"Checks" and Balances

In about a month, the IRS will announce the new contribution and benefit limits for 2018 – and that could be good news even for those who don’t bump against those thresholds.

These are limits that are adjusted for inflation, after all – designed to help retirement savings (and benefits) keep pace with increases in the cost of living. In other words, if today you could only defer on a pre-tax basis that same $7,000 that highly compensated workers were permitted in 1986 – well, let’s just say that you’d lose a lot of purchasing power in retirement.

But since industry surveys suggest that “only” about 9%-12% currently contribute to the maximum levels, one might well wonder if raising the current limits matters. Indeed, one of the comments you hear frequently from those who want to do away with the current retirement system is that the tax incentives for 401(k)s are “upside down,” that they go primarily to those at higher income levels, who perhaps don’t need the encouragement to save. Certainly from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes.

Drawing on the actual account balance data from the EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), the nonpartisan Employee Benefit Research Institute has found that those ratios were relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000. (See chart.) In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes – and not “upside down.”

And yet, according to Vanguard’s How America Saves 2017, only about a third of workers making more than $100,000 a year maxed out their contributions. If these limits and incentives work only to the advantage of the rich, why aren’t more maxing out?

Arguably, what keeps these potential disparities in check is the series of limits and nondiscrimination test requirements: the boundaries established by Internal Revenue Code Sections 402(g) and 415(c), combined with ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to do just that – to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

Those who look only at the external contribution dollar limits of the current tax incentives generally gloss over the reality of the benefit/contribution limits and nondiscrimination test requirements at play inside the plan – and yet surely those limits are working to “bound in” the contributions of individuals who would surely like to put more aside, if the combination of laws and limits allowed.

One need only look back to the impact that the Tax Reform Act of 1986 had on retirement plan formation following the imposition of strict and significantly lower contribution limits – as well as a dramatic reduction in the rate of cost-of-living adjustments to those limits – to appreciate the relief that came in 2001 with EGTRRA.

Anyone who has ever had a conversation with a business owner – particularly a small business owner – about establishing or maintaining a workplace retirement plan knows how important it is that those decision-makers have “skin in the game.”

While we don’t yet know what the limits for 2018 will be, gradually increasing the limits of these programs to keep pace with inflation helps assure that these programs will be retained and supported by those who, as a result, continue to have a shared interest in their success.

And that’s good news for all of us.

- Nevin E. Adams, JD

Here We Go Again ...

What were you doing in 1986?

It was a big year in my life. I got married, hit one of those birthdays with a zero in it, watched my-then hometown Chicago Bears dominate Super Bowl XX, and picked up and moved my new bride (and our menagerie) several hundred miles south to take on a new job heading up a recordkeeping operation.

Before the end of that year, that recordkeeping operation (and, thanks to a recent bank acquisition, the seven different platforms it was running on) would be struggling to understand, implement and communicate a wide array of sweeping changes associated with the Tax Reform Act of 1986. Even though it came during a period when tax code changes (ERTA, TEFRA, DEFRA, REA), were being thrown at us about every 18 months, on average, it’s still difficult to absorb the scope and breadth of the work it took to implement the changes that came with TRA 86.

For all the work that had to go into complying with the new regulatory regimen that came with TRA 86, its real impact would come in the years that followed, via the newly established 402(g) limit (back then we simply called it the $7,000 limit), not to mention the multiple iterations of the nondiscrimination testing that often produced problematic refunds for the highly compensated group. There’s little question that those changes (and others) did what they were designed to do – generate additional tax revenue in the here-and-now by limiting the deferral of taxes.

Yes, the talk is all about tax reform, but the motivation is generally tax cuts, and with a $20 trillion debt, Uncle Sam will need to find some way to offset the projected loss in revenue – and that’s where the tax incentives to establish, fund and contribute to a workplace retirement plan inevitably find themselves in the budgetary crosshairs.

While those paying attention to such things realize that most of those tax preferences are temporary – that is, taxes will be paid on those employer, pre-tax contributions and the earnings thereon when they are withdrawn – the government bean counters look at revenues and expenditures within a 10-year window, and since the payment of most retirement benefits occurs outside that window, the amount of taxes postponed looks, from a budgetary standpoint, to be taxes permanently foregone. And, on that basis, even though the retirement preferences are completely different from other tax deductions, from a budgetary scoring standpoint, it’s a big, juicy target.

We saw what that might mean as recently as 2014 when then-Chairman of the House Ways and Means Committee Rep. Dave Camp (R-Mich.) put forth a proposal that would pay for tax reform (or at least some of it) by freezing the COLA limits that apply to defined contribution plans for a decade and limiting the annual ceilings on elective deferrals so that only half could be made on pre-tax basis (weirdly, this would have applied only to employers with more than 100 workers). The first part of the proposal was deemed to raise $63.4 billion in revenue over 10 years, the latter an additional $144 billion, by basically forcing workers who would otherwise have taken advantage of pre-tax savings to pay taxes on those contributions upfront. And let’s not forget that those burdens would have fallen particularly harshly on those who decide to offer these plans in the first place and to match employee contributions.

