The Unintended Consequences of Obama’s 401(k) Cap

When politicians and their supporters talk about that some people should take a greater share of the burden, more people (especially those who this share of the burden was supposed to help) end up paying a price.

President Obama’s new budget proposal aims to trim Americans’ nest eggs by setting a cap on lifetime contributions of 401(k)s at an average of $2.7 million will end up hurting more people than just getting the rich.

Initially, it was estimated that the cap would affect only 180,000 of the 60-million retirement-benefit participants.

However, the Employee Benefit Research Institute estimates close to 1 million young people in their 20s and 30s who are aggressively saving through their defined-contribution plans, as well as older people who have accumulated a few million dollars collectively in all their retirement accounts, could run into the cap problem.

In addition, the “chutzpah” of this proposal is calculating the limit and who actually has to do it. Obama proposes to limit the deduction or exclusion for contributions to defined-contribution plans, defined-benefit plans, or IRA for an individual who has total balances or accrued benefits under those plans that are sufficient to provide an annuity equal to the maximum allowable defined-benefit plan benefit. The maximum benefit, the administration said, is currently an annual benefit of $205,000 payable in the form of a joint and survivor benefit commencing at age 62, is indexed for inflation, and the maximum accumulation that would apply for an individual at age 62 is approximately $3.4 million.

Did you get that? Of course not? Do you know who will have to calculate these limits, as it is tuned in to the defined benefit plan limit? Of course, employers because they have nothing better to do.

If you tell employers that they will have to enforce a benefit limit on their top paid people and in most instances, the very same people they are talking to. Do you think employers who are told that they have this added recordkeeping burden as well as limiting benefits to their top paid people is less likely or more likely to maintain a 401(k) plan?

While the latest Frontline documentary pin the death of defined benefit plans on 401(k) plans, people forget that limits placed on defined benefit limits set for the by TEFRA and the Tax Reform Act of 1986 did more damage to defined benefit plans as it limited the benefit and compensation earned by the top people for the employers maintain them. So while people think that limiting benefits to the top paid people was a good thing, it hurt lower paid people worse. The coverage of lower paid people in defined benefit plans went from 24% in 1981 to about 17% in 1987 because so many employers wanted to chuck defined benefit plans because they were no longer a bigger bang for the buck, thanks to these limits.

So imagine what this latest proposal will do to 401(k) plans. People who forget history are soon doomed to repeat it.  Employers will terminate 401(k) plans if their top paid people have their benefits limited and the employers are forced to calculate and enforce that limit. We have a retirement plan crisis and any proposal that has the intended or unintended effect of having lower paid people saving for retirement plans must be stopped.

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One Response to The Unintended Consequences of Obama’s 401(k) Cap

  1. Absolutely, Ary. The mathematical equations are very simple in a National Retirement Policy (which I keep harping on). Retirement plans for organizations are voluntary; they are not mandated by a State or the Federal government. (Heaven help us if the decision-makers decided to eliminate qualified plans and instead establish a mandatory national retirement program designed and run by the Feds!!) We all know the structural basics of our current qualified plan environment: in order to encourage Employers to voluntarily establish and maintain retirement programs for their employees, Congress has provided three subsidies in the Internal Revenue Code: (1) the Employer’s contributions are a deductible expense of doing business, (2) the Employer’s contributions are treated as Deferred Compensation (not immediately taxable) with respect to the Employees in the retirement plan, and (3) the retirement plan’s trust is treated as a not-for-profit entity, such that investments therein are compounding in a tax-sheltered environment. So far, so good. There are many practitioners who will argue that the “best” goals for providing a retirement plan are to attract, retain, and motivate employees.

    But there is one final ingredient that must be present: the needs of the “Central Player(s)” must be addressed. That “Central Player” might be the principal shareholder of a for-profit entity, the CEO of a non-profit organzation, the physician or dentist of a medical establishment, or whatever the title/position for an organization that makes the decision about establishing and maintaining a retirement plan. While it may sound selfish and self-centered, the fact is that if the Central Player of an organization does not see his or her self-interest addressed by the qualified retirement plan, then it isn’t going to happen. I’ve been designing and establishing retirement plans for a long, long time, and the one steadfast presentation element I must always emphasize (sell) is the ultimate benefit to the Central Player(s). “What’s in it for you, Mr. Chief Executive?” How many CPAs would there be in the U.S. if the Central Player(s) were not asking the tax accountants to minimize their personal income taxes? Gotta take care of the people at the top. Any practitioners out there who “sell” retirement plans want to disagree with me on this basic tenet?

    My argument herein is not political. I’m first and foremost an American citizen, not a member of some political party. Mr. Obama has committed a very serious fundamental error, all in the name of a supposed “budget balancing” goal: reduce the ultimate benefit to the Central Player(s) in a qualified retirement plan. In so doing, he has illustrated formally that he (and his handlers and advisers) do not understand the requisite needs for a very important National Retirement Policy, and it’s most fundamental ingredient – – addressing the needs of the Central Players. The 1986 Act is vividly in front of our eyes; by reducing the retirement benefits in defined benefit plans, Congress effectively killed their import in our National Retirement Policy. That’s fact. Yet the elected President and Members of Congress have retirement benefits that are far superior to the Central Players in the public sector. Compare the eight years of a two-term President to the benefits of a highly-paid executive with only 8 years of service in the qualified plan arena. Would Members of Congress be willing to reduce their own retirement benefits? Would they be sitting in the elected chair they occupy if their retirement benefit had not been an important decisional factor? The FACT is that Mr. Obama’s decision to reduce the benefits of the Central Players will result in fewer retirement plans established and maintained. Which means that there will more citizens who will have inadequate income to support them in their retirement years; there will be more Wards of State for taxpayers to support. Put on your amateur economist cap and project that ill-advised Executive Decision by the U.S. President and Congress to the overall economy of the U.S.

    The behaviorists can postulate and extrapulate all they want, but the fact of human nature is that certain humans throughout the world look first and foremost to satisfy their personal interests, before they go to another goal such as providing for their employees in a retirement plan or a group medical plan. The trite saying is that “this is what makes the world go round.” It isn’t always the smartest or the prettiest. It’s not even most self-important or self-centered. And it is extremely important to understand and accept that this behavioral characteristic is not something immoral or illegal.

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