The administration views certain savings for retirement to be a tax loophole. The just released budget, in its Overview, states: “[The budget] ends a loophole that lets wealthy individuals circumvent contribution limits and accumulate millions in tax-preferred retirement accounts.” [There is no acknowledgement that these dollars are subject to ordinary income tax when withdrawn nor is there an explanation of how these wealthy folks get around contribution limits which apply regardless of income.] In the section of the budget that is titled Providing Middle Class Tax Cuts and Rebalancing the Tax Code through Tax Reform, there is a description of the President’s attack on retirement savings that states:
Prohibit Individuals from Accumulating Over $3 Million in Tax-Preferred Retirement Accounts. Individual Retirement 
Accounts and other tax-preferred savings vehicles are intended to help middle class families save for retirement. But under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving. The Budget would limit an individual’s total balance across tax-preferred accounts to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or about $3 million for someone retiring in 2013. This proposal would raise $9 billion over 10 years.
In a budget that claims to simplify the tax code, this provision, if it becomes law, is fraught with complexity and will result in reams of new regulations. Some of the issues that would require regulation might include:
- In measuring an “individual’s total balance across tax-preferred accounts” are defined benefits ignored? Nope, not according to the “Greenbook.” (As opposed to one of these “green books“.)
- Since annuities are interest-rate sensitive, account balances falling under the “about $3 million” threshold would increase as interest rates rise – assuming they ever do. How would those adjustments apply and when?
- What are the variables that determine an annuity of $205,000 per year? The “Greenbook” states it’s a joint and 100% survivor annuity commencing at age 62.
- Does the limit apply at any time or only when someone reaches some undisclosed retirement age? The “Greenbook” states that the determination will be made annually and by taking each account balance and converting it into an actuarial equivalent annuity (presumably for all participants). No administrative cost there!
- And what happens if you go over the limit? The “Greenbook” suggests that there will be a cessation of contributions and accruals, but earnings can continue. However, that point underscores just how ineffective this cap is likely to be at limiting retirement savings (which is a poor goal to begin with). In many cases, large retirement account accumulations (particularly in IRAs) are not the result of excessive contributions, but of investment of assets. Generally speaking, at the point at which someone’s account reaches $3 million dollars, the investment return has the potential to be significantly more valuable in growing the account than additional contributions.
- Of course, if the limitation increased, contributions and accruals could start again. Certainly every employer looks forward to addressing these additional administrative headaches. And, it would seem that every American participating in both a 401(a) plan and an IRA will have to employ her own actuary.
- Do Roth earnings count toward the limit or is it just traditional pre-tax dollars and their earnings that count?
- Will the limit be indexed on some basis?
Surely there are many more issues that will need attention before this type of limitation might be implemented. The cost of implementation by government and the private sector may even challenge the $9 billion in proposed federal savings!
An unintended consequence of such a limit may be that business owners whose own accounts could reach the limit, or who don’t want the added administrative cost, either terminate their company plans or eliminate employer contributions to those that continue in operation. That would be detrimental to the middle class that the administration believes it is protecting. If the idea is to put a limit on the tax-favored savings of the so-called “wealthy” [actually many may just be smart savers and investors], it is fraught with the potential to backfire and harm the middle class. On the other hand, this may all be smoke and mirrors. EBRI followed up the release of the budget by demonstrating that about 1% of all account holders would be affected in today’s interest environment. However, EBRI points out that the threshold would decrease dramatically, cover many more accounts and have the most significant impact on the younger generations as time goes by. But if so few are impacted, why would any employer want the additional headache? And will the DOL let the plan pay for this – probably not – after all, it only affects the wealthy, right?
Best of all, this is intended to go into effect for taxable years beginning January 1, 2014 – if it becomes law.
In the first article of this series, we discussed the approach described by the Government Accountability Office (GAO) in evaluating tax expenditures and laid out the issues that impact treating the deduction, exclusion and deferral mechanisms for tax-qualified retirement plans the same as “spending” tax expenditures. In the second article, we focused on two of the critical questions posited by the GAO in the GAO Report that are intended to assist Congress with its seeming effort to revise the Code. In this last article in the series, we will focus on a few additional questions posited by the GAO in the GAO Report and draw some conclusions.
