Sign up today and take advantage of member-only content — the kind of timely, cutting edge industry insight that only Money Management Executive can deliver.
  • Exclusive Online Only Content
  • Free Daily Email News Alerts
  • Asset Management Blogs

Critics Assail Fund-Friendly Growth Act: Pension Industry Plans Vigorous Opposition


The Growth Act, a surprisingly obscure piece of tax code reform legislation that could be a boon for the mutual fund industry, has found a key ally in the Investment Company Institute.

Unfortunately, it's also found itself in the crosshairs of another, equally powerful Washington lobby that could quiet the newborn legislation before it's heard outside the Beltway.

The American Society of Pension Professional & Actuaries (ASPPA), a group that represents the $5 trillion private pension system and its 5,500 professionals on Capitol Hill, released a study earlier this month called "Savings Under Tax Reform: What Is the Cost to Retirement Savings."

Principally targeting President Bush's advisory panel on tax code simplification, the study supports the need for reform but is obviously skeptical of any measure that might jeopardize participation in employer-sponsored, qualified retirement plans.

In particular, the study's authors, former Congressional Joint Committee on Taxation members Judy Xanthopoulos and Mary Schmitt, express fear over proposals, like the Growth Act, that would eliminate the tax on capital gains and dividends in mutual funds.

"Reductions in capital gains and dividend tax rates would provide greater tax advantages to individuals investing in stocks, mutual funds and other capital investments, which would create a significant disadvantage to investing through the employer-sponsored retirement plan system," the authors concluded, additionally characterizing mutual funds held outside of employer-sponsored plans as "short-term" savings vehicles.

Smitten With Tax Breaks

But tax breaks are exactly why the mutual fund industry is so smitten with the bi-partisan Growth Act. Introduced in the House of Representatives three weeks ago by Reps. Paul Ryan (R-Wis.) and William Jefferson (D-La.), the Generating Retirement Ownership Through Long-Term Holdings Act (H.R. 2121) would optimize the tax code for millions of Americans who are saving for retirement through mutual funds. Whereas capital gains on today's mutual fund accounts are taxed every year, under the Growth Act taxation would be deferred until the fund shares are sold.

"That keeps more retirement savings invested longer and growing longer by taxing income when it's withdrawn, not savings while they are being built up," said ICI President Paul Schott Stevens.

Modifying the tax treatment so that gains are allowed to compound for taxation when shares are sold rather than being nicked year-by-year, Stevens observed during the ICI's officials endorsement of the act three weeks ago, would dramatically help the broad spectrum of American mutual fund investors saving for retirement.

For starters, Growth Act proponents say that such a modification would encourage more middle-income taxpayers to build retirement portfolios, where, unlike those with higher income levels, they have previously demonstrated an inability to rearrange their finances and avoid capital gains.

Such a deferral would also recognize shareholders' expectations, they say, because people who choose to reinvest, rather than collect a dividend, should not find themselves taxed on what they did not receive.

For example, according to figures released earlier this month by Lipper, taxable mutual fund investors, over the last 10 years, have lost an annual average of 20% to 38% of their load-adjusted returns to taxes.

And capital gains taxes are only headed upwards, Lipper data suggests. Coming off multi-year performance lows, short- and long-term mutual fund capital gains increased 126% and 404%, respectively, in 2004.

The Growth Act, Stevens added, would therefore recognize the unique nature of mutual fund investing.

"Long-term investors need a long-term tax policy," Stevens said.

That position, however, runs contrary to the agenda at the ASPPA, as well as key allies like the Small Business Council of America and the Profit Sharing Council of America. Their modus operendi is to encourage Americans to participate in qualified employer-sponsored pension programs that already provide for tax deferrals on capital gains.

According to Brian Graff, executive director and CEO of ASPPA, the success of the employer-sponsored retirement plan system relies on today's tax code. While he admits that the code is not perfect and invites improvements, his organization thinks anything but the most prudent of reforms could inadvertently make things worse.

"We're concerned about the Growth Act, or anything that is going to make qualified plans seem less attractive," Graff said in a recent telephone interview.

The issue, Graff contends, goes beyond what might be perceived as nothing more than the fiercely competitive landscape of the financial services industry. While the ICI argues that tax deferral on capital gains and dividends within mutual funds would allow more Americans to invest for their retirement, Graff claims reforms like the Growth Act will accomplish exactly the opposite.

Income & Discipline'

"Access to a mutual fund is not restricted," said Graff, whose members represent three-quarters of the nation's qualified retirement plans. "Put money in an employer-sponsored 401(k) and you can't take any out. Lower-income people may not have the discipline to keep their money in a mutual fund."