The two candidates take different approaches in improving employee access to 401(k) plan balances and in lowering the taxes retirees pay when they receive a 401(k) plan distribution.
Under a proposal by Democratic nominee Sen. Barack Obama, 401(k) plan participants in 2008 and 2009 could withdraw 15 percent of their account balance, up to $10,000, for any reason and not be assessed the 10 percent penalty tax that now applies on such withdrawals. Regular income taxes would continue to be imposed.
The Obama proposal would be a big change from current law regarding withdrawals. In addition to being hit with both income and penalty taxes, such withdrawals now are allowed only if they meet hardship criteria laid down by the Internal Revenue Service.
Under a proposal by Republican nominee Sen. John McCain, distributions of up to $50,000 taken in 2008 and 2009 would be taxed at a 10 percent rate. Under current law, distributions are taxed as ordinary income. For retirees in the top tax bracket—now 35 percent—the change advocated by McCain would mean potential tax savings of up to $12,500 a year in 2008 and 2009.
In addition, while differing somewhat in detail, the proposals by McCain and Obama both would temporarily relax so-called minimum distribution requirements that now require retirees to start withdrawing funds from their 401(k) plans in the year in which they reach age 70. The distributions are based on life expectancies and increase with age.
Under the McCain proposal, the minimum distribution requirements would be suspended for one year, according to his advisors.
Retirees would reap a double benefit from a suspension. Depending on investment results, assets that remain in the 401(k) plan would have more time to earn investment income, while retirees would not be taxed on the contributions and investment income as long as the assets were not withdrawn.
Obama’s approach would limit to two years the suspension of the minimum distribution rules.
McCain said that unless the minimum distribution rules are suspended, retirees would be forced to sell plan assets at a time when asset values are very low. Obama, whose minimum distribution proposal was announced shortly after McCain’s, acknowledged the Republican candidate’s lead on the issue, saying he “had to give credit where credit is due.”
But the candidates weren’t as mutually supportive on their other 401(k) proposals.
McCain said Obama’s proposal to allow employees to take penalty-free withdrawals from their 401(k) plans would encourage withdrawals and exacerbate the decline of the equities markets.
“This is an invitation to capital flight, and therefore continued instability in the market, at a moment when the opposite is needed,” McCain said in a recent speech in Blue Bell, Pennsylvania.
Similarly, while McCain said his proposal to reduce taxes on 401(k) plan distributions was needed to provide relief to retirees to allow them to keep more of their savings, Obama staffers said the proposal was geared to aiding wealthier retirees.
Benefit experts say they aren’t surprised 401(k) plan issues are drawing the interest of the presidential candidates, given the recent dramatic fall in the equities markets.
“This a reflection of what is going on with the economy,” said Diann Howland, vice president of legislative affairs at the American Benefits Council in Washington.
Benefit experts question Obama’s proposal to allow participants to withdraw, without penalty, the lesser of 15 percent of their 401(k) account balance or $10,000.
Scott Macey, senior vice president and director of government affairs at Aon Consulting in Somerset, New Jersey, said a more focused approach would be to modify the proposal so that only those who qualify for hardship withdrawals would be exempted from the 10 percent penalty tax.
In fact, by allowing employees to withdraw funds without penalty from 401(k) plans, employees could be hurt: If they withdraw the funds now, they will have less plan assets available when they retire, said Mark Warshawsky, director of retirement research at Watson Wyatt Worldwide in Arlington, Virginia.
“Employees will end up hurting themselves,” said Michael Weddell, a consultant with Mercer in Detroit. “We don’t want people raiding their 401(k) plans for consumer spending,” said Kathryn Ricard, vice president of retirement policy at the ERISA Industry Committee in Washington.
If Congress were to approve Obama’s plan to allow penalty-free 401(k) plan withdrawals, employers would face the burden of amending their plans and communicating the changes to plan participants.
Benefit experts generally declined to comment on McCain’s proposal to temporarily cut the tax rate to 10 percent on 401(k) plan distributions up to a maximum of $50,000 a year for two years, noting that is more of a tax policy rather than a retirement plan issue.
Still, Aon’s Macey noted that while the concept “perhaps isn’t a bad one, the effect might be to encourage retirees to take distributions sooner than they needed.”
There is broad support, though, for easing, if not eliminating, the minimum distribution rules. For example, by forcing retirees to start taking money out at age 70, the chances of retirees outliving their account balances increases, Macey said.
Others note the policy behind the minimum distribution rules “raising tax revenue for the government” is suspect since the funds eventually will be distributed and taxed.
Workforce Management's online news feed is now available via Twitter