In a word, the committee sees the income tax deferrals associated with qualified defined contribution (DC) retirement plans as expenditures—despite the fact that income tax will eventually be paid on qualified DC account assets when participants use them for annual income in retirement. Under current law, payments from Social Security retirement benefits are also partially excluded or fully excluded from an individual’s gross income, further adding to the government’s “expenditures” for retirement tax benefits.
It’s not that the joint tax committee is unaware of the fact that taxes will eventually be paid on qualified retirement plan assets (at least when it comes to DC accounts), says Rep. Reid Ribble (R-Wisconsin). The problem is rather how the Congressional Budget Office (CBO) and other key players in the tax assessment, collection and expenditure process are forced to account for tax-deferred savings under current law.
Put simply, the CBO and others are “not allowed to score anything dynamically,” Ribble explains, “so the shortfall of income from taxes on plan contributions necessarily becomes part of debt now.”
Ribble says he has introduced legislation that would have the CBO establish a long-term scoring option to better track and assess tax deferrals related to retirement plans (see “There Is Hope for Retirement Security Policies from Congress”). “Right now we’re trapped in these rules,” he adds.
The new analysis from the Joint Committee on Taxation looks at the federal government’s entire tax collection and expenditure expectations for both individuals and corporations—of which retirement plan-related deferrals are only a small part. The report makes its estimates based on the provisions in federal tax law enacted through June 30. Expired or repealed provisions are not listed unless they have continuing revenue effects associated with ongoing taxpayer activity. Proposed extensions or modifications of expiring provisions are also not included until they have been enacted into law.
The tax expenditure calculations are based on the January 2014 CBO revenue baseline assessment and subsequent joint committee staff projections of the gross income, deductions, and expenditures of individuals and corporations for calendar years 2013 to 2018. Based on these criteria, the federal government expects to “spend” about $399 billion on tax deferrals for DC plans between 2014 and 2018. The annual figure grows from $45 billion this year to $81 billion in 2016 and nearly $112 billion in 2018.
For defined benefit (DB) plans, federal government spending on tax deferrals for individuals accruing a future benefit with a present cash value is projected to be $248 billion between 2014 and 2018. The figure starts at $26 billion this year and reaches an estimated $50 billion in 2016 and nearly $70 billion in 2018.
For tax-advantaged individual retirement accounts (IRAs), the federal government expects to spend about $70 billion over the five-year time period. For 2014 the figure is about $12 billion, growing slowly year-over-year to reach $16 billion in 2018. Spending on Roth IRA tax deferrals will amount to just more than $30 billion between now and 2018, according to the tax committee. An additional $6 billion in spending is projected for “credits for certain individuals for elective deferrals and IRA contributions.”
Language in the tax committee report suggests that, under “normal income tax law,” employer contributions to pension plans and income earned on pension assets generally would be taxable for employees as the contributions are made and as the income is earned, and employees would not receive any deduction or exclusion for their retirement plan contributions. Under present law, however, employer contributions to qualified pension plans and, generally, employee contributions made at the election of the employee through salary reduction are not taxed until distributed to the employee, and income earned on pension assets is not taxed until distributed.
Ribble says it will be critical for the retirement readiness of the U.S. workforce to maintain the present tax deferral rules for retirement plan participants. He warned attendees at the 2014 PLANSPONSOR National Conference in June that several tax reform proposals being circulated in Washington could start to cut away at these tax benefits.
With the federal budget deficit being what it is, he said there are various proposals in the pipeline that look to update the architecture of retirement vehicles and thus provide more revenue that could be used to alleviate the deficit. These include:
- Updating the U.S. tax code rules to reduce tax expenditures and raise revenue;
- The 2014 Tax Reform Act (TRA) from Dave Camp, chairman of the U.S. House of Representatives Ways and Means Committee;
- An Obama Administration proposal to regulate contribution limits by seeking to cap the aggregate accumulation in all tax-favored retirement plans;
- The 20/20 Proposal from the National Commission on Fiscal Responsibility and Reform; and
- A proposal from the Brookings Institution that would shift the benefits of retirement plans more towards non-highly compensated employees.
Various industry groups have raised the alarm about these proposals and others, especially the wide-reaching tax reform package introduced this year by the House Ways and Means Committee Chairman. While the 979-page document does not include taxation of retirement contribution amounts and benefits caps President Obama suggested in earlier budget proposals, there are similar or new provisions industry groups say will result in double taxation and discourage retirement plan benefit offerings.
The full Joint Committee on Taxation report, “Estimates of Federal Tax Expenditures for Fiscal Years 2014 – 2018,” is available for download here.