Should you worry about the proposed cap on tax-deferred retirement accounts which appears in the draft Obama budget? Yes and…no, not really.
Yes because, in principle, any effort to reduce the value of your tax-deferred savings is a serious concern. Huge numbers of working Americans need the advantage offered by private, taxpayer-friendly retirement savings accounts. We should be amply encouraged to use them more.
The trouble with attempts to rein in “abuse” of the private retirement system is the chilling effect it might have on savers in the future. As it is, we don’t use them nearly enough: On average, the typical household only has $120,000 in such accounts.
Under the proposal, the benefits of tax-deferred 401(k) and IRA accounts would disappear after an amount necessary to finance an annuity that provides income of $205,000 per year, according to the proposed budget language.
That might be $3 million, or perhaps $3.4 million. What’s harder to know is how tough a ceiling that could turn out to be in the years to come.
The proposed cap in the Obama budget is clearly there to shut down overuse of retirement accounts by high-income folks, people who conceivably can put away $51,000 a year under current law.
That’s a tiny slice of taxpayers, for sure. But could you fall under the proposed cap?
A worker at age 25 who maxes out his or her 401(k) and gets the typical employer match might very well arrive right at that ceiling. It seems that the White House took the current allowable numbers for “ordinary” people and extrapolated a diligent-saver scenario to get their target number for the new Obama budget.
What’s less clear is how the cap would affect anyone who might seek to add on to that goal, say, by using a Roth IRA, deferring income through health savings accounts or otherwise taking advantage of retirement savings tools Congress presumably wants us to use.
It also punishes success. If your investments compound faster than you expected, should you suddenly stop saving? Hope for a market downturn? If that downturn comes in your last few years of work there’s really no way to make it back, is there?
So, the simple answer is: Write your Congressional representative if you feel a ceiling is bad policy.
Moreover, whatever happens in the current Obama budget or the next one, expect the debate to continue and for tax-friendly legislation of the past to be on the negotiating table for years to come.
On the other hand, so few Americans are anywhere near losing the tax advantage offered by private retirement accounts that it’s laughable. Having too much in your retirement accounts is exactly the kind of problem most Americans would love to have these days.
Nevertheless, policymakers should strenuously avoid creating the impression that retirement rules might change with a stroke a pen.
We’re not the best savers in the world, but a rule book that gets rewritten every few administrations is no way to encourage better behavior.