Does the Tax Expenditure Generate Net Benefits In the Form of Efficiency Gains for Society as a Whole?
The GAO Report states: Resources are used most efficiently when they provide the greatest possible benefit or wellbeing. The concept is to reflect “net benefits in efficiency gains for society.” In a nutshell, this means that what is being given up should be less valuable than what is being provided for society as a whole in order to justify the expenditure. In the case of retirement plan expenditures, net current tax revenue may be given up that could go to appropriate uses. A gain results from a seemingly enhanced retirement structure for American workers that is greater than it would otherwise be if not for the tax expenditures. It is reasonable to assume that enhanced savings for retirement is a benefit for society. Therefore, the question is best answered by looking at the numerous independent studies of the Employee Benefits Research Institute (EBRI) that “measure” the benefit. In general terms EBRI’s work would support the notion that there is an enhanced benefit that results from the tax expenditures. Measuring that against whatever other use Congress and the Administration might make of tax dollars “saved” by reducing or eliminating the expenditures is pure political conjecture.
It is broadly accepted that there is an enhancement in retirement savings as a result of the tax benefits Congress makes available to qualified plans, both with respect to the employer deduction and the employee income recognition deferral. However, there are some who may be naysayers. See Joe Lustig’s Bloomberg BNA Pension & Benefits Daily™ article of February 6, 2013 describing a different perspective contained in the report, Subsidies vs. Nudges: Which Policies Increase Savings the Most? This report, prepared by researchers from Harvard University and the University of Copenhagen, takes a look at the Danish system and concludes that a reduction in tax incentives has virtually no impact on increasing total savings. The Lustig article describes the EBRI disagreement with this conclusion and refers to EBRI’s countervailing report: Tax Preferences and Mandates: Is the Danish Savings Experience Applicable to the United States? EBRI states that the Subsidies vs. Nudges report is flawed since the two countries have different savings incentive structures. Believe what you will, we suppose.
Regardless, there seems to be ample evidence that, based on our employer-sponsored system, tax expenditures are a critical component. They encourage plan adoption and retention by employers, plan contributions by both employers and employees and assist greatly in America’s overall savings for retirement. The critical unknown based on the GAO question is a determination of “how much” expenditure is needed to make sure that there are net benefits in the form of efficiency gains for society as a whole. If Congress were to reduce the 415 limits, for example, the reduction would arguably be based on a determination that the current limits either do not result in net benefits in the form of efficiency gains for society as a whole, or that the limits can be reduced somewhat to provide the same net benefits. Finding that “sweet spot” would seem, at best, to be conjectural. The last time Congress reduced the limits in 1986, as we pointed out in an earlier issue on this topic, savings rates plummeted. One might suspect that the result was a dramatic loss in net benefits – probably a primary reason Congress has not repeated the error for almost 30 years.
Since tax expenditures for retirement are “recouped” by the federal treasury over time, the issue raised by the GAO question may be irrelevant except for a matter of degree. Unfortunately, its relevance, to the extent there is some, comes from the budgeting process described in our first installment, a process that fails, for the most part, to draw a distinction between the tax expenditure impact for retirement plans and the tax expenditure impact for spending expenditures. It should be demonstrable that retirement plan tax expenditures always result in net benefits in efficiency gains for society as a whole. For statistical bases reflecting plan utilization, see these studies from the Bureau of Labor Statistics and this Department of Labor bulletin. Putting a measuring stick on the size of the expenditures is a complex task. However, as discussed above, Congress has proved in the past that a significant reduction does result in a deleterious consequence.
Subsumed within the net benefits question contained in the GAO Report is this question:
What is the Benefit to Society of the Activity the Tax Expenditure Encourages?
The activity is saving for retirement. The conclusion here, assuming that the tax expenditure is effective, is the encouragement of saving that has led to an overall $19.4 trillion in retirement savings. Not only does this sum portend that many Americans will be the beneficiaries of valuable retirement benefits, but it suggests that the system results in a significant net economic benefit to society. Although there may be arguments about the efficacy of the tax expenditures in being able to accumulate $19.4 trillion, it is illogical to suggest that the tax expenditures did not help grow this monumental pot of assets. Ultimately, the benefits to society are numerous: (1) retirees having sufficient funds on which to live, (2) less pressure on the social security system, (3) extensive investment in America’s corporations, and (4) support for, and creation of, jobs. Of course, the list goes on, but the point is that tax expenditures for retirement savings do benefit society as a whole.
Some Conclusions
The American retirement system, for better or worse, is rooted in having employer-sponsored retirement plans. Having the ability to save at the point of receipt of wages makes it easy and efficient for employees to save. One might argue that employers need not be “big brothers” and go to the expense and fiduciary risk of providing plans since every individual should save on his or her own whether or not there is an employer plan. Practicality and the statistics do not bear this out, however. The percentage of those who save where there is an employer-based plan far exceed the percentage of savers where no plan is made available at work. To what extent do the tax expenditures cause and/or enhance these results? Congress demonstrated that the cause and effect is significant as a result of the reduction in limits that came about through 1986 legislation. Employers are more likely to sponsor plans and fund them and employees are more likely to save where there is a tax benefit in doing so.
On the other side of the coin, one might contend that having a plan is part of a competitive hiring market, i.e., the best prospects will certainly want their employer to provide the best possible plan. Therefore, employers will sponsor plans even without the tax incentive or with greatly reduced tax incentives in order to hire the best employees. It is unlikely that Congress would dare to test this unproven hypothesis. But even if it did, what would it do to the savings rate in today’s 401(k) universe? Would as many employees participate, would they save as much, would employer matching contributions shrink? The lesson of 1986 suggest that answers to all of these are not favorable.
In the final analysis, it would be best for Congress to appreciate that the tax incentives for retirement plans do not create a true expenditure since the federal fisc ultimately gets most, if not all or more of, its money back, a situation that does not exist with “spending” tax expenditures. So when Congress looks to the retirement plan tax incentives, hopefully it will appreciate that the tax expenditures for retirement plans provide positive answers to the GAO questions and truly benefit society in a meaningful way. Congress should recognize that ultimately the cost of providing these incentives is not harmful to the federal fisc. This would suggest that societal efficiency gains result in a significant net benefit.
Related Link
InvestmentNews – Survey Shows Americans Support Tax Incentives for Retirement Benefits
In the first post of this series, we discussed the approach described by the Government Accountability Office (GAO) in evaluating tax expenditures and laid out the issues that impact treating the deduction, exclusion and deferral mechanisms for tax-qualified retirement plans the same as the “spending” tax expenditures. In this second article, we will focus on two of the critical questions posited by the GAO in the GAO Report that are intended to assist Congress with its upcoming effort to revise the Code.
What is the Tax Expenditure’s Intended Purpose?
Examples used in the GAO Report include the following:
- To encourage taxpayers to engage in particular activities.
- To adjust for differences in individuals’ ability to pay taxes.
- To adjust for other provisions of the tax code.
- To simplify tax administration.
The last example above makes for eye-rolling. When it comes to the complex tax scheme of the qualified plan system, changes made by Congress since the promulgation of ERISA in 1974 have typically made tax administration more complex. It is anticipated that any changes Congress would make in 2013, possibly well-intentioned, will still result in full employment for the small group of Americans who are responsible for administering the plans and the IRS’s relatively small group of agents who are charged with tax administration of this complex system.
The first example above is one that directly addresses the concerns that Congress might “cut back” on the relevant tax expenditures. No doubt the purposes of the tax expenditures for qualified plans are to encourage employers to sponsor plans and to encourage employees to save for retirement. The ultimate goal has always been to have a solid third leg for the three-legged retirement stool (Social Security, individual savings outside a plan, and a tax-advantaged, employer-sponsored retirement plan). Therefore, reducing the tax expenditures would seem to be inconsistent with this purpose. However, there are many complexities to analyzing the impact that reducing the tax expenditures might have. For example, small business owners might be less likely to sponsor plans if they themselves cannot engage in significant deferrals. Many employees may be less likely to save through plans like 401(k) and 403(b) plans if the tax expenditures are reduced. Of course, many participants save in amounts less than what a cutback might represent. For example, the current elective deferral limit of $17,500 is very high for many workers who cannot afford to reduce take home pay enough to fully fund their deferral account to the limit each year. On the other hand, the fact that there are so many two wage earner families today might allow one spouse to fully fund her account while the other spouse saves less in his account. However, reducing the deferral limit may well disincentivize business owners who fully fund their deferral accounts today. Some of them may even stop sponsoring these plans depending on the depth of any cutback in the expenditures, the actual or perceived cost to them in sponsoring a plan and the competition in the marketplace to hire good workers who insist on having a form of retirement plan at their workplace.
More significant perhaps would be a reduction in the overall funding limit of Section 415 of the Code. Today the limit is 100% of compensation to a maximum of $51,000 (plus a $5,500 catch-up potential for those who are at least 50 years old during the plan year). The Simpson-Bowles Commission recommended a reduction to 20% of compensation not to exceed $20,000. The tax cynic and the tax scholar would likely agree that effecting such a significant reduction would be intended for the sole purpose of raising revenue. This purpose is not a tax expenditure purpose. This current limits allow for significant company and employee contributions, allow for employers in successful years to reward employees with funds for retirement (profit sharing), and allow business owners the opportunity through many plan designs to fund for themselves in a way that is consonant with their expected standard of living in retirement. (more…)
This is the first post in a three part series where we’ll focus on the impact that upcoming “tax reform” and the “second fiscal cliff” negotiations might have on qualified retirement plans, particularly on 401(k) plans. The impetus for writing this series is not the political rhetoric emanating from Washington nor is it something already proposed like the report of the Simpson-Bowles Commission. Rather, the impetus is the recent paper issued by the United States Government Accountability Office (the “GAO”) entitled Tax Expenditures: Background and Evaluation Criteria and Questions (the “GAO Paper”).
The GAO does not identify any particular “tax expenditure” in the GAO Paper. Rather, the GAO paper is intended to assist Congress in understanding the effectiveness of tax expenditures as it embarks on its effort to revise the Internal Revenue Code (the “Code”).
The GAO describes tax expenditures as “reductions in a taxpayer’s tax liability that are the result of special exemptions and exclusions from taxation, deduction, credits, deferrals of tax liability, or preferential tax rates.” This quote comes from James R. White, Director, Strategic Issues, GAO in a letter dated November 29, 2012 to The Honorable John Lewis, Ranking Member, Committee on Ways and Means, Subcommittee on Oversight, United States House of Representatives (“White Letter”). The White Letter is a cover letter for the GAO report. The GAO further states in the White Letter that an estimated $1 trillion in revenue was foregone from the 173 tax expenditures reported for fiscal year 2011. Interestingly, this is approximately the amount of the annual budget shortfall (deficit) for 2011.
In the White Letter, the GAO states that it considers tax expenditures to be tax provisions that are exceptions to the “normal structure” of individual and corporate income and other taxes necessary to collect federal revenue. Tax expenditures, according the White Letter, can have the same effect as government spending programs. And here is where the retirement community must diverge. A spending program means the money has left the government for uses that do not cause the “spent” funds to be returned to the federal fisc. It is gone, hopefully, to support some proper public purpose.
The “tax expenditures,” if we wish to call them that, inherent in the retirement system do come back to the federal fisc since they are taxed later. In other words, the tax implications for the retirement system do not have the same effect as a government spending program. That is the case if one understands the meaning of deferral. Congress apparently does not. Congress passes budgets based on the short term and does not take all of the deferred retirement plan income into account when doing so. Congress passed the Congressional Budget and Impoundment Act of 1974 requiring that it not consider income and expense beyond a five year period of time, effectively causing the process to ignore the bulk of deferred income that will come from tax-qualified retirement plans. Most deferrals for retirement extend out far longer than five years, and, therefore, the taxes they will generate are mostly overlooked in the budget process. The timing mechanism used to “net” the amount of the expenditure is surely flawed as retirement savings are intended to follow a long-term horizon. And, of course, in the long-term, tax rates, market conditions and many other factors will influence the amount of funds returned to the federal fisc.
Congress established a system of deferred compensation through defined contribution and defined benefit plans of many types to assist Americans with the prospect of retirement with dignity. However, that system may be at risk when Congress fails or refuses to recognize that the retirement plan “tax expenditure” is unlike most, if not all, others.
(more…)
After a long lockout, the NHL will begin its season this weekend thanks, in part, to a pension plan. Among the sticking points for the players, as noted in this article, was the desire to return to a defined benefit pension plan. The NHL was somewhat ahead of its time in 1986 when it switched to a DC-only style retirement plan. However, the players in this recent round of bargaining pushed hard for a pension plan, and succeeded. While the NHL has not released very many details about the pension plan, and some of the information we’ve found is conflicting, this report from CSN Washington suggests that players can be eligible for the maximum benefits permitted by law.
While it is interesting to see an institution as prominent as the NHL buck a clear trend in the retirement space, it goes without saying that this is probably not the beginning of a sea change in retirement benefits back to defined benefit plans. As noted in this Globe and Mail article, even Kevin Westgarth, a Los Angeles Kings forward and a member of the NHLPA’s bargaining committee, called moving to a pension plan “way out of style.” .
While pensions may be way out of style for most of us non-athletes, as noted in this article from Bankrate.com, many U.S. professional sports organizations actually offer some kind of pension plan for their players (we’ve previously discussed the pension plans for MLB players here). So the NHL was actually a bit out of step with the rest of its sports brethren (as the Globe and Mail article also suggests). Therefore, in the NHL’s case, this isn’t so much bucking a trend, really a return to an industry standard, in a sense.
Interestingly, many of the arguments that were advanced in support of a pension plan for the NHL players, while somewhat paternalistic, could nevertheless be made for rank and file employees of most other industries as well. Essentially, they boil down to the advantages of lifetime income protection. However, in the current environment (outside of professional sports), we think the more likely move for plan sponsors will be to lifetime income options in defined contribution plans, rather than a return to defined benefit plans. What do you think?
So we know you’re probably tired of hearing about the fiscal cliff. We know this because we are sure many of you nominated “fiscal cliff” as one of the “words” that should be banished from the English language in 2013. However, there are some benefits provisions in the generally Orwellian-named American Taxpayer Relief Act. Fortunately, they were not the ones we were worried might be included, and in fact, some of them actually provide some tax relief.
- First, there’s the Roth conversion opportunity we covered previously.
- Educational assistance tax benefits, which previously had to be extended each year, are now “permanent” (as that term is generally used in tax law).
- The same is true for adoption assistance.
- The tax exclusion for transit benefits is now permanently on par with commuter parking (previously, the tax exclusion for transit benefits was lower than for commuter parking).
- The CLASS Act (the voluntary long-term care program that was part of health reform) was finally repealed. Those who follow benefits news may recall that HHS declined to implement it once the program was determined to be financially unsustainable.
- Any remaining funding for CO-OPs (which are essentially non-profit insurers that were supposed to compete with for-profit insurers under health reform) has been eliminated. Only about half of the funding for CO-OPs had been used, and that will remain outstanding, but the rest has been clawed back.
So thanks to the fiscal cliff, you can educate your workforce, help them build a family, encourage them to take mass transit, and let them convert their 401(k) savings to Roth! Helpful? Yes. But unlikely to save “fiscal cliff” from the English-language chopping block, particularly when combined with the substantial additional tax burdens imposed by the “Relief” Act.
Disclaimer/IRS Circular 230 Notice
Related Links
Washington Post – Fiscal Cliff Bill Cuts $1.9 Billion from Obamacare
Summary of Other Bryan Cave Blog Posts Covering Different Angles of the Fiscal Cliff
Congress continues to work (or some might suggest not work) in its typically convoluted motif. Among the tax law changes in the American Taxpayer Relief Act (ATRA) (also known as the fiscal cliff compromise bill) is a provision expanding the availability of Roth conversions inside defined contribution, 403(b) and 457(b) plans. One might think of lots of good policy reasons for this expansion (like reducing plan leakage; giving participants greater flexibility for retirement planning), but Congress did not pass this law for good policy reasons. It passed it to raise revenue, plain and simple. This part of ATRA was scored by the Congressional Budget Office to raise $12.2 billion over 10 years. In fact, Roth expansion was not one of the considered tax law changes debated since the election. This is the second time that Roth conversion inside qualified plans has been used for the purpose of raising revenue, although the first time there was the pretext of reducing plan leakage. The last time was with Small Business Jobs Act of 2010 (H.R. 5297).
So what does the new law do? To understand it, let’s first look at what the conversion rules were before 2013. Before ATRA, traditional amounts in defined contribution, 403(b) and 457(b) plans could be converted to Roth amounts within the plan if two requirements were met: (1) the amounts were eligible for distributable rollover; and (2) the plan allowed for regular non-rollover Roth contributions.
The new law eliminates that first requirement beginning in 2013. Therefore, participants in 401(k) plans no longer need to have terminated employment or be at least 59-1/2 in order to convert their accounts. Additionally, it appears a plan no longer needs to provide for an age 59-1/2 distribution right for the amount to be eligible for an in-plan Roth conversion. All vested amounts in defined contribution, 403(b) and 457(b) plans are eligible for conversion. The plan must still allow for regular non-rollover Roth contributions, and unlike with conversions in IRAs, there is no provisions for revocation, i.e., an in-plan conversion is irrevocable.
Special features applicable to pre-2013 in-plan conversions should still apply. These include:
- If part of the conversion involves a participant loan, it can be converted to Roth without being treated as a new loan.
- No early distribution excise tax will be due for those under age 59-1/2.
- Conversions should not be subject to the new 3.8% tax on net investment income of higher income taxpayers.
- No spousal consent is required for a conversion, even if the plan requires spousal consent on distribution.
- A notice of the right to defer a distribution is not required.
- If the converted amount is subject to protected benefits (such as certain distribution rights), they still apply after conversion.
- Conversions are not subject to either 20% or optional withholding, but underpayment penalties may apply.
- Surviving spouses, alternate payees who are former spouses or surviving spouses may convert their accounts.
This new flexibility should make lots of work for financial planners. There are definite tax advantages for many plan participants, but it’s important for someone who understands the vagaries to analyze whether or not conversion makes sense in individual situations. Plan sponsors whose plans don’t currently provide for Roth accounts should also be busy determining whether or not to add the Roth option to their plans. If they opt to do so, a plan amendment and a summary of material modifications will be need to be prepared.
Disclaimer/IRS Circular 230 Notice
Related Links
Washington Post Blog – The Worst Budget Gimmick in the Fiscal Cliff Deal
IRS Notice 2010-84 – Pre-ARTA Guidance on In-Plan Roth Rollovers
Summary of Other Benefits Provisions of the Fiscal Cliff Bill
This column in USA Today highlights a potential concern of the impending federally-facilitated exchanges under health reform. Specifically, because the exchanges have to determine eligibility for advanced payments of tax credits, the IRS and the Department of Homeland Security have to share information with the Department of Health and Human Services. As a result, there is a significant amount of sensitive data that needs to be secure.
The authors of the column express concern that the government can effectively and efficiently secure the data in the fairly compressed timeframe by which the federally-facilitated exchange has to be created and operational. It seems like a valid concern, especially given that so many states have opted not to set up state exchanges and the current pressure on federal budgets.
Health plan sponsors are aware of the sometimes stringent privacy and security requirements imposed by HIPAA. One would hope that the government would impose standards at least as rigorous as the HIPAA standards, if not more so, to protect the sensitivity of the information.
Why should plan sponsors be concerned about potential data security issues with public health insurance exchanges? To the extent employers are considering dropping coverage and sending employees to the exchanges (or their employees receive subsidized coverage through any exchange), they should be aware of the potential risks that create the prospect for significant employee distractions and concomitant reductions in productivity. Additionally, as employers have to share data regarding their health coverage with the IRS, employers will need to be able to articulate to employees that they have taken all reasonable measures to ensure data security compliance to avoid claims from employees that any data breaches are a result of the employer’s breach of fiduciary duty.
A while back, we posted some of our thoughts about compliance obligations that employers should consider before jumping into a private corporate health exchange. Since that time, we have had a chance to hear and research a few more details about how some of these private corporate health exchanges would work and recognize that some of the concerns we expressed are mitigated by the structure.
As we understand it, the policies offered through these exchanges will not be individual policies, but will be group policies issued in the name of the sponsoring employer. This alleviates concerns we had that employers might believe incorrectly that they were not sponsoring an ERISA plan and it limits the number of Schedule A filings an employer would have to make. It also addresses our concern about multi-state insurance requirements, since the insurance contracts would presumably be governed by the state in which they are delivered (most likely, the state of the employer’s primary office).
The exchanges we’ve heard about would offer specific, non-negotiable plan designs set up by the exchange provider, but with a broader selection of insurers than most employers typically obtain themselves. The broad array of insurers would allow employees to select the insurer with the most favorable network in his or her area, which is a feature an individual employer may not be able to secure on its own.
However, contrary to what many employers believe, the group policy for a particular employer would still be underwritten based on that employer’s experience; the experience would not be combined with other employers in the pool. To counterbalance that, the insurance products are rated on a regional basis, so that employers can take advantage of insurer efficiencies in regional markets.
On the flip side, the exchange provider is responsible for insuring the plans meet the necessary actuarial value thresholds to keep employers out of the “play or pay” penalties under health care reform due to the minimum value requirements. However, whether the products are ultimately affordable will depend on the level of employer subsidy provided.
The bottom line in all of this, at least from what we have heard so far, is that employers will essentially be giving up control of plan design in exchange for ease of administration. Whether that trade makes sense for any particular employer is a question each has to answer on its own. If you’re considering a private exchange, or if you have thoughts to share about private exchanges, let us know your thoughts!
Disclaimer/IRS Circular 230 Notice
Related Links
Employee Benefits News Opinion Piece on Private Exchanges
In this post on Forbes.com, Jeffrey Brown points out (we think, correctly) that the employer tax subsidy plays a key role in the offering of retirement plans. We agree.
However, we think there is at least one point that Mr. Brown doesn’t really address. As he notes, the recent study reported in the New York Times economics blog that supposedly demonstrates that retirement tax incentives do not increase savings for high-income earners misses a big piece of the picture. The policy implications for the 401(k) deduction go beyond high-income earners.
Often times, those individuals have other uses for their money that the prescriptive investment and distribution rules of a 401(k) plan make it difficult for them to use the money as they intend. Even if those rules are not an impediment, nondiscrimination rules and existing legal limits may prevent them from saving sufficiently inside a plan, which is probably part of why, for them, employer-sponsored retirement plans may not necessarily increase their savings rate.
But all of that aside, some suggestions for lowering the 401(k) contribution limit (like the Simpson-Bowles report we’ve talked about previously) are likely to have a disproportionate impact on moderate income workers, not just the high earners. Capping contributions at 20% of pay (or $20,000, if less) is likely to hit almost everyone, not just the high rollers.
Interestingly, the authors of that study noted that most people are passive savers and are likely to take the path of least resistance. The infographic on SaveMy401k.com agrees, showing that over 70% of people offered an employer plan will save on a tax-deferred basis, compared to less than 5% without. So if, in fact, we have a retirement crisis in this country, and if we know that people will generally take the path of least resistance, why would Congress make the path to saving for retirement harder?
Related Links (Last Updated Dec. 27, 2012)
Fiscal Cliff Updates on TrustBryanCave.com
NAPA Net – Obama Fiscal Cliff Offer Would Harm 401(k) Plans
Fox Business – How the Fiscal Cliff May Impact 401(k) Plans
