Ideas for Retirement Savings Reform

Most people won't look like this in retirement.

On 1/28/16, the Senate Finance Committee held a hearing on - Helping Americans Prepare for Retirement: Increasing Access, Participation and Coverage in Retirement Savings Plans.  This isn't the first time for this topic.  There were a few hearings on this in 2014. I'm not sure if anything is driving the renewed attention to this topic now.  While tax reform is challenging in an election year, this important topic seems good for any year.  There is a need for reform of the tax rules for retirement plans to make them more equitable and simple to help more people save for retirement.

Here are a few suggestions I have for reform in this area.  They focus on equity.  I submitted these to the Senate Finance Committee in April 2015 when they were seeking ideas for tax reform via their working group project.  I'll likely submit them again and add more on simplification. One overall reform I recommend is to change the focus of retirement plans from the employer to the employee, making them truly portable from job to job and if in employee or contractor status or both.

Bring greater equity to retirement savings rules and better enable young people to save for retirement. Possible approaches include:

·         A simple system to enable all workers (employees and self-employed individuals) to have a retirement savings account. This should occur for both part-time and full-time workers and even if an employer does not help with administration or contributions.

·         Retirement savings contributions should be coordinated with payroll tax deductions. A system to enable self-employed individuals to also make contributions along with self-employment tax payments should be considered.

·         Find ways to help individuals improve their financial literacy.

·         Portability. Be sure the system allows for contributions to be made to one account even if a worker changes employers or also has income from self-employment.

Example of a new approach: The first time an individual receives a W-2 or pays self-employment tax (whichever happens first), the government could set aside a set dollar amount in a retirement account for that person. This would constitute the start of their retirement account that would be used for all future contributions; there would be only one account. When the individual works for an employer who also wants to contribute to employee retirement accounts, such funds are placed in the individual's existing account. Also, for each paycheck or quarterly estimated tax payment of a self-employed individual, an amount would be contributed to their retirement account. Individuals could be allowed to transfer their retirement account to a commercial broker for management or let it stay with the federal government. The federal government could be allowed to transfer management to third parties for a fee.

Annual reporting would be required to let individuals know their account balance and other details. Rules would continue to exist, but in more simplified form, governing how much could be contributed annually, how much employers could also contribute, the age when distributions may begin, hardship withdrawals, etc.

Benefits of this type of approach:

·         All individuals who work would have a retirement account. This single account would be used whether they are an employee or sole proprietor or both.

·         The initial contribution from the government ensures that all workers start a retirement account.

·         The initial contribution from the government may also encourage individuals to be tax compliant from the start of the time they begin earning money.

·         The system ties to payroll tax withholding and so should not be burdensome to any size employer since they already are required to comply with payroll tax rules.

·         For low-income workers, the annual contribution could be made via part of the earned income tax credit (EITC) the worker receives.

What do you think? What would help all individuals better save for retirement?

IRA and 401(k) rulings - the law is complicated!

There have been a few rulings recently involving IRA or 401(k) distributions that led taxpayers to court. That's a lot of time and expense. One taxpayer was a tax lawyer in a large law firm who would be viewed as a tax expert - with tax knowledge well beyond most (he lost in court). Another involved a wife (later to become ex-wife) taking funds from her husband's IRA without his knowledge. And another case involved an ex-wife using her ex-husband's 401(k) to obtain money he owed her. Without knowledge of the tax law or how to think in a tax-like manner, she did not realize she would owe tax on that distribution and should have instead told the husband to take the distribution and pay her from those funds.

Yes, the law is complicated. I don't think it can be fixed to help someone stealing funds from a spouse, but it should not be so complicated as to trip up a tax expert or someone who really thought she was just getting a debt repaid.  I think there are ways to simplify all of this. Perhaps only allowing Roth IRAs would be a way to go. What do you think.

Click here for my summary of and links to the three rulings at CPELink's blog site.

What do you think?

Tax Day - April 15, 2014 - It Can Be Easier

The complexity of completing one's federal and state income tax returns is not necessarily tied to one's income level. One of the more complex federal tax rules is the Earned Income Tax Credit (EITC) for low-income workers. Could the individual income tax be simpler? Yes.  Here are some ideas.

