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401(k) break at risk as policymakers mull retirement shift

Sep 13, 2011, 4:18 a.m.
The Capitol dome in Washington, August 2, 2011. REUTERS/Jonathan Ernst

By Linda Stern

WASHINGTON (Reuters) - U.S. retirement programs could look different if a grand deficit-cutting bargain is struck in upcoming negotiations.

On Thursday, the powerful Senate Finance Committee will explore "Tax Reform Options: Promoting Retirement Security." Despite the sleepy title, the hearing will be one of the first outward signs of something that's been actively discussed privately all over this city in recent weeks and months: How to tweak retirement to make 401(k) plans more efficient, keep Social Security afloat and save some money for the federal Treasury.

Among the ideas being floated are a replacement of the 401(k) deduction with a tax credit that would offer bigger benefits to lower earners, changes in the withdrawal choices that workers face when they retire and a shift in the way Social Security benefits are calculated. That is on top of the increase in the retirement age that has been mentioned several times in recent months.

A variety of economic pressures and demographic trends have come together to put these new ideas on the table. There's also some disillusionment within the Obama Administration and among people with close ties to the administration with the way the 401(k) system is operating. The Social Security program is projected by its own trustees to exhaust its trust fund in 2036. The so-called "retirement deficit" - the difference between what Americans have saved for retirement and what they should have saved - has been put at $6.6 trillion by Boston College's Center for Retirement Research.

At the same time, Congress and the White House are under pressure to cut federal deficits. And prominent members of both political parties have talked up the idea of loophole-closing, rate-lowering tax reform.

Put all of that together, and it points to changes in the sprawling retirement system. "The kinds of points at which you can get fundamental changes adopted is in the midst of a big deal," says Dallas Salisbury, who has been watching retirement policy closely as head of the Employee Benefit Research Institute. "And President Obama wants a grand bargain."

Of course, it may be that no big deal gets struck and retirement plans remain unchanged between now and the 2012 election. In that case, expect some of these themes to continue surfacing after the heavy campaigning is done.

"Any time they are looking at spending and revenue over the next 40 or 50 year, these issues will be on the table," Salisbury predicts.

THE 401(k) COMPLAINTS

The tax break for defined contribution retirement plans will cost the Treasury $212.2 billion between 2010 and 2014, according to the Joint Tax Committee. But the vast amount of that benefit - as much as 80 percent - goes to the top 20 percent of earners, according to estimates from the Tax Policy Center, a nonpartisan, but liberal-leaning, think tank.

For example, a person in the 35 percent tax bracket saves $35 in taxes every time he puts $100 in his 401(k), for a net cost of $65. Someone in the 15 percent bracket pays $85, after tax, for the same $100 contribution. The Pension Rights Center, which has favored traditional defined benefit pensions and other programs aimed at lower-income retirees, advocates rolling back the current $16,500 annual 401(k) tax-deferred contribution limit to the $10,500 level it was at before the Bush tax cuts, its director, Karen Ferguson, has said.

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