies, the Trump Department of Labor (DOL) has come out with a really solid improvement to the electronic participant disclosure rules. But that’s about it. The list of problems it has not solved, or indeed made worse, is pretty long. The environmental, social and governance (ESG) investing proposal has generated a lot of controversy and is unlikely to reduce the zigzagging of ESG policy we’ve seen every time there is a regime change in Washington. The fiduciary advice prohibited transaction exemption proposal, in my humble opinion, smuggles into its preamble most of the Obama DOL’s Fiduciary Rule. DOL has refused to provide guidance on the treatment of “missing participants,” instead choosing to regulate by audit and threat-of-litigation.
Most critically, DOL has made no effort to reduce DC fiduciary litigation—which it could do simply by clarifying what is expected of DC plan fiduciaries in participant choice plans. Instead, in the Administration’s brief opposing Supreme Court consideration of Brotherston v. Putnam, it obstructed an effort to get judicial clarity on key issues.
In the current context, IRS’ brief is much narrower than DOL’s, but it too has failed, e.g., in not solving the DB “closed plan” problem (a problem that IRS itself created).
It’s hard to believe that a Biden Administration would be much worse. Biden Administration officials might say harsher things about the industry, as did President Barack Obama in his 2015 speech to the AARP in support of the re-proposal of the Fiduciary Rule.
But—in the agencies—it’s unlikely that a Biden Administration will do anything other than continue to pursue the policy priorities of the permanent staff.
Thus, the real difference between Trump and Biden retirement policy is most likely to manifest itself in whatever tax plan a President Biden might propose in his first year.
How far a Biden Administration will be able, in such a tax bill, to “equalize the tax benefits of defined contribution plans” will depend a lot on, first, the post-election political situation. If Democrats don’t win a Senate majority, it’s unlikely they will be able to make fundamental changes to the current 401(k) system. Indeed, there may even be Democrats who would oppose such changes—401(k)s remain a very popular benefit.
The other big issue will be cost—making the numbers work in a way that provides a meaningful benefit to low paid employees while maintaining support for the system among higher paid employees and employers, without breaking the budget. (For more detail on this issue, see the sidebar.)
Retirement savings “tax benefit math” is somewhat dense and unintuitive. Here is a brief review, for those who want to go deeper on this issue.
Under the current system (and ignoring Roth treatment), an exclusion from income is given at contribution, earnings accumulate tax free, and the distribution is taxed at ordinary income tax rates. Assuming the same tax rate at contribution and distribution, the tax benefit of saving in, e.g., a tax-qualified 401(k) plan is equal to the tax that would otherwise be paid outside the plan on in-plan investment earnings. Some taxes on investment earnings, e.g., long-term capital gains taxes, are less progressive than income taxes, so that the “upside-down-ness” of the tax incentives in this case is in fact relatively modest. The current system does in some cases permit a saver to shift income from a high tax rate year to a low tax rate year, and this feature may be of significant benefit to some middle- and upper middle-income taxpayers.
Switching to a tax credit system raises the issue of whether and how you will tax distributions. If you don’t tax them at all, then up-front tax credits become expensive very fast. If you tax the entire distribution at ordinary income tax rates, then higher income/tax bracket taxpayers will have no tax incentive to save, because they are only getting a modest credit on the front end and paying taxes at a much higher rate on the back end. If you only tax the earnings distributed, then you must come up with a way to calculate a participant’s basis in her account—which is going to add complexity and confusion and reduce the appeal of savings overall.
Finally, we would note that—as we saw with the Affordable Care Act—fundamental change is hard. 401(k) plans—with all their features, including nondiscrimination testing, employer matching contributions, and (especially in the current crisis) relatively easy access-to-savings—are deeply embedded in the American employment system. Going to a tax credit system will disrupt a lot of participant expectations. And gore more than one ox.
My guess is that, after putting up a good fight, a Biden Administration is most likely to settle for a modest improvement in the Saver’s Credit and declare victory.
Hence my conclusion that—with respect to retirement policy at least—I think this is not likely to be the most important election of our lifetimes.
Michael Barry is president of O3 Plan Advisory Services LLC. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.
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