• Make all income you received subject to tax. What is income? Let's say it is anything that increases your wealth. So, it would be any payment from the government, debt forgiveness, gross wages, employer-provided health insurance, scholarships, gains from selling assets, etc. What would not be income? Borrowing money (it does not increase your wealth because you have an offsetting liability). Receipt of expense reimbursements from your employer (it makes you whole for what you, in essence loaned to your employer when you incurred the expense).  The simplification comes from not needed to determine if something you received is taxable; generally, it would be.
• Allow very few non-business deductions.  It should just be personal and dependency exemptions that, in effect, remove from your income what it takes to live. The rationale is that you need some portion of your income to live and it should not be available for paying taxes. The amount should be tied to some multiple of the poverty level based on family size and your address to reflect that it costs more to live in some parts of the U.S. 
• Allow business deductions including an inflation-adjusted expensing amount (Section 179) that would provide simplification and incentives to small to medium sized businesses. Expensing should apply to both tangible and intangible personal property.
• Address equity issues with simple rules. For example, the state condemns your personal or business property resulting in you realizing a gain. But, you want to (or need to) buy replacement property. If you have to pay tax on the gain, you may not have enough for replacement property. So, keep a simplified Section 1033 on involuntary conversions that allows for gain deferral. Perhaps also allow for deferral of cancellation of debt income for insolvency or bankruptcy (to help with a fresh start for the person). The balance of the current, lengthy and complex cancellation of debt income exclusion rules could be removed. Others? There will be situations where someone has had some unusual, bad, expensive event, such as a casualty or large medical expense, that prevents them from having sufficient funds to pay their income tax. Some simple, limited rules for these types of events should be provided. We'd also need simple rules to ensure that income earned outside of the U.S. was not taxed by two countries. A foreign tax credit not to exceed what the U.S. tax on the income would be should work.
• Retirement plans and savings - this is a bit more challenging. Individuals should be saving for their retirement.  The money you put into your retirement is money not available for paying taxes.  Also, if you pay tax on the income when earned and again when withdrawn, that doesn't seem fair (except for what you pay on the income earned while the money was in the retirement account). Also, lower income individuals will need an incentive to fund a retirement account due to limited funds. So, should they get a deduction for putting funds in a retirement account?  Retirement rules is an area of our tax law in need of significant reform. The current rules primarily benefit higher income individuals as they can take better advantage of the rules. The rules are also complex due to the number of different types of retirement plans.
• Education incentives - today there are at multiple, duplicative, complex provisions offering various tax savings for higher education costs. I think that for the most part, this should all be taken care of outside of the tax law because there is already a system in place, such as for Pell Grants. When these rules are brought into the tax law, they primarily benefit those with enough income to owe tax - individuals who likely don't qualify for Pell Grants. But, what about my earlier point that the student receiving the scholarship will include it in income? Should they get some tax relief?  Or should we expect them to work to get the money to pay tax on the scholarship or seek a gift from family and friends?  Perhaps some version of the current American Opportunity Tax Credit (AOTC) should remain. It would also help the student without a scholarship or Pell Grant who is working to pay for tuition. It would not need to be refundable because once your tax is down to zero due to your personal exemption, you are not paying tax on the scholarship. Tax rules for higher education also need attention for simplification and equity issues. For example, the current AOTC is for the first 4 years of college, providing a maximum annual credit of $2,500.  That has differing results for these two students: (1) Ann who attends a private university for 4 years; gets a $10,000 benefit from the government. (2) Barbara who attends community college for 3 years where the annual tuition is less than the AOTC amount so she doesn't get full benefit of the credit and then she attends public university for 3 years to complete her degree and where the tuition is higher.  Her total benefit is less than $10,000.  This needs to get fixed.
• Other changes?  
• Lower tax rates to reflect that the tax base is larger with the above changes. With lower tax rates, capital gains should be taxed at those same rates. 
• The net investment income tax (3.8% Medicare tax for high income individuals) should be repealed (an adequately progressive income tax rate structure would take care of it). 
• AMT should be repealed because there should be only one minimum tax and removal of most of the special deductions, exclusions and credits would leave no need for it.
• Some replacement should be made for the current income exclusion for state and local bond interest income. This exclusion benefits higher income individuals who buy the bonds and it helps state and local governments. Whatever the average annual "cost" to the government has been for the exclusion for the past five years should become a fund that the federal government would make available to state and local governments to replace the lost benefit of the exclusion.  And add the caveat that they can only get the funds if they conform their state income tax to the new, simplified federal income tax system (to better ensure true simplification for individuals).
• More simplification such as fewer penalties and clearer rules on worker classification.

What do you think?

Modernizing retirement plans and savings

The congressional tax committees have a website for people to submit tax reform ideas and comments - https://taxreform.gov/.

Here is one I submitted on May 26:

Rethink Retirement Plans and Savings Incentives for the Modern Era

Several changes have occurred which make retirement savings more important to workers, but which also make it more difficult to build such savings. For example, years ago, many employees could expect to have a defined benefit type retirement vehicle provided by their employer. This required little action by employees. They did not have to understand investment options, contribution requirements, and tax rules. Today, many employees are offered no retirement plan and thus, must figure out on their own how to establish one. They have a choice of tax vehicles for an IRA (such as regular or Roth) and they have many options as to where to set up their IRA (stock brokerage firm, bank, etc.).

Many workers do not expect to stay, and in fact do not stay, at one employer for many years. Thus, even if an employer sponsors an IRA or 401(k) plan, the employee will need to be involved in the management and movement of the funds when they change jobs. Employees who changes jobs several times could end up with multiple accounts if they do not or cannot consolidate the funds saved at each place of employment into a single retirement plan.