For those of us who remember 1986 – or perhaps the years in between that and EGTRRA – the references to TRA 86 as a model for Tax Reform 2017 are a bit chilling. Because when it comes to winners and losers in tax reform – and make no mistake, tax reform is all about winners and losers – more often than not, retirement comes out on the short end. And every time it does, it feels more than a little bit like having to bail out your brother-in-law with a loan from your 401(k) – again.

For months now we’ve been talking about tax reform, and the potential implications for retirement policy. It was a focus at this year’s NAPA 401(k) Summit, and it will be front-and-center at this year’s NAPA DC Fly-In Forum. The reason is obvious: If you’re going to lower tax rates and be revenue neutral, the money to offset those tax reductions has to come from somewhere. And traditionally, the tax preferences that foster the growth and expansion of retirement plans and retirement savings have been a “go to” source, perhaps never more so than a generation ago with TRA 86.

The road ahead could be rocky, particularly as it comes in the wake of the application of the Labor Department’s fiduciary regulation, whether delayed or not, and perhaps modified. It’s said that being forewarned is being forearmed, and we’ve certainly worked to do that over the last several months.
If you are not already, you’ll want to stay connected on these issues in the weeks ahead.

Get informed. Get involved. Before it’s too late.

- Nevin E. Adams, JD

A Pension Protection Perspective

It’s hard to believe, but the Pension Protection Act of 2006 will be a decade old next month. And it’s probably done more good for the nation’s retirement security than most realize.

The PPA drew its name from the portions targeted at shoring up defined benefit plans (and PBGC funding, I suppose), though at the time I remember most people thinking it was an ironic name, in that it may have been intended to secure the pensions that were already in existence, but might well accelerate the demise of some on the cusp, and in any event was unlikely to help spur any new growth in that area. Some went so far as to call it the Pension Destruction Act.

Indeed, at a recent panel session featuring the perspectives of a number of the Hill staffers who shepherded the at times controversial legislation through its passage, the emphasis was largely on the DB aspects that, though well-intentioned, had been overwhelmed (if not undermined) by the onset of the 2008 financial crisis and the “historically low” interest rate environment that continues to pressure pension funding to this day.

DC Developments

In contrast, the aftermath of the PPA on the defined contribution side has been nothing short of extraordinary. Sure it was all voluntary – the use of carrots like safe harbors for automatic enrollment, rather than the sticks that accompanied the DB provisions. And yet, seemingly overnight, and without a government mandate or regulatory imperative, the decades-old concept of “negative election” (now “rebranded” as automatic enrollment) became part of every credible retirement plan advisor’s toolkit.

Without relying on a mandate to impose its will, nearly overnight the paradigm on automatic enrollment shifted. Sure, it’s still far more common among larger employers than those downstream – and yet, those larger plans are where most participants are. And if the adoption of contribution acceleration has lagged behind automatic enrollment, it is nonetheless far more advanced than it would have been in the absence of the PPA.

For my money, the biggest long-term positive impact of all may have been the rapid expansion of the qualified default investment alternative (QDIA) as the plan default investment option. One need look no further than the millions of dollars in retirement savings that have been channeled into a range of professionally managed asset allocation solutions to appreciate the impact that change has had. All have significantly and positively moved the needle in helping enhance the ultimate financial security of thousands, if not millions, of American workers.

‘Staying’ Power

However, perhaps the most-overlooked, if not underappreciated, aspect of the PPA was that it made permanent the retirement savings incentives enacted under the Economic Growth And Tax Relief Reconciliation Act of 2001 (EGTRRA), including annual contribution limits for IRAs, Roth 401(k) plans, enhanced portability of retirement benefits, and reduced administrative burdens on plan sponsors. Without that support, all the gains made on those provisions would have fallen back. The PPA also made the Saver’s Credit permanent, as well as resolving legal uncertainty surrounding cash balance plans, and requiring DC plans to permit employees to diversify out of investments in employer securities if the securities are publicly traded.

The work is not done, of course. Innovative retirement income offerings continue to be introduced, but can’t seem to find traction, the focus on outcomes (these days generally under the banner of financial wellness) is still nascent, and the challenges of compliance with the DOL’s new fiduciary regulation lie ahead.

With so much progress made – and yet so much yet to be achieved – it may seem naïve in this exceedingly unusual election year to hold out hope that the nation’s legislative bodies could put their heads together and work together as constructively as they did just a decade ago.

But one can (still) hope.

- Nevin E. Adams, JD