President Again Proposes Cap on Retirement Savings

President Obama says the proposed cap on tax-deferred savings distributes the cost of government more fairly among taxpayers of various income levels, while still providing substantial tax incentives for reasonable levels of retirement saving.

There is a familiar proposal in President Obama’s Fiscal 2017 Budget that seems to crop up every year—aimed at placing a cap on amounts that can be accumulated in tax-deferred retirement savings plans.

According to an Internal Revenue Service document explaining the proposals in the budget, Obama believes the current limitations on retirement contributions and benefits for each plan in which a taxpayer may participate do not adequately limit the extent to which a taxpayer can accumulate amounts in a tax-favored arrangement through the use of multiple plans—especially defined benefit plans, defined contribution plans and individual retirement accounts (IRAs). 

Never miss a story — sign up for PLANSPONSOR newsletters to keep up on the latest retirement plan benefits news.

“Such accumulations can be considerably in excess of amounts needed to fund reasonable levels of consumption in retirement and are well beyond the level of accumulation that justifies tax-advantaged treatment of retirement savings accounts,” the document says.                              

Obama contends that requiring a taxpayer who, in the aggregate, has accumulated very large amounts within the tax-favored retirement system to discontinue adding to those accumulations would reduce the federal deficit, make the income tax system more progressive, and distribute the cost of government more fairly among taxpayers of various income levels—while still providing substantial tax incentives for reasonable levels of retirement saving. 

Obama is proposing to cap the accumulation into retirement accounts at $3.4 million. Under his proposal, the limitation would be determined as of the end of a calendar year and would apply to contributions or accruals for the following calendar year. Plan sponsors and IRA trustees would report each participant’s account balance as of the end of the year, as well as the amount of any contribution to that account for the plan year. 

For a taxpayer who is younger than 62, the accumulated account balance would be expressed as an annuity value by converting the accounts based on generally accepted actuarial assumptions. This theoretical annuity would come in the form of a 100% joint and survivor benefit using the actuarial assumptions that apply to converting between annuities and lump sums under tax-qualified defined benefit plans. For a taxpayer who is older than age 62, the accumulated account balance would be converted to an annuity payable in the same form, where actuarial equivalence is determined by treating the individual as if he or she was still age 62. In either case, the maximum permitted accumulation would continue to be adjusted for cost of living increases.

Plan sponsors of defined benefit plans would generally report the amount of the accrued benefit and the accrual for the year, payable in the same form. 

NEXT: What happens when cap is exceeded

If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings and gains.  If a taxpayer’s investment return for a year was less than the rate of return built into the actuarial equivalence calculation (so that the updated calculation of the equivalent annuity is less than the maximum annuity for a tax-qualified defined benefit plan), there would be room to make additional contributions. In addition, when the maximum defined benefit level increases as a result of the cost-of-living adjustment, the maximum permitted accumulation will automatically increase as well. This also could allow a resumption of contributions for a taxpayer who previously was subject to a suspension of contributions by reason of the overall limitation.

According to the proposal, any excess in accumulation would be treated in a manner similar to the treatment of an excess deferral in a defined contribution plan under current law. The taxpayer would be allowed a grace period during which the taxpayer could withdraw the excess from the account or plan in order to comply with the limit. If the taxpayer did not withdraw the excess contribution (or excess accrual), then the excess amounts and attributable earnings would be subject to income tax when distributed, without any adjustment for basis (and without regard to whether the distribution is made from a Roth IRA or a designated Roth account within a plan). 

This same proposal has been submitted for years, with much backlash from industry groups. In addition, surveys show retirement plan participants are opposed to any changes to tax advantages of benefits.

Other proposals in the budget include limiting Roth conversions to pre-tax dollars and eliminating deductions for dividends on stock of publicly traded corporations held in employee stock ownership plans (ESOPs). More proposals in the “Loophole Closers” section of the budget can be found starting on page 160 of the IRS document.

Pension Plans Focused on Improvement

Pension funds are “owning” five strategic aspects of management, a survey finds.

Pension funds’ mission to deliver optimal outcomes over the long term continues to be tested by historically low interest rates, booming retiree populations and increased life expectancies, as well as unprecedented market volatility, State Street Corporation notes in a new research report.

The report, “Pensions with Purpose: Meeting the Retirement Challenge,” reveals pension plan sponsors are taking action in governance, efficiency, long-term investing, risk management and talent development to ensure successful outcomes for retirement plan participants over the next three years.

