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.
"These types of plans," he said, referring to the litany of savings options, "have been moving closer together as time has marched on, so there are benefits that could be gained through consolidation."
For instance, Benna offered, consolidation would remove the barriers encountered by many employees who switch from, say, a government job where they invest in a 457(b) to a private sector position where the employer uses a 401(k).
To supplement Save at Work, the panel suggests a "Save for Retirement" account, where all taxpayers would be eligible to contribute up to an additional $10,000 annually. Contributions would be made with after-tax dollars and earnings would grow tax-free. It would replace existing IRAs, Roth IRAs, Nondeductible IRAs, deferred executive compensation plans and the tax-free "inside buildup" of the cash value of life insurance policies and annuities.
In addition, the panel suggests a "Save for Family" account, which would replace existing educational and medical accounts, 529 plans and Archer Medical Savings. There's a $10,000 annual limit, contributions are made after taxes and savings are tax-free.
Save at Work, Save for Retirement and Save for Family would be available under both the simplified plan and the investment plan. Taken together, they might dramatically simplify the tax code, but they might also sound the death knell for the annuity industry.
Annuities are attractive supplements to employer-sponsored plans because that "inside build-up" is tax-free and savings are tax-free. The panel suggests that if its simplified plan package were adopted, rules should be put in place to treat annuities like other investments. In other words, they'd be taxed annually, and while they could still be purchased through the tax-deferred Save for Retirement and Save for Family accounts, the $10,000 annual contribution limits would apply.
"I don't think the [president's panel] fully appreciates the role insurance products play in saving for retirement," said Deborah Tucker, a spokeswoman for the National Association for Variable Annuities of Reston, Va. "We certainly hope [the recommendations] don't go anywhere and get put on a shelf somewhere, especially in this environment where people will be receiving less in Social Security and there are fewer employer-sponsored plans being offered."
The panel's recommendations also fail to take into account the U.S. economy's reliance on the housing market, warned Greg Olsen, a partner with Lenox Advisors in New York.
As it stands, taxpayers are allowed to deduct interest paid on up to $1 million of mortgage debt secured by the taxpayer's first or second home. Homeowners may also deduct interest on home equity loans of up to $100,000. That tax treatment, the panel argued, far exceeds what is necessary to encourage home ownership or help first-time buyers. In fact, the panel concluded, it encourages taxpayers to purchase luxury residences and vacation homes. In that sense, they said, it unfairly favors higher-wage earners. The panel cites findings from the Joint Committee on Taxation, which indicate that in 2004, more than 55% of the estimated tax expenditure for home mortgage interest deductions went to 12% of taxpayers earning annual cash incomes of $100,000 or more.
The panel wants the deduction lowered to $412,000, which, Olsen said, would leave less money for investors to place into retirement and college savings plans.
"There's only so much money available to you on a monthly basis, so something has to give," he said, adding that such an environment would also drive down home prices and shock the economy, rather than provide the stimulus sought by the president's panel.
His clients, however, might favor a simpler tax code at the cost of after-tax contributions, but only if it allowed for tax-free withdrawals.
"The problem is that everyone wants a tax deduction, the immediacy of it," he said. "Very few people are looking down the road. I think this is going to end up a lot like the flat tax proposal from Steve Forbes, a good idea that just died."
Interestingly, Benna said the fate of the panel's recommendations might lie in the Supreme Court nomination of Judge Samuel Alito.
"If the nomination gets through without a significant blowup between the parties, that could provide an environment for tax reform," he said. "This is also a bi-partisan recommendation, so that makes it hard for Democrats to say it's just another Dubya-plan.'"
(c) 2005 Money Management Executive and SourceMedia, Inc. All Rights Reserved.
http://www.mmexecutive.com http://www.sourcemedia.com
