A Deja View on Retirement Policy?

One of my favorite movies — and perhaps my favorite “holiday” move — is Groundhog Day, the 1993 film starring Bill Murray as an arrogant weatherman who finds himself stuck in Punxsutawney, Penn. by a blizzard, who then discovers that he is also “stuck” reliving February 2 — over and over and over. A feeling, quite literally, of “déjà vu all over again.”

Murray’s character goes through some semblance of the five stages of grief (denial, anger, bargaining, depression and acceptance) as he comes to terms with his predicament, but even as he tries to break out of this cycle, he learns from his past experience(s) and modifies his behaviors accordingly; avoiding stepping in a deep puddle of slush, ducking an insurance salesman, and even carrying his own jack to help change a tire. Eventually, of course, all that “learning” pays off, though not without a lot of pain and frustration.

There was, in fact, something of a feeling of déjà vu in President Obama’s budget proposal yesterday, certainly with regard to workplace retirement plans. In addition to some new incentives around encouraging automatic enrollment and expanding access to part-time workers, making a return appearance was giving the Pension Benefit Guaranty Corporation (PBGC) the authority to set risk-based premium rates for pension plans and the administration’s proposal to mandate employer offering of “automatic” IRAs who do not already offer a workplace retirement plan, this time channeled to the myRA structure outlined a year ago.

The 2016 budget proposal also resurrects the notion of imposing a reduction on the value of itemized deductions to 28% — including retirement contributions, and the imposition of a retirement savings cap.

Arguably, these proposals stand little chance of making their way into reality. That said, the latter two proposals in particular are blunt policy instruments, and seem likely to reduce, not enhance, the nation’s retirement security prospects.

Consider that a year ago when the savings cap was introduced in the 2015 budget, projections by the nonpartisan Employee Benefit Research Institute (EBRI) show that more than 1 in 10 current 401(k) participants are likely to hit the proposed cap sometime prior to age 65, even at the current, albeit historically low, discount rate of 4%. When you apply the higher discount rate assumptions closer to historical averages, the percentage of 401(k) participants likely to be affected by these proposed limits increases “substantially,” according to EBRI.

As for the itemized deduction cap, it would mean that those affected — likely those making the decisions on matching contributions of offering a plan in the first place — would pay taxes on contributions in the year the contributions are made, and then again at the full rate when contributions are distributed at retirement. How’s that for dis-incentivizing workplace retirement savings?

Indeed, perhaps the thing most troubling about the latter two proposals in particular is that they reveal a basic misunderstanding about the interrelationship between the incentives to employers to offer these programs, and the existence and expansion of these plans.

In sum, they don’t appear to understand that if you diminish the incentives to employers of participating in workplace retirement plans, you’ll likely see fewer retirement plans in the workplace.

So, while we’d like to think that those guiding retirement policy would learn from their mistakes, it looks like instead it’s déjà vu all over again.

- Nevin E. Adams, JD

Ripple Effects

One of my favorite short stories is Ray Bradbury’s “A Sound of Thunder.” The story takes place in the future when, having figured out time travel, mankind has found a way to commercialize it by selling safaris back in time to hunt dinosaurs. Not just random dinosaurs, mind you—cognizant of the potential implications that a change in the past can ripple through and affect future events, the safari organizers take care to target only those that are destined to die in short order of natural causes. Further, participants are cautioned to stay on a special artificial path designed to preclude interaction with the local flora and fauna. Until, of course, one of the hunters panics and stumbles off the path—and the group finds that, upon returning to their own time, subtle (and not so subtle) changes have occurred. Apparently because in leaving the path, the hunter stepped on a butterfly—whose untimely demise, magnified by the passage of time produced changes much larger than one might have expected from its modest beginnings.

The recently released White House budget proposal for 2014 included a plan to raise $9 billion over 10 years by imposing a retirement savings cap for tax-preferred accounts. While initial reports focused on the aggregate dollar limit of $3 million included in the text, it soon became clear that that figure was merely a frame of reference for the real limit: the annual annuity equivalent of that sum, $205,000 per year in 2013 for an individual age 62.¹

Of course, there are a number of variables that influence annuity purchase prices. As an EBRI analysis this week outlines, while $3 million might provide that annual annuity today, if interest/discount rates were to move higher, that limit could be even lower. As the EBRI analysis explains, if you look only as far back as late 2006, based on a time series of annuity purchase prices for males age 65, the actuarial equivalent of the $205,000 threshold could be as low as $2.2 million—and a higher interest rate environment could result in an even lower cap threshold.

At the same time, the passage of time, which normally works to the advantage of younger savers by allowing savings to accumulate, tends to increase the probability that younger workers will reach the inflation-adjusted limits by the time they reach age 65, relative to older workers. The Employee Benefit Research Institute’s Retirement Security Projection Model® (RSPM) allows us to estimate what the potential future impact could be. Utilizing a specific set of assumptions,² EBRI finds that 1.2 percent of those ages 26–35 in the sample would be affected by the adjusted $3 million cap by the time they reach age 65, while 4.2 percent of that group would be affected by the cap of $2.2 million derived from the discount rates in 2006 cited above.

While the EBRI analysis offers a sense of how variables such as time, market returns, and discount rates can have, there are other potential “ripples” we aren’t yet able to consider, such as the potential response of individual savers—and of employers that make decisions about sponsoring these retirement savings programs—to such a change in tax policy.

Like the hunters in Bradbury’s tale, the initial focus is understandably on the here-and-now, how today’s decisions affect things today. However, decisions whose impact can be magnified by the passage of time are generally better informed when they also take into account the full impact³ they might have in the future.

Nevin E. Adams, JD

¹ With the publication of the final budget proposal, we also learned that the calculation of the threshold also includes defined benefit accruals. While our current analysis did not contemplate the inclusion of defined benefit accruals, it seems likely that the number of individuals affected will change. The White House budget proposal is online here.

² The specific assumptions involved taking age adjustments into account in asset allocation, real returns of 6 percent on equity investments, and 3 percent on nonequity investments, 1 percent real wage growth, and no job turnover. This particular analysis was focused on participants in the EBRI/ICI 401(k) database with account balances at the end of 2011 and contributions in that year. The assumptions used in modeling a variety of scenarios is outlined online here.

³ As with all budget proposals, most of the instant analysis focuses on the numbers. The objective in this preliminary analysis was simply to answer the immediate question: How many individuals might be affected by imposing such a cap on retirement savings accounts? Of necessity, it does not yet consider the administrative complexities of implementation and monitoring such a cap, nor does it take into account the potential response of individual savers and their employers to such a change in tax policy—all of which could create additional “ripples” of impact. The latter consideration is of particular importance in considering the implications of tax policy changes to the current voluntary retirement savings system.