Rinse and repeat: will tax reform lead to more retirement account “revenue” tricks?

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I was recently reading an article by Mark Miller (columnist for Reuters), entitled “Will Republicans fund tax cuts by tapping retirement piggy bank?” (see his complete article at the bottom of this post), and it reminded me of an article I wrote in 2010 related to in-plan 401k Roth conversions and the way in which the federal government “raises revenue” in order to offset other tax cuts – even if those revenue raisers result in lower long-term revenue.

In the case of in-plan 401k Roth Conversion, let me explain further…  Prior to September 27, 2010, people who had a large pre-tax 401k balance, but had no plans to move away from their current employer (and thus, had no ability to move their 401k funds into an IRA), had no way of execute a “Roth conversion” – which essentially involves moving pre-tax retirement money into a post-tax (“Roth”) account.  For example, prior to 2010, someone with a $200,000 pre-tax IRA could move some (or all) of their retirement savings into a Roth IRA (assuming he/she was willing to pay tax currently, in exchange for tax-free distributions later), but someone with $200,000 in a pre-tax 401k could not.

The “Small Business Jobs and Credit Act of 2010” (signed into law by President Obama) provided $12 billion in temporary tax incentives (e.g., one-time 100% bonus depreciation – designed to encourage businesses to buy stuff), but there was a need to “raise revenue” in order to offset the tax revenue losses.  One way this was done was to allow in-plan 401k Roth conversions, which would encourage accountholders to convert to Roth, and thus, pay income tax.  Of course, the flaw of this logic, at least over the long-term, is that the more money ends up in Roth accounts, the less revenue the federal government will have in the future – because the tax revenue within the retirement account is collected up-front, rather than gradually as the person withdraws the funds during their “retirement years”.  [Side note: allowing anyone to execute a Roth conversion also leads to almost all large Roth accounts being held by high net-worth individuals, which has had collateral consequences and has drawn the ire of some lawmakers].

This brings us back to the possibility of major tax reform in 2017 (or beyond).  Will the federal government look for a way to utilize the 25.3 trillion dollars (as of 12/31/16) that are currently sitting in retirement accounts in order to meet short-term goals (e.g., 15% corporate tax rate)?  We shall see…


Will Republicans fund tax cuts by tapping retirement piggy bank?

By Mark Miller

Tax reform is up next for our Attention Deficit Disorder Republican government, which just rushed through a chaotic, ugly battle to reform our complex healthcare system. The fight over tax reform promises to be just as chaotic and ugly – and it could mean big changes for Americans saving for retirement.

The Republican tax plan will include huge tax cuts for the wealthy and corporations, reducing top income tax rates, rates on investment income and corporate tax rates. Our lawmakers will need to find new revenue somewhere to offset the cuts. That is where retirement saving could come into play.

To understand why, it is important first to understand this term: “Tax expenditure”.

This is Washington budget-speak for tax revenue foregone due to special tax treatment. The phrase refers to billions of dollars in tax code exemptions, deductions or credits. Tax expenditures are designed to benefit specific activities or groups of taxpayers; the most important include deductions taken by employers for employee health insurance costs, capital gains and mortgage debt interest.

The spectacular collapse of the U.S. House healthcare bill last week will ratchet up pressure to find revenue as part of any tax reform bill, since the proposed healthcare reforms were expected to cut federal deficits by $337 billion over the next decade. By some estimates, the tax reformers will need to find $1 trillion or more in new revenue.

Retirement saving is an attractive target – and one that has been in Republicans’ crosshairs before. Tax expenditures for retirement saving exceeded $158 billion in 2015, and will be more than $1 trillion from 2015 to 2019, according to the nonpartisan Tax Policy Center. That includes tax breaks on traditional pensions, 401(k)s and traditional and Roth IRAs.

“Going to the retirement trough certainly is one possibility”, said Shai Akabas, director of fiscal policy at the Bipartisan Policy Center.


The most ambitious retirement reform would place limits on the current system of tax-deferred saving in 401(k) and traditional IRA accounts, shifting the emphasis to Roth accounts. In a 401(k) or traditional IRA, income taxes are deferred until funds are withdrawn; Roth contributions are made with post-tax dollars, which keeps tax revenue in the current year.

The blueprint for this approach can be found in the 2014 tax reform plan crafted by former U.S. Representative Dave Camp, the Michigan Republican who chaired the House Ways and Means Committee at the time. Camp proposed capping employee deferrals into 401(k)-type plans at $8,750; any contributions over that amount would be taxed upfront (this year, the employee contribution limit is $18,000).

Camp also proposed requiring all employers with more than 100 workers to allow Roth contributions in their workplace plans. The income limits on Roth IRA contributions would have been removed, and contributions to traditional IRAs would have been disallowed.

Moves like this appear to generate new revenue by closing down expenditures, but that is partly because the government estimates tax revenue only for the coming 10 years – it does not account for income taxes collected on IRAs far into the future.

“It looks like you’re raising a lot of new money now, but from an actual macro budgeting standpoint, it doesn’t do that”, Akabas said.

Shrinking upfront tax preferences could dampen saving rates, he thinks. It also would encourage account “leakage” – the phenomenon of drawing down retirement savings for nonretirement purposes. Roth accounts permit withdrawal of principal at any time without penalty (taxes and penalties are levied on withdrawn investment returns until age 59-1/2; at that point, all funds can be withdrawn penalty-free on accounts held for at least five years).

More recently, House Republican leadership has signaled interest in creating a new Universal Saving Account (USA) that would permit contributions up to $5,500 per year of post-tax income, and that would be free of additional taxes going forward. It is somewhat like a Roth, with a big difference: funds could be withdrawn for any purpose at any time.

USA accounts could help address the lack of emergency savings in many households. But they also might discourage small businesses from offering retirement plans, according to Brian Graff, chief executive officer of the American Retirement Association, an umbrella organization for several pension and retirement plan professional associations.

“If you now have a tax-free saving account available, I’m not sure I need to have a retirement plan if I’m a small business”, he said. “That means employees are going to be less likely to save for retirement.”

Graff is pointing to the biggest problem here: making big decisions about retirement policy in the context of broader tax reform is the wrong way to go. Considering the huge retirement security challenges facing average American households, we should be considering policies aimed at encouraging people to save.

Cracking open the retirement piggy bank to offset tax cuts for corporations and the wealthy? That is an idea that should be resisted.