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.