Congress takes aim at 401(k)s to pay for mounting Federal deficit

Have no fear... who more to trust with your money, than government?

Congress takes aim at 401(k)s
By Jennie L. Phipps · Bankrate.com

Should Congress put limits or even completely do away with the tax incentives that make saving within a 401(k) or some other tax-advantaged retirement plan attractive in order to cut the deficit?

The Congressional Joint Committee on Taxation and the Treasury Department's Office of Tax Analysis conclude that these retirement planning programs will cost the federal government about $600 billion in lost revenue over the next five years.

Here's what they suggest instead:
Bipartisan Policy Center Debt Reduction Task Force -- Maintain existing accounts but cap tax-preferred contributions to the lower of $20,000 or 20 percent of income.
National Commission on Fiscal Responsibility and Reform -- Consolidate the various retirement accounts and cap tax-preferred contributions to the lower of $20,000 or 20 percent of income.

The American Society of Pension Professionals & Actuaries, or ASPPA, says the government's math is fuzzy because it doesn't accurately figure deferred revenue -- savers eventually take the money out and pay taxes on it. Based on its calculations, the government would only gain about 25 percent more in taxes and the price would be reduced income and security for people living in retirement.

A separate study by the Stanford University Graduate School of Business says that the introduction of 401(k)s has had an enormous impact on how people invest in stocks and bonds. At the end of World War II, individual citizens owned 90 percent of the stock market; by 2006, they owned only 30 percent. The other 70 percent was held by institutions, including mutual funds, insurance companies and pension funds.

Ilya Strebulaev, associate professor of finance and primary author of the study, recommends that tax reformers consider making the tax rate on capital gains equal to the tax rate on equities held in tax-advantaged accounts. Now, of course, the capital gains rate is 15 percent for most people -- less for low-income people, while the rate son equities in tax-advantaged accounts are the same as for ordinary income. This would level the playing field and potentially make it less attractive to hold stocks in a tax-advantaged accounts. He believes that among other things, holding stocks outside of institutional accounts would encourage individual investors to pay more attention to how their money is invested. "Institutional investors are very passive. They delegate their vote. It's not the best social outcome," Strebulaev says.

Strebulaev dismisses the idea of limiting the tax advantages of retirement accounts to increase revenue. "What I think what our research delivers is that all these small twists in taxation are very unlikely to work."