There is a greater need for workers to have retirement savings today than was true decades ago because people are living longer.

Tax law changes to increase the number of workers participating in retirement plans should consider the following:

• A simple system to enable all workers (employees and self-employed individuals) to have a retirement savings account. This should occur for both part-time and full-time workers and even if an employer does not help with administration or contributions.
• Retirement savings contributions should be coordinated with payroll tax deductions. A system to enable self-employed individuals to also make contributions along with self-employment tax payments should also be considered.
• Find ways to help individuals improve their financial literacy.
• Portability. Be sure the system allows for contributions to be made to the one account even if a worker changes employers or also has income from self-employment.
• Strive for simplicity.

The government can play a role in establishing accounts, simplification, and educating individuals.

Example of a new approach: The first time an individual receives a W-2 or pays self-employment tax (whichever happens first), the government could set aside a set dollar amount in a retirement account for that person. This would constitute the start of their retirement account that would be used for all future contributions; there would be only one account. When the individual works for an employer who also wants to contribute to employee retirement accounts, such funds are placed in the individual's existing account. Also, for each paycheck or quarterly estimated tax payment of a self-employed individual, an amount would be contributed to their retirement account. Individuals could be allowed to transfer their retirement account to a commercial broker for management or let it stay with the federal government. The federal government could be allowed to transfer management to third parties for a fee.

Annual reporting would be required to let individuals know their account balance and other details. Rules would continue to exist, but in more simplified form, governing how much could be contributed annually, how much employers could also contribute, the age when distributions may begin, hardship withdrawals, etc.

Benefits of this type of approach:

• All individuals who work have a retirement account. This single account would be used whether they are an employee or sole proprietor or both.
• The initial contribution from the government ensures that all workers start a retirement account.
• The initial contribution from the government may also encourage individuals to be tax compliant from the start of the time they begin earning money.
• The system ties to payroll tax withholding and so should not be burdensome to any size employer since they already are required to comply with payroll tax rules.
• For low-income workers, the annual contribution could be made via part of the earned income tax credit (EITC) the worker receives.

What do you think? 

Have you submitted any proposals?

 

The Pressing Need to Rethink Our Existing Tax Rules for Retirement Savings

On 6/26/08, the House Ways & Means Committee held a hearing on Individual Retirement Accounts (IRA) due to concern over underutilization and reasons why many small businesses did not offer some type of IRA plan for workers. The GAO report on the topic was highlighted. Subsequent to this hearing, a few other committees held hearing on retirement savings and a report was released by Ernst & Young on people not having enough to live on in retirement.
There are some troubling data and realities about IRA participation and inadequate retirement savings. For example:

For 2004, 79% of all taxpayers were eligible to make an IRA contribution (about 145 million taxpayers). Just 14.7 million taxpayers made a contribution though (about 10%). Participation was highest for taxpayers with $200,000 or more of AGI and that group also made the largest average contribution. For eligible taxpayers with positive AGI, participation was greater among higher income taxpayers. [Bryant, Accumulation and Distribution of IRAs, IRS, 2004]

In 2001, 60% of taxpayers either had assets in or income from an IRA or employer-sponsored plan. Thus, 40% of taxpayers have no retirement accounts although they may have other assets for retirement. (Sailer & Holden, IRS, 2004)

I have more information in a short article - Rethinking IRAs.

On 7/10/08, the Joint Economic Committee held a hearing on the shift from defined benefit plans to defined contribution plans, the greater risk upon workers under DC plans, and the greater return DB plans produced. A representative of the venture capital industry noted the importance of DB plans to providing funds for investment.

On 7/16/08, the Senate Special Committee on Aging held a hearing on people not saving enough for retirement, the recent increase in hardship withdrawals from 401(k) plans and the possibility of "automatic IRAs" that allow for payroll contributions to IRAs. Click here for more information on this topic from Chairman Kohl.

The EY report (July 2008) - Retirement vulnerability of new retirees, found that "almost three out of five middle-class new retirees can expect to outlive their financial assets if they attempt to maintain their current pre-retirement standard of living. To avoid outliving their financial assets, middle-class retirees will have to reduce their standard of living, on average, by 24 percent." The report was prepared for Americans for Secure Retirement.

Living longer, inadequate participation in retirement savings, financial illiteracy, greater personal responsibility for managing retirement savings (DC versus DBs), frequent job changes, and retirement tax rules that are skewed to benefit higher income individuals all point towards a retirement savings crisis that will cause people to work longer, put pressure on social programs and children of retirees, and lower our standard of living.

The reality of greater personal responsibility for retirement will require greater financial education in schools, easier options for retirement savings (such as automatic payroll contributions) and modification of existing tax rules to bring greater equity to the system.

What do you think?