|Mark Machiz, former Associated Solicitor at the Labor Department during the Clinton administration, and James Delaplane, a vice president of the American Benefits Council, answer your questions on improving retirement security.|
Ash from Southington, CT asks:
Why do current government regulations limit tax-deductible retirement investments to $3,000?
Considering we may not be able to rely on Social Security funds, why are there any limits on tax-deductible accounts? What are the public policy objectives of such tax exempt retirements accounts?
There are different limits on different sorts of accounts and benefit plans, which can vary according to your circumstances. Like so much of our tax code, complexity in these rules comes from the push and pull of contending interests.
When you step back and look at the big picture and ask what's the underlying rationale for the rules, there is often no good answer. The need for some limits on deductibility or exclusion from income of retirement savings is pretty clear. It costs the Treasury (and hence other taxpayers) money to provide these tax breaks.
Put differently, if tax rates were held constant, and these limits were increased, the surplus would fall, or the deficit would rise. There is no free lunch. What's more, these tax breaks primarily benefit the relatively well-off portion of the population--people who can both afford to save benefit, and the benefit is greatest to those in the highest tax brackets.
The policy issue is this -- how much should the government spend to encourage the middle class to save.
The $3,000 limit you asked about is the limit on tax-deductible contributions to an Individual Retirement Account (IRA). This limit was increased from $2,000 under the tax bill passed by Congress in 2001 and will rise to $5,000 by 2008.
For workers who participate in an Employer-Sponsored Retirement Savings Plan -- such as a 401(k), 403(b) or 457, -- the limit on tax-deductible contributions is significantly higher. Here, the limit is $11,000 in 2002, and will rise to $15,000 by 2006.
These rules do leave individuals without a workplace savings plan at a disadvantage with respect to the amount of tax-deductible savings they can contribute. The reason that Congress has not increased the IRA savings amount beyond $5,000 is because it fears that doing so would deter small employers from starting 401(k) plans.
If a small business owner could save as much on a tax-deductible basis in an IRA as he could in a 401(k), then he might not have much of an incentive to start the 401(k) plan (which benefits all the workers at his firm).
Increasing the tax-deductible IRA amount beyond $5,000 would also mean substantially less tax revenue for the federal treasury, which is also a concern to Congress. Congress has generally imposed limits on tax-deductible savings not only for these reasons but also because it believes that it would be predominantly high-income individuals who would be able to save beyond the existing dollar limits.
The basic public policy objective behind tax-exempt retirement accounts is to encourage individuals to save for their own retirements.
Our public pension programs, Social Security, was never intended to be the sole source of retirement income, and Congress has provided tax incentives to encourage individuals to save and to encourage employers to establish retirement plans for their employees. If individuals can build significant personal and pension savings, they will have a higher quality of life in retirement and will be less dependent on governmental programs for their basic income and health needs.