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Playing Politics With Your Retirement

President Obama will deliver his State of the Union address tonight, and the word on the street is that he will spend part of that time talking about retirement. Not his retirement; yours. It’s sure to be another indication that federal and state governments want to play a much larger role in your retirement decisions. Unfortunately, as is often the case, these efforts seem designed to score political points, while leaving the details of implementation, and the unintended consequences of these policies, to the rest of us.

Tonight, retirement savings will become a prominent part of the tax reform debate. Specifically, the President is expected to propose:

  • a cap of $3.4 million for the amount of savings that can be held within an IRA;
  • an increase in the tax rates on capital gains realized from the sale of investments; and,
  • elimination of the basis “step-up” when transferring assets to the next generation, which could result in the double-taxation of investment gains.

At a time when the United States faces a retirement crisis, all of these proposals will make it more difficult for Americans to retire comfortably and securely.

Even more troubling are recent efforts by the federal government and several states to get into the retirement savings game. Right now, nearly a dozen states are considering proposals that would require small companies that don’t offer retirement plans to automatically enroll their employees in plans to be managed by the state. One of these states is Illinois, which has guided its own employees’ pension plan to the brink of collapse, and has the lowest credit rating of any state in the union.

On the federal side, the president has rolled out a new plan called MyRA, which is intended to encourage more young and low-income workers to save for retirement. Unfortunately, it violates several important rules of sound retirement plan design. It offers only one undiversified investment option, a government bond index with low risk but correspondingly low returns. It allows for easy access to the funds before retirement, making the plan more of a glorified piggy bank than a true retirement savings vehicle. And although there is no cost to participate, the plan requires funds to be rolled over to a private IRA after reaching a relatively low dollar threshold. This opens the door to lots of fees and commissions down the road from a captive audience of investors. In fact, the financial firm selected by the feds to manage the MyRA program is Comerica, the recipient of countless complaints and negative reviews as administrator of the government’s TreasuryDirect program.

Take a step back from the details and the trend toward more government activity in this area is unmistakable. For those of us who take retirement planning seriously, the takeaways are clear.

  • The tax treatment of retirement savings and retirement plan distributions is complex and ever-changing. Taxes are pervasive, and their impact should be considered in every investing decision we make.
  • Government savings plans, as well intended as they might be, can have some significant drawbacks, and require the utmost confidence in the administrative abilities and financial well-being of the government sponsor. Before opting into one of these programs, be sure to evaluate it carefully and compare it to other available options.
  • Employers have an opportunity to attract and retain high-quality employees by including a retirement savings program in their menu of benefits. Contrary to popular belief, the 401(k) plan is not the only option. Alternatives like the Simplified Employee Pension (SEP), the SIMPLE IRA and the Payroll Deduction IRA are easy to set up, easier to administer, and much less costly than the traditional 401(k).

Retirement savings and politics have been linked since the Social Security program was established in the 1930s. As the pendulum swings toward a more prominent role for government, financial success will depend on knowing the rules, understanding your options, and adapting to changes when they occur. Stay tuned.

Kevin Fix