General Practice, Solo & Small Firm DivisionMagazine
Volume 17, Number 6
PENSION REFORM POINT AND COUNTERPOINT
By Dianne Bennett and Paula A. Calimafde
Point: The Misnamed Taxpayer Refund and Relief Act. Virtually every significant provision of the Taxpayer Refund and Relief Act (Act) is designed to grant tax benefits to plan participants who earn more than $100,000 annually. The likely result will be to shift the tax burden from high-income to low-income taxpayers and to take benefits away from middle- and low-income taxpayers. The likely effect of the Act’s pension provisions will be to expand retirement plans that benefit only owners of businesses and to reduce dramatically the benefits granted to nonowner employees in small business plans.
Specific provisions most likely to produce this adverse effect on retirement income are: (1) the increase in compensation counted for retirement plan purposes, from $160,000 to $200,00; (2) the increase in the maximum annual employee salary reduction contributions to a section 401(k) plan, from $10,000 to $15,000; (3) the increase in the maximum permitted contributions to a defined contribution plan, from $30,000 to $40,000 and from 25 percent to 100 percent of compensation; (4) the increase in the annual benefit dollar limit for defined benefit plans, from $130,000 to $160,000; (5) the Roth 401(k); (6) the return to facts-and-circumstances nondiscrimination testing; (7) the increases, by 2006, in IRA contribution limits to $5,000—and higher for people over age 50; and (8) increased AGI limits for Roth IRAs. In large companies, these changes will benefit higher-level executives. In small businesses, the changes will take away pensions from rank-and-file workers. The security of pensions and their tax benefits go to the higher paid. Period.
IRAs throw tax benefits to the wealthy more than to the middle class. The expansion of IRAs to $5,000 not only skews tax benefits to the wealthy; it also threatens to close many small business retirement plans. If a small business owner can contribute $5,000 to a personal IRA, why would the owner establish a qualified plan and contribute for others? Many middle- and low-income employees do not value dollar-for-dollar contributions to retirement plans. To remain competitive in the workplace, employers often prefer to give these employees their wages directly in cash.
If the goal of Congress is to promote retirement savings by those who otherwise might not save, it is doing the opposite by increasing the IRA limits and diverting funds from qualified plans. The Roth IRA is a complete shift of tax benefits to high-income taxpayers, providing tax benefits they do not need, to save money they already would be saving. Providing Roth 401(k) accounts exacerbates the shifting of tax benefits to higher-income taxpayers, helps the wealthy accumulate more money for their children to inherit, and undermines the qualified plan system.
It is deceptive to tout this legislation as benefiting women and promoting simplicity. The idea that individuals can "catch up" on their contributions will benefit primarily high-income taxpayers. Women who drop out of the workforce to raise children and then return must first earn enough money to play that catch-up game. Most of the people playing catch-up will be high-income earners who did not put away the maximums when they were young. Simplification also was thrown out the window with this legislation. Simplification is used to triumph the repeal of laws that benefit the rank and file: why else replace numerical discrimination testing with facts-and-circumstances testing? If small businesses perceive pension laws as too complex, in many cases they simply need to be educated about the prototypes and formula plans that are available.
Counterpoint: Pension Law Changes That Deliver What They Promise. The total cost of the pension reform provisions contained in the Act is roughly 1.9 percent of the total tax bill. Yet this relatively small amount may provide more real retirement security for millions of small business employees than any other part of the tax bill. This legislation will promote the formation of new small-business retirement plans by significantly reducing complex and unnecessary requirements and increasing benefits.
There are two major reasons why a small business chooses not to adopt a retirement plan. The first is that the system is perceived as too complex and costly. The devastating legislation of the ’80s and ’90s layered additional requirements on small businesses, with overlapping and unnecessarily complex rules aimed at preventing any conceivable abuse in the system or discrimination against the lower-compensated, non-key employees. Probably the most offensive of these rules are the so-called top-heavy rules. When a plan is top-heavy, the small business must make special, required contributions that increase the cost of the small business plan; vesting is slightly accelerated. Some have criticized this bill for not repealing the top-heavy rules because they are obsolete, discriminatory, and/or serve as a real roadblock for small businesses to enter the qualified retirement plan system. Others have criticized it as the first step toward repeal of the top-heavy rules—if you try to remove any burdens, it’s just a matter of time before all the rules are repealed.
The Act strips away some of the burdens in the top-heavy rules, but it retains the two meaningful provisions of the top-heavy rules: minimum required contributions and accelerated vesting. The second reason why small businesses stay away from the retirement system is that the benefits that can be obtained by the owners and the key employees are perceived as too low. Cutbacks in contribution levels back in the 1980s hurt key employees and owners. Of course, they hurt low-wage earners, also, but it took a long time to understand the very real correlation between what small business owners would put away for themselves and their key employees and what would be set aside for low-wage employees.
The Act understands there are two steps to bringing small business into the qualified retirement system—a reduction in complexity and costs, and increasing the contribution limits closer to where they stood in 1982. Some people say that these limits will not operate as an incentive for small businesses to sponsor retirement plans and will be used only by the so-called rich. I disagree on both counts—not only will the increased limits serve as an incentive to small businesses to sponsor a retirement plan, but the higher limits will be enjoyed by employees who are not "rich." For example, it is commonplace today for both spouses to be employed. Quite often, these couples decide to use one income as much as possible for contributions to a 401(k) plan. It is only because both spouses are working that they are making decent income levels, and we should provide the means by which they can save in a tax-advantaged fashion while they can. This same principle applies particularly to women who enter and leave the work force intermittently, as the second family wage earner. They stand to benefit the most from increased retirement plan limits, because the increased limits will provide the flexibility that families require due to demands such as child rearing, housing costs, and education that affect their ability to save for retirement and fluctuations in earnings vary over time.
Dianne Bennett is from Buffalo, New York. Paula A. Calimafde is from Bethesda, Maryland.
This article is an abridged and edited version of one that originally appeared on page 12 of The ABA Section of Taxation Newsletter, Fall 1999 (19:1).