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RESA Tax Provisions Aim to Improve Retirement Security

By Shai Akabas

Tuesday, December 6, 2016

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This is the fifth post in our series about promising proposals to advance retirement security in America.  

The tax code is an important mechanism through which the federal government influences retirement policy. Specifically, the tax treatment of retirement savings provides a strong incentive for employers to offer workplace retirement savings plans, which are the primary vehicle by which Americans accumulate savings for retirement. Together, these retirement-related tax provisions are valued at more than $150 billion annually (although this estimate does not incorporate long-term effects).

RESA would modify existing retirement tax incentives in ways that would improve access to retirement savings. 

The Retirement Enhancement and Savings Act (RESA) of 2016, which was recently passed unanimously by the Senate Finance Committee, would modify some of the existing retirement tax incentives in