Limiting Retirement Account Growth Would Punish Saving

June 24, 2013

President Obama's proposed 2014 budget includes a limit on the growth of tax-advantaged retirement accounts. Though Congress is unlikely to adopt his budget proposal, the idea of limiting retirement account accumulations could garner support among policymakers who favor wealth taxes. However, limiting tax-advantaged accumulations violates a promise people relied on when they made deposits to these accounts, says Pamela Villarreal, a senior fellow with the National Center for Policy Analysis.

Obama's budget assumes the 2013 limit of $3 million is sufficient to pay a lifetime annuity of about $205,000 a year.

But, in theory, a worker contributing the maximum allowed to a 401(k) plan (assuming the contribution limit was increased annually for inflation) for 40 years could easily have more than $3 million in a retirement account, depending on the rate of return.

  • With a 7 percent rate of return (before adjusting for inflation) compounded annually, the 401(k) account would have a balance of $6 million -- the equivalent of $1.8 million in today's dollars -- and fall within the "reasonable" limits defined by Obama's budget.
  • However, with a 10 percent rate of return, the saver would have a balance of $12.9 million -- the equivalent of $3.8 million in today's dollars, slightly higher than the "reasonable" limit defined by Obama's budget.
  • With a 12 percent return, the saver would have a balance of $22.2 million -- equal to $6.6 million today, far exceeding the limit.

 An accumulation limit would create a host of problems.

  • An arbitrarily set "reasonable" amount of tax-advantaged retirement income does not account for cost-of-living differences.
  • When workers accumulate tax-advantaged savings, they have the option of choosing which financial product best fits their retirement needs. But a limit of $3,000,000 for an individual retiring this year would favor annuities over timed withdrawals.
  • Accounts could easily exceed what is needed to fund a $205,000 annuity after adjusting for inflation.
  • Simplified employee pension plans have more generous contribution limits than 401(k)s or IRAs -- up to $51,000 in 2013. However, if the current maximum contribution were adjusted annually for inflation, after 40 years they would exceed the cap.

What is the solution? Create a level playing field. An arbitrary accumulation limit attempts to level the outcome of tax-advantaged retirement accounts without leveling the playing field. Instead of taxing accumulations above a certain amount (essentially, punishing wise investment) policymakers should address the unequal contribution limits among the various plans.

Source: Pamela Villarreal, "Limiting Retirement Account Growth Would Punish Saving," National Center for Policy Analysis, June 24, 2013.

 

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