Increase Retirement Savings Plan Fairness

One day last week I came across an article in the USA Today comparing the pensions of the top 100 CEOs to the retirement savings of average americans demonstrating a deep divide.  The capitalist in me viewed this as no big deal, because obviously higher income people will have higher retirement account balances.  The top 100 CEOs combined have $4.9 Billion in retirement accounts, with Yum brands CEO David Novak leading the pack with $234 million in retirement assets.  But wait a minute….aren’t we all limited to $18,000 per year in contributions to retirements accounts?  Either these CEOs have had amazing returns, or they play by a different set of rules.

Executive Retirement Savings Plans

Unfortunately the later is true.  In The USA Today article Kevin McCoy writes “The chief executives saved $78 million on their 2014 tax bills by putting $197 million more in their tax deferred accounts than they could have if the set-asides were governed by the same rules as other workers.”  So how on Earth do they get such treatment?  For starters, tax code 162(m) Deductibility of Executive Compensation allow for up to $1 million of compensation to be deferred for CEOS and the top 4 other highly paid individuals at a firm.  Wow.  That’s WAY more than the $18,000 limit on deferred comp. most of us have, but that isn’t the end of it.  There is also an option called a Non qualified deferred comp. plan.

In a non-qualified deferred compensation plan (NQDC) the employee (usually the CEO, but sometimes other highly compensated individuals) can elect to receive some if his salary at a later point in time, which will also change when taxes are due on that salary.  For example, if Bob Smith is the CEO of XYZ inc. and is scheduled to receive $50 million in compensation this year he could elect to defer as much of it as he wants, say $40 million until 2022, when he plans to no longer be CEO and will move to a lower taxed state.  Even though Bob hasn’t received this money, or been taxed on it, he can invest it.  Plans differ as widely as 401K plans, but in general NQDC’s allow the account owner to put the money into investments such as mutual funds.  Besides the unlimited contribution level the NQDC is also more flexible than your average retirement account. The owner can elect when to receive the compensation, which doesn’t necessarily have to be at age 59 1/2 or later.  Sounds like a great deal overall right?

There is one major downside to an NQDC, and that is the ownership of the account is in the hands of the employer.  If the company were to go bankrupt the recipient could be SOL, as the funds could be used to pay creditors. Since the CEO would have the most control over the solvency of the business, I suppose the risk would be fairly low to him or her.  Another downside to an NQDC is that the owner can not borrow from it, like he could a 401(K), although in all honesty, the owner of a plan shouldn’t need to borrow from it anyways.

Retirement Savings Plan Fairness For The Rest Of Us

Are you outraged by this?  Does it seem like it isn’t fair?  Well, you would be right, it isn’t fair.  And neither are our other retirement rules.  For example if your employer offers a 401K you can put $18,000 into it, but what if it doesn’t? You can only save $5,500 into an IRA.  This is an unfairness that genuinely affects far more workers.  Because their employer isn’t willing or able to offer a 401K (like my employers) these employees are limited to only being able to save 30% of what other workers can in a tax deferred account. Why on Earth are IRAs limited to $5,500?

And what about how the tax deduction system already greatly benefits higher earners?  Someone in the 35% tax bracket saving $10,000 receives a $3,500 benefit while someone in the 15% tax bracket saving the same $10,000 will only receive a $1,500 benefit.  Is this retirement plan fairness? Remember inequities aren’t just in existence between the 1% and the 99%, there are several inequities between the 60% and the 40%.

So What’s The Solution?

I think it would only be fair to get rid of the current limitations on deductibility of retirement savings. If any individual is able to defer an unlimited amount of compensation, than all individuals should be able to defer unlimited amounts of compensation.  This should be true regardless of what our employers decide to offer. If they want to match deferred compensation they should be welcome to, but it shouldn’t be a requirement. Under this plan retirement savings vehicles would be fair to all individuals regardless of who their employer is and what position they hold in a company.  If  congress is unwilling to do this, then perhaps the NQDC and 162(m) laws need to be removed and executives should only be able to defer the same amount of compensation as the rest of us.

Another option would be to end deductibility of retirement savings all together. If we must use the tax code for social engineering it would make more sense to concentrate on increasing retirement savings for people in lower income brackets than in higher income brackets. I seriously doubt we have to worry about wether or not the top 100 CEOs in America will have enough money saved for retirement.   I think an expansion of the retirement savers tax credit would be a good start.  With a larger incentive for retirement savings given to lower income workers.   The tax credits would be limited to a fixed amount and only provide incentives for a certain amount of savings and anything over that amount wouldn’t receive a credit, but the funds would still grow tax deferred.

Lastly, congress could eliminate barriers for employers to offer 401(k)s.  Offering a 401K can be expensive and a major administrative burden for small businesses.  If these barriers were greatly reduced more employers would offer 401(k)s.  Perhaps a small tax incentive could be given to employers to offer a 401(k) for its employees.

So what can you and I do?  Well we can’t change the laws on our own, but we can do our best to save what we are allowed to under the rules we currently have.  Most people don’t come anywhere near challenging the limits set by the IRS.

Action Steps:

  • 1. Max Your 401K if available
  • 2. Get a High Deductible Health Care Plan with an HSA and max it
  • 3. Contribute the max to your IRA and a Spousal IRA.
  • 4. If your employer doesn’t offer a 401K, try to figure out why and help them find a way to offer one, and/or consider finding another employer who does offer one.
  • 5. Open a taxable account at Betterment and take advantage of the 0% tax rate on long term capital gains if you are in (or can put yourself in) the 15% tax bracket.  Betterment also takes advantage of Tax Loss Harvesting and TaxMin Lot selling.
  • 6. This is the most important one: Don’t worry about someone else who seems to have a better deal than you do, just do your best and compare yourself today to where you were last year, 2 years ago, 5 years ago. As Tony Horton would say “Do Your Best and Forget The Rest

What are your ideas? How would you change the retirement savings tax incentives in America, or are they OK the way they are?  How do you feel about CEOs being able to defer an unlimited amount of income?

John C. started Action Economics in 2013 as a way to gain more knowledge on personal financial planning and to share that knowledge with others. Action Economics focuses on paying off the house, reducing taxes, and building wealth. John uses the free tool Personal Capital to track his net worth and posts quarterly updates on his finances. Check out the Action Economics archives section for all past posts.

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