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Fiscal Cliff Talks Target Retirement Plans

Retirement plans are in congressional crosshairs for one basic reason: the tax-deductible contributions made to the plans cost the government tens of billions of dollars a year in reduced tax revenues.

December 3, 2012
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For the first time since the mid-1980s, retirement plans are being targeted by federal lawmakers looking for ways to reduce the government's massive deficit, benefits experts say.

The assault likely will come in two stages. The first is connected to the fiscal cliff, in which mandated spending decreases on federal entitlement programs and tax increases will kick in early next year unless lawmakers find a way to reduce the deficit.

The second stage, which experts say poses a greater threat to retirement plans, will come next year when lawmakers will look at a broader range of ideas to pare the deficit, perhaps as part of a tax reform package.

"It is absolutely clear that tax expenditures for retirement savings will be looked at in connection with tax reform," said Anne Waidmann, a director with PricewaterhouseCoopers L.L.P. in Washington.

"Retirement plans definitely are on lawmakers' radar," said Alan Glickstein, a senior retirement consultant with Towers Watson & Co. in Dallas.

"As part of tax reform, I don't think anything is off the table," said Alison Borland, retirement solutions leader with Aon Hewitt in Lincolnshire, Illinois.

Retirement plans are in congressional crosshairs for one basic reason: the tax-deductible contributions made to the plans cost the government tens of billions of dollars a year in reduced tax revenues.

Most vulnerable to the congressional hunt for revenues will be the amount of contributions employees can make to 401(k) plans. Under current law, employees—regardless of their income—can contribute up to $17,000 a year to 401(k) plans in 2012, with that maximum increasing to $17,500 next year.

In addition, employees age 50 and older can make up to $5,500 in annual catch-up contributions to the plans.

Reducing those maximum pretax contributions would increase employees' taxable incomes and, with that, increase the amount of taxes they pay.

While such a step would raise revenues and reduce the federal deficit, benefits lobbyists say such an approach would be counterproductive.

"You are cutting off your nose to spite your face. It would backfire later on," said Lynn Dudley, senior vice president-policy with the American Benefits Council in Washington.

If contribution limits are cut, employees will have less savings at retirement, putting more pressure on financially stressed federal programs, such as Social Security.

Employer plans have a double value, Dudley said. "When the money comes out, it is taxable and it reduces the need for public programs," she said.

Dudley also said tax expenditure figures don't take into account that when 401(k) plan participants receive distributions, such as at retirement, that money is fully taxable.

Whether lawmakers will take an ax to employer retirement plans isn't known, but there is precedent for such action.

In 1986, as part of legislation that ultimately became the Tax Reform Act of 1986, lawmakers slashed to $7,000 from $30,000 the maximum annual contribution employees could make to 401(k) plans.

They also tightened non-discrimination tests on 401(k) plans, effectively reducing how much higher-paid employees could contribute to the plans.

Lawmakers targeted retirement plans in other ways. The 1986 tax law ended the ability of higher-paid employees covered in employer plans to also contribute to individual retirement accounts, imposed a 10 percent excise tax on surpluses employers recovered after they terminated overfunded pension plans, and reduced the number of years employees had to participate in a retirement plan before fully vesting in the benefits they had earned.

But some of those cutbacks were partly reversed by lawmakers. For example, in 2001—a time of big federal budget surpluses—Congress passed legislation boosting maximum 401(k) plan contributions, and other changes, such as increasing the amount of employee compensation that could be counted in calculating pension benefits, that enabled retirement plans to provide richer benefits.

Lawmakers this time around could aim their deficit reduction arrows in other benefits areas as well. For example, lawmakers have been discussing a gradual increase to the age in which individuals are eligible for Medicare, now 65.

Such a change would affect employers in two ways: For employers without retiree health care plans, more employees would stay on the job longer, increasing their health care costs. For those with retiree health care plans, a higher Medicare eligibility age would lengthen the time their employer plans—not Medicare—would be the primary payer of retired workers' health care claims.

Jerry Geisel writes for Business Insurance, a sister publication of Workforce Management. Comment below or email editors@workforce.com.

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