Tax Reform Suggestions Raise Eyebrows: Critics: Employer Plan Participation, Annuities at Risk
November 14, 2005
A bi-partisan committee tasked with simplifying the Federal tax code recently delivered a pair of recommendations to the U.S. Treasury Department, but if the reception they've received from the money management industry serves as any indication, they're bound for a pitched battle on Capitol Hill.
At their roots, the recommendations seek to simplify a tax code that everyone agrees has become downright befuddling to America's 300 million taxpayers. As the President's Advisory Panel on Federal Tax Reform said in remarks that accompanied the recommendations, "Our tax code has been rewritten so often that it should be drafted in pencil." Those revisions have created a myriad of alphanumeric retirement plans, deductions, exemptions and credits that may have been practical for the group they originally sought to benefit, but have ultimately proved to be "a poor way to write a tax code," the panel said.
If its suggestions were drafted into more specific legislation, it would represent the most major tax reform package since 1986. The recommendations put forth by the panel include a simplified income tax plan, or "simplified plan," and a growth and investment tax plan, or "investment plan."
The simplified plan, according to the president's panel, cleans out targeted tax breaks that have cluttered the system, and lowers tax rates. It discards "gimmicks and hidden traps," such as the woefully perplexing alternative minimum tax, while it preserves and simplifies major features, like benefits for home ownership, charitable giving and healthcare.
It makes small business tax calculations easier and updates the corporate tax structure so that it's easier for U.S. companies to compete globally. Perhaps most importantly, it "removes disincentives to saving," the panel said.
Lower Taxes, Single Rate
The investment plan, meanwhile, builds on the simplified plan by adding a major new feature: moving the tax code closer to a system that would not tax families or businesses on their savings or investments. It would also lower tax rates and impose a single, low tax rate on dividends, interest and capital gains, as well as allow businesses to expense or write-off their investments immediately.
The Investment Company Institute has endorsed the recommendations as a valuable contribution toward making the tax code simpler, fairer and more conducive to economic growth.
"Of particular interest to the institute are the panel's suggestions related to reducing taxes on investments, which is important not only to helping Americans save for longer and more expensive retirements, but also to economic growth and making our country more competitive in the global market," said Paul Schott Stevens, president of the Washington-based lobbyist, in a statement.
But at least one group dismisses the panel's findings lock, stock and barrel.
The American Society of Pension Professionals & Actuaries (ASPPA), a Washington lobbyist that represents the interests of defined benefit and defined contribution plan professionals, said the panel's ideas would be "devastating" to the retirement security of millions of Americans and would effectively "take away America's 401(k)."
Chief among its complaints against the panel's findings is a savings proposal contained in both recommendations that would combine employer-sponsored defined contribution plans - the 401(k), Simple 401(k), Thrift, 403(b), governmental 457(b), SARSEP and Simple IRA - into one account, called a "Save at Work" account.
In arguing for the Save at Work account, the panel noted that while more than 90 million employees currently take part in a retirement plan at work, the number of different plans and their individual complexities creates a costly administrative and compliance burden. That deters employer sponsorship, said the panel, which additionally noted that just 53% of private employers offer a defined contribution retirement plan to their workers.
Small businesses, which employ about 40% of all American workers, find it particularly costly. The current system isn't necessarily fair, either, as workers whose employers match their contributions are treated more favorably than those whose employers don't offer a match.
Under both plans, Save at Work includes automatic enrollment, an idea that's been gaining great momentum among retirement planners. It automatically enrolls an employee in Save at Work unless they actively choose not to participate; employee contributions automatically increase over time; investments are automatically placed in broad index or lifecycle funds, unless the employee chooses otherwise; and plans are automatically rolled over if the employee changes jobs.
Under the simplified plan, however, the Save at Work account would operate under the current tax rules and contribution limits of a traditional 401(k), whereas under the investment plan, contributions would be made on an after-tax basis and distributions would be tax-free, much to the chagrin of ASPPA.
"Without the upfront tax deduction, we believe many workers currently saving in their 401(k) will not choose to save," said Brian Graff, director of the 5,500-member ASPPA.
But Ted Benna, founder of the 401(k) concept, said the recommendations generally make sense.