Retirement planning under the Biden administration

The election of Joe Biden as President may clear the way for many changes in the retirement planning landscape. As of this writing, some U.S. Senate races are still undecided, so the ultimate balance of power in the Senate can certainly affect the content and implementation of these proposals.

Biggest change in qualified plans in almost 50 years

Over 30% of Americans contribute to tax preferenced retirement plans (401(k), IRAs, 403(b), 457 and MEPs). Participants have invested $58M in 401(k) plans alone. The funding currently accounts for over $29 trillion dollars. The Democratic proposals would shift some of the benefits of tax deferral in traditional retirement accounts toward lower- and middle-income earners with the goal of encouraging additional saving by those taxpayers.

Biden’s proposals convert the current deductibility of traditional retirement contributions into matching refundable tax credits for 401(k)s, individual retirement accounts (IRAs), and other types of traditional retirement vehicles, such as SIMPLE accounts. Biden’s proposal would eliminate traditional deductible contributions and instead provide a 26% refundable tax credit for each $1 contributed. The tax credit would be deposited into the taxpayer’s retirement account as a matching contribution. Existing contribution limits would remain, and Roth-style tax treatment would be unaffected. (see comparisons below).

A full comparative analysis can be found below.

Traditional retirement accounts allow taxpayers to defer paying tax on contributions, deducting the contribution when calculating adjusted gross income (AGI). Taxpayers can let the contribution earn returns when invested, eventually paying tax on the distributions when the funds are withdrawn.

Traditional treatment can be contrasted with Roth-style tax treatment, where taxpayers pay income tax on the contribution up front but can withdraw the principal and return tax-free upon distribution. These tax treatments are equivalent (assuming the contribution and tax rates are identical over time), while ensuring the tax code is neutral with respect to saving and consumption decisions.

Because the individual income tax is progressive, the value of a tax deduction rises as income increases. For example, a taxpayer in the top marginal tax bracket receives a $37 tax benefit for every $100 contributed into a retirement account, while a taxpayer in the bottom bracket would only get a $10 tax benefit for the same $100 contribution.

President-elect Biden’s proposal to offer a flat 26% tax credit for retirement contributions seeks to equalize this treatment. Compared to current law, the flat credit would provide a larger benefit to lower-income earners and reduce the benefit to higher-income earners. This can be illustrated by converting the proposed 26% tax credit into a tax deduction of equal benefit, allowing us to see how much of a deduction would need to be provided to give the same benefit as the matching tax credit.

To see how, consider the after-tax cost of a taxpayer contributing $100 into a traditional account. The 26% credit is equal to a deduction at a 20.5% marginal tax rate for all taxpayers, independent of their income level: If a taxpayer contributed $100 and received a 20.5% deduction, their after-tax cost of contributing $100 to their retirement account would be $79.50. Under the proposed changes, if the taxpayer had no deduction but contributed $79.50 and received a 26% matching credit, they would have contributed a total of about $100 at the same after-tax cost.

Additionally, this credit is expected to be roughly revenue neutral, with the elimination of deductibility offsetting the revenue lost from the new tax credit.

In effect, the proposal takes the rising value of deductibility by income level and converts it into a flat deduction. This provides a new benefit to taxpayers in lower income tax brackets, while providing slightly worse treatment for higher earners.

A taxpayer in the 12% tax bracket earning $35,000 would receive a 12% deduction under current law for their traditional retirement contributions, but under Biden’s proposal would see an effective deduction at a 20.5% marginal tax rate (higher than currently) when they receive the 26% matching tax credit. By contrast, a taxpayer in the 37% tax bracket would only receive an equivalent deduction at a 20.5% marginal tax rate, rather than a deduction at a 37% marginal tax rate they receive under current law.

This means that taxpayers in the 10% and 12% tax brackets (roughly up to $80,250 filing jointly) would benefit from this change, while those in the higher brackets would lose some of the value of traditional accounts when compared to current law.

Proponents of this change argue that this would help encourage lower income earners to save by providing a salient reward for saving in the form of a matching tax credit and raise the value of saving on the margin, as higher earners tend to contribute more often (see table below). They also argue that higher earners would not decrease their savings on net, as they often use retirement accounts to shift other savings they already had from taxable to non-taxable accounts.

There are drawbacks to this idea, however.

First, Roth-style retirement accounts will become more attractive to higher earners, which could shift savings away from traditional accounts. Second, this plan would reduce the tax benefit of traditional retirement accounts for those earning above $80,250 but under $400,000. This proposal would be paired with additional changes, such as establishing an “auto-IRA” for lower-income Americans.

The Pension Rehabilitation Administration

The change in administration and Senate control also paves the way for the enactment of the the Rehabilitation for Multiemployer Pensions Act, also known as the Butch Lewis Act, which bails out multiemployer plans at the expense of the taxpayer. The Act would establish the Pension Rehabilitation Administration (PRA) within the Department of the Treasury and a related trust fund to make loans to certain multiemployer defined benefit pension plans.

To receive a loan, a plan must be either in critical or declining status (including any plan with respect to which a suspension of benefits has been approved), which is expected to apply to 96% of multiemployer plans in the future.

The Treasury must issue bonds to fund the loan program and transfer amounts equal to the proceeds to the trust fund established by this bill. The PRA may use the funds, without a further appropriation, to make loans, pay principal and interest on the bonds, or for administrative and operating expenses. The bill amends the Employee Retirement Income Security Act of 1974 (ERISA) to allow the sponsor of a multiemployer pension plan that is applying for a loan under this bill to also apply to the Pension Benefit Guaranty Corporation (PBGC) for financial assistance if, after receiving the loan, the plan will still become (or remain) insolvent within the 30-year period beginning on the date of the loan.

The bill also appropriates to the PBGC the funds that are necessary to provide the financial assistance required by this bill.

Although not specified, plans would likely pay an interest rate of only 3% or less. If plans cannot repay their loans when they come due, the bill specifies that plans could receive loan forgiveness or alternative repayment plans.

The Central State Teamsters multiemployer pension plan is an example. The plan has roughly $39 billion in unfunded pension promises and is on track to become insolvent in 2025. (The full 2016 Form 5500 Filing for the Central States Southeast & Southwest Areas Pension Plan is available for download at FreeERISA. The plan had a reported shortfall of $38.9 billion in 2016.)

According to the Teamsters plan, the Butch Lewis Act would provide it with $20 billion to $25 billion in direct cash assistance, and $11 billion to $15 billion in loans. (The website for the Central State Teamsters previously stated that the Butch Lewis Act would provide between $11 billion and $15 billion in loans to be repaid after 30 years, and an additional $20 billion to $25 billion in PBGC assistance that would not need to be repaid. Central States Pension Funds. See, “Pension Crisis: Current Legislative Efforts.”)

With the cash and loans that the PRA provides, pension plans would be required to purchase more secure investments from the private sector to guarantee that their workers and retirees would receive their promised benefits. Plans would also need to use the funds to invest in the market, in hopes of generating high returns to repay the loans.

By purchasing assets such as private annuities, recipients of multi-employer pension promises would gain ownership of 100% of their promised pension benefits while taxpayers would take on 100% of the liabilities. This would be great for workers and retirees with multiemployer pensions, while it would essentially empty the coffers of multiemployer pension plans and leave taxpayers with hardly a glimmer of hope that pension plans could repay their loans. In total, taxpayer liabilities could exceed the entire multiemployer pension system’s $638 billion-and-growing shortfall.

CBO initial estimates: Massively underscoring bill’s true cost

In light of what the CBO called “highly uncertain” budgetary effects based on the Butch Lewis Act’s broad language, the CBO has not issued a formal score of the bill. It did, however, provide a preliminary analysis of a more than $100 billion cost from 2019 to 2028, but then noted in a later letter that “[u]nder some interpretations of the bill language, … few plans would qualify for loans and assistance, resulting in federal costs that would be substantially less than $100 billion.” CBO letter to Sen. Orrin Hatch, 7/16/18.

A $34 billion bailout cannot solve a $638 billion shortfall.

Proponents of the bill — including its sponsor Senator Brown — used the CBO’s revised $34 billion estimate to argue that the Butch Lewis Act would solve the multiemployer pension crisis and prevent benefit cuts at half the cost of requiring taxpayers to shore up the Pension Benefit Guaranty Corporation (PBGC). See, Heritage Foundation, No. 3371 (12/11/18). This is almost certainly impossible (and it fails to acknowledge that taxpayers are explicitly not responsible for the PBGC’s deficit). Fully 96% of people with multiemployer pensions are in plans that are less than 60% funded, and the multiemployer pension system has promised $638 billion more in benefits than it set aside to pay. See, “Rehabilitation for MultiEmployer Pension Act,” by Rachel Greszler, Washington Times (8/12/19).

The $34 billion CBO score assumes that few plans would receive loans and cash assistance. As noted by a Pension Analytics report on the cost and impact of the Butch Lewis Act, a “narrow interpretation [of the number of plans that would qualify for assistance] would render the BLA [Butch Lewis Act] entirely useless, because a loan program that originates only a small number of loans cannot possibly prevent the tidal wave of insolvencies that is quickly approaching.” (See, The Pension Analytics Group, “The Multiemployer Solvency Crisis: Estimates of the Cost and Impact of the Butch Lewis Act.”

Considering that the bill intends to prevent any and all multiemployer pension cuts, along with the fact that it does nothing to require plans to increase their contributions, it should be obvious that $34 billion in taxpayer assistance cannot cover $638 billion in pension shortfalls. If the bill’s costs were actually that low, it would be — as noted by the CBO — because the bill would not prevent benefit cuts for many troubled plans. That is not the intent of the bill and it is not what its proponents say it does.

The Pension Analytics Group estimated that if the Butch Lewis Act instead provided loans to all 231 plans that are projected to become insolvent over the next 30 years, it would require more than $160 billion in immediate loans, and fully 52% of plans receiving loans would default on their loans within the first 30 years. (See, The Pension Analytics Group, “Proposal to Strengthen the PBGC’s Multiemployer Insurance Program Through a Combination of Premium Increases and Benefit Reductions,” November 2019)

Even if the CBO scored a more generous interpretation of the Butch Lewis Act — one that, as described by its sponsors, prevents all benefit cuts — its score would still be only a fraction of the bill’s true long-term costs. (See previous cited source.)

That is because the CBO’s prescribed methodology for scoring bills includes a limited 10-year scoring window and non-market-based accounting, and it excludes significant macroeconomic incentive effects.

Limited time window

The CBO typically provides 10-year cost estimates, meaning it evaluates the Butch Lewis Act over the 2019–2028 period. While a significant number of multiemployer plans are expected to fail during that period, they are likely to fail around 2025, imposing costs in only three or four years of the next 10 years. The true costs of a plan that fails in 2025 could span 80 years into the future. (See previous source.)

The direct cash bailout component of the bill could have a significant impact in the 10-year window if plans receive single lump-sum payments. If they instead receive annual payments over multiple years, a significant portion of the costs would come outside the 10-year window. Moreover, because the bill specifies interest-only payments for 30 years, any potential loan losses will not come into play in a 10-year score, or even a 30-year score because the loans would take time to be dispersed and final repayment would be outside any scoring window that the CBO considers.

Additionally, the majority of plans that will fail will do so outside the 10-year window. While 1,158 multi-employer plans are less than 60% funded, the PBGC projects that only 46 are expected to fail within the next 10 years. (See previous source.)

Extending the time window to include the next 30 years, five times as many plans — 231 in total — will fail. (See the previous source.) Thus, many plans that would receive assistance under the Butch Lewis Act would not receive it within the 10-year scoring window.

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP®, AEP, a member of the newsletter’s Board of Editors of Accounting and Financial Planning for Law Firms, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions.