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Retirement and deficit reduction

By Jennie L. Phipps · Bankrate.com
Sunday, December 5, 2010
Posted: 10 am ET

The deficit reduction panel, otherwise known as the National Commission on Fiscal Responsibility and Reform, released its final recommendations this week. One of the things it took aim at is tax-advantaged 401(k) savings accounts, an important part of most people's retirement planning.

The proposal would:

  • Consolidate retirement accounts (401(k)s, IRAs, SEPs, etc., into one retirement savings plan.
  • Cap tax-preferred contributions to lower of $20,000 or 20 percent of income.
  • Expand the saver's credit.

I asked Fidelity Investments, the nation's largest provider of 401(k) plans, and Prudential Financial, also a significant provider of these plans, what they think the impact of these potential changes would be. Both replied that the question was too complex for them to answer immediately and they would be studying the issues.

Meanwhile, the the American Society of Pension Professionals & Actuaries put out a statement saying it was "deeply concerned." The organization's chief actuary, Judy Miller, pointed out that the current caps are higher for tax-advantaged savings and argued that limiting rather than increasing them is counterproductive for a nation that needs to encourage people to save as much as they can for retirement.

Here are the 2011 caps for the most popular retirement savings plans and the current income limits for the saver's credit that augments retirement savings for low- and moderate-income savers.

On the surface, limiting the tax advantages of saving in a retirement account to $20,000 wouldn't seem to affect most savers. The average income in the U.S. is $50,000. At that level, 20 percent is $10,000. People with incomes of twice the average still could save 20 percent of their incomes and enjoy a tax deduction.

Miller says her organization, whose customers are primarily small- and mid-size companies, believes that the committee's recommendations are shortsighted, because they discourage businesses and their higher-earning owners and executives from providing retirement savings plans and matches for their employees, in some part because high-earning decision-makers wouldn't benefit as much under-capped plans.

"The sum of these recommendations would sharply reduce the incentive for employers to set up and maintain profit-sharing plans. ... Simply put, the retirement security of American workers will greatly suffer if the Deficit Reduction Commission's recommendations are enacted," the actuaries said in a statement.

Losing an employer 401(k) match would undoubtedly hurt many retirement savers, but higher earners who would be affected most are offered some trade offs in the plan. For instance, the punishing alternative minimum tax and the PEASE and PEP taxes that limit deductions for higher earners disappear, and the tax bracket for highest earners is capped at 28 percent, a 7 percentage point drop from the current top rate and an even bigger drop from pre-Bush tax levels.

There are going to be losers and winners in every scenario. To me, this looks like it could be a draw.

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