One such area that received attention is the current level of deductions for qualified retirement plans like 401(k)s. It is interesting that this is being done against a backdrop that indicates that the public is not saving enough toward retirement. 

There have a number of proposals that have been floated, including the Simpson-Bowles plan, which calls for reducing the limits on contributions to employer-sponsored qualified retirement plans and individual retirement accounts to 43% of their current level.

One specific proposal has been to limit 401(k) deferrals by employees to the lesser of $20,000, or 20%. This approach seems to hurt low-paid employees more significantly than high-earning employees.

An employee earning $100,000 annually could contribute $20,000, $3,000 less than the current $23,000 amount. In contrast, an employee earning $40,000 annually would be limited to contributing $8,000. This doesn’t appear to be equitable.

In addition, a low-earning employee wouldn’t have the discretionary income to contribute more than 20% of his pay—and that might be more than enough. However, people who have been out of the workforce for an extended period would be adversely impacted by this proposal because they weren’t able to contribute to a 401(k) plan during that time. They would need to catch up to meet their savings goals.

Another proposal that is being floated deals with capping the maximum tax rate for the income tax deduction to 28%. This means that, if a taxpayer is in the 39.7% marginal tax rate, he would only be able to deduct a portion of his contributions. Yet, when he withdraws his 401(k) plan balance—presumably at retirement—the full amount will be subject to income tax.

As a result, people who are in a high-income tax bracket at the time they contributed to the plan would be in a situation where a portion of their 401(k) contributions would be subject to “double taxation.” Only a partial amount of their contributions would be on a pre-tax basis, but fully taxable when withdrawn. 

Clearly, the United States needs to solve its budget deficit issues. The largest items in the federal budget are so-called entitlement programs, Social Security and Medicare. If the government is going to meaningfully resolve the burgeoning deficits, it will need to make some changes.

One widely discussed measure is to postpone the eligibility age for receiving benefits—which means people would have to save more through 401(k) plans and IRAs. But enacting limits that discourage establishing 401(k) plans because a company owner doesn’t perceive enough of an advantage over an IRA doesn’t help employees, if a plan isn’t established. 

Policymakers are astute enough to understand the potential disincentive to 401(k) plans, and they are likely aware of that possible consequence.

It has been reported that Sen. Tom Harkin (D-Iowa) and Sen. Mike Enzi (R-Wyo.) have been working to craft legislation that would create a new retirement plan called “Universal, Secure and Adaptable (USA) Retirement Funds.” It would combine features of defined-benefit and defined-contribution plans. Under the proposal, employers and employees would contribute to an independent, privately managed fund that would invest their savings and pay retirees an annuity for the rest of their lives.

A key consideration is how much the employer mandatory contribution will be. Previously, Sen. Harkin has advocated for employers to make “modest contributions” to this type of account.

There is no doubt that changes are afoot with regard to tax legislation, particularly retirement plans. Independent agents need to stay abreast of changes—for themselves and their clients.

Dave Evans is a certified financial planner and an IA l-h contributing editor.