Now that HR 4, the "Pension Protection Act of 2006," is on the verge of passing Congress, many of the objectives of retirement reformers have been met. EGTRRA limits have been made permanent, and things are much more flexible.
So what's next? What should the general objectives of policymakers be to further improve this vital area of tax policy?
1. Repeal All Income Limits on IRAs
Congress is moving in this direction, anyway. HR 4 indexes these limits to inflation, and previous posts here have demonstrated how the Roth IRA contribution limits are being slowly eroded. Over time, all income-based restriction limits on Traditional and Roth IRAs should just be repealed. It makes no sense to disincentivize saving for retirement.
2. Eliminate the Elective Deferral Limit on Defined Contribution Plans
In 1986, Congress decided to limit how much workers can put into their 401(k), 403(b), and 457 plans at work. This limit has been raised over time and now stands at $15,000 (slated to rise with inflation). Congress has clearly moved more in this direction, as well (especially seen in the "catch-up" contribution provisions of EGTRRA, though those don't count against this particular limit).
Rather than having a separate elective deferral limit, workers would only need to stay under the overall limit of pension contributions made on their behalf ($44,000 plus catch-up in 2006).
3. Raise the 415 Limit to 100% of Compensation
The "415 Limit" of 25% of compensation limits how much can be contributed to SEPs and employer matches to 401(k)s and 403(b)s. In the case of self-employed SEPs, it is an even lower 20% of compensation.
Lifting this limit to the lesser of the overall limit of $44,000 or 100% of compensation would dramatically simplify retirement savings, especially for the self-employed. It would also encourage a great deal more savings for retirement.
4. Allow "Roth" Options for Everything
Beginning in 1998, IRA-eligible workers could choose to make "Traditional" (pre-tax) or "Roth" (after-tax and tax-free forever) contributions to their IRAs. As part of EGTRRA, Congress also allowed this for elective deferrals beginning in 2006.
The "Roth" option should be extended to the remaining areas of defined contribution pensions (and maybe even defined benefit pensions). These areas include:
- SEP contributions
- SIMPLE IRA and 401(k) matches and deferrals
- 401(k) and 403(b) matches
- 457 deferrals
5. Restore the pre-1983 FICA/SECA Tax Treatment of Elective Deferrals and Extend This Treatment to SEPs and 457 Plans
Prior to 1983, 401(k) deferrals were pre-FICA tax. To this day, 401(k) matches, 403(b) matches, and SEP contributions made to employees are pre-FICA. Elective deferrals on 401(k), 403(b), and 457 plans are only pre-income tax. Additionally, SEP contributions made by partners and sole proprietors are only pre-income tax.
Making all workplace retirement savings pre-FICA and pre-SECA would enormously encourage the growth of these vehicles. Additionally, it would probably help the Social Security solvency issue since most high-income people would largely-exempt themselves from payroll taxes. This would be like having personal accounts through the back door.
Does all of this need to be done in the next year? No. But these should be the guiding principles on defined contribution pension reform for the next decade.
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