Get more!  Sign up for PLANSPONSOR newsletters.

The survey of 400 pension professionals in 20 countries found board training and education will be the focus of 2016. Martin J. Sullivan, head of asset owner sector solutions for North America at State Street Corporation in Boston, tells PLANSPONSOR that particular finding jumped out to him this year. “What I’m seeing is an increased focus on governance and how to optimize plan assets and administration,” he says. “I’m also seeing a greater focus by boards themselves about how they can be more effective—an increased desire for education.”

Sullivan notes that last year, pension plans were focused on taking on more investment risk, but that has dropped back a little in this year’s study, with governance taking the main stage.

According to the research, pension funds believe that board expertise is not strong enough in critical areas and must be improved. Only 32% rate as “very strong” their board’s ability to think beyond short-term issues to address longer-term, strategic factors affecting the portfolio. Additionally, only 36% rate as “very strong” their board’s understanding of the risks facing the retirement fund, and 38% believe their board has a high level of general investment literacy.

As a result, 92% of funds are planning to upgrade their governance model over the next 12 months, and roughly half (45%) are planning to increase training and education opportunities for board members.

In the U.S., 41% expect to increase transparency to members about the governance and investment performance of their fund over one year, and 37% expect to adjust the balance of responsibilities between management and the board.

NEXT: New investment focus

As pension funds seek to improve risk-adjusted returns, the survey indicates they are accelerating the move into alternative assets. Over the next three years, 51% will increase exposure to funds of hedge funds, 50% to real estate, 46% to private equity and 41% to infrastructure.

Eighty-three percent expressed moderate or high interest in environmental, social and governance (ESG) investments. Of those interested in ESG, 80% of respondents in North America and 78% of respondents in EMEA say they are more likely to appoint a manager with ESG capabilities.

According to Sullivan, this in part reflects the interest of plan participants, but pension plans realize they control huge amounts of capital, and while they want to generate strong returns, they are also thinking of how to do good with those assets, by allocating capital to ideas that help society, such as climate change or infrastructure of states, for example. Sullivan adds that in the U.S., this is also reflective of the Department of Labor’s most recent guidance about ESG investing.

Among survey respondents globally, 36% say they are ready to take on more risk, while 45% are actively looking for ways to decrease the amount of risk in their portfolios. Yet, no more than 20% of funds rate themselves as highly effective at managing key risk areas, including investment and liquidity risk.

In the U.S., 63% are looking for ways to decrease investment risk. Nearly two-thirds (65%) will continue to apply risk factor analysis, while 28% say they will cease. Only 8% think their in-house risk talent is very strong, but 41% say their consultants’ insight into risk is very strong.

NEXT: Consultants versus in-house management

Overall, pension funds are ramping up their internal specialist talent, with nearly half planning to increase their internal risk teams (48%) and investment teams (45%) over the next three years, particularly as they gear up for increased ESG investing. However, funds will remain reliant on external partners with 65% of all funds agreeing that their consultants are essential to guiding their investment process.

In the U.S., 83% say their consultants are essential in guiding their investment process, and 75% are satisfied with the value consultants deliver relative to fees paid. More than half (53%) are building their internal risk teams.

“There’s a dichotomy between larger plans building internal staff versus middle-market plans looking to work with consultants further or outsource the discretion of investments,” says Sullivan. “Not only is size an influence in the U.S., but also whether a fund is public or private. Outsourced CIOs are used more in corporate and not-for-profit plans, while public plans tend to do things in house.”

While the survey did not ask about pension risk transfers, Sullivan notes this is an ongoing trend. However, he attributes recent reports about defined contribution (DC) plan assets overtaking defined benefit (DB) plan assets to something else. “Plan sponsors have changed their approach to DC plans. They are being more thoughtful and creative as to what types of assets they offer. Yields for DC participants are stronger as plan sponsors drive costs down and offer more sophisticated investment options,” he says.

Finally, Sullivan notes that one of the things State Street did as part of the research is use United Nations data to look at projections within a variety of countries of changing demographics and reliance on capital in the pension space. The data shows populations are aging and more dependent on these types of assets. “This reinforces the significance of pension assets, managing them and making a commitment to better running these plans,” Sullivan concludes.

More information is available at www.statestreet.com/PensionsWithPurpose. The survey report will be available next week.

«

 

You’ve reached your free article limit.

  You’re out of free articles!! 

Subscribe to a free PW newsletter - get free online access!

 Don’t leave before subscribing! 

If you’re a subscriber, please login.