Don’t Turn Off Your Faucet: A Political Opinion on Retirement Policy vs. Tax Policy

About half the people I work with were born after I started my job here, so it’s become apparent that what I still think of as pop culture is now simply history. References, quotes and clichés from movies, TV and politics from the 70’s and 80’s are met with blank stares. I fully expect that if I mentioned “trickle down economics” (TDE) or “Reaganomics”, I would get that deer in the headlights look (though I do expect my younger colleagues would know who Ronald Reagan was – the president that is, not the actor).  Note that it was another actor, Will Rogers, who actually coined that phrase.

What Is TDE?

The theory behind TDE (also called “supply-side economics”) is that you can drive economic development through tax incentives for businesses and raise the collective wealth of society, that is, the economic benefits will trickle down to the masses. The success of such a policy has been debated much over the years – but I think one area where TDE actually works is in retirement plans for small businesses. The fact is, most small business owners offer retirement plans because of the personal benefits to them individually, not to be a generous employer or to attract and retain quality employees.  They could attract and retain qualified employees by simply paying higher wages. We often hear the question, “Wouldn’t I be better off without a plan, paying the taxes and just putting the money in my pocket?”  Our response is generally a resounding “No”.

The current tax deduction, the power of tax-deferred compounded investment earnings and some complex nondiscrimination rules allowing small business owners to contribute substantial sums for themselves – in excess of $200,000 a year in some instances, provide the incentives to have retirement plans. These complex rules, often deemed a loophole to benefit the rich, ultimately benefit their rank and file employees even more. How? Well, we know the plan exists because the business owner reaps significant individual benefits. However, in order to take advantage of the so-called loophole and satisfy nondiscrimination rules, the employer/small business owner must contribute on behalf of all their employees at a certain minimum level ranging from 5% to 7.5% of pay, sometimes more – every year, regardless of profits, and on a non-elective (i.e., non-matching) basis.

Some in Washington would like to limit the ability of the small business owner to accumulate tax-deferred retirement funds on this basis, thus dis-incenting small businesses from offering these generous retirement plans with significant owner benefits. If successful, the only incentive for these employers would be to offer a very basic/minimal plan, if any plan at all. And note, these same small business owners, even without a tax favored retirement plan, could and likely would still save for retirement as they have the means to do so.  They also likely have the ability to continue working as long as they want, being the boss and all. But what about their employees? Maybe they would get more in their paychecks instead, and maybe they would save enough on their own for a reasonable standard of living in retirement or maybe they could remain productive later in life to continue working and not be forced to retire.  However, I think that would be the exception rather than the rule. The reality is, the small business owner is going to get his/hers first, and ultimately if they have to pay higher taxes, it just means less available for their employees (or fewer employees).

Why Limit Retirement Contributions Even More?

Retirement plan contributions and accumulations are already limited by the tax code, so why limit them further? The small business owner in America is not going to accumulate a $100M Romney-like IRA, which seems to have ignited this debate (please note, his IRA will eventually get taxed at ordinary income tax rates).  Why give the small business owner a reason to not offer retirement plans? Limiting the small business owners will directly impact their employees’ retirement benefits, too.

Isn’t a system that readily enables working class Americans to accumulate 10% or more of pay each year toward retirement, in combination from the employer and the employee, over an entire working career good social policy and exactly what we need to avoid a generation of retirees in poverty and relying on public assistance? And isn’t that worth a tax deferred benefit for the small business owner – one who will ultimately pay taxes on that benefit regardless? I believe so.

Conclusion

Generating current tax revenue at the expense of the future welfare of those working for small business America AND future tax revenue, is counterproductive.  Remember these are tax-deferred plans and taxes from these plans will eventually be paid. Wouldn’t it be better to spread the tax burden of this subsidy over more taxpayers now than saddling a smaller base of future taxpayers – our children and grandchildren, by the way?  We already know the number of employed, tax-paying Americans is declining as the population ages and that trend may continue.  So let’s not diminish the buildup of tax-deferred retirement funds that will be available to fuel future economic activity and tax revenues, not to mention enable those employed by small business America to retire in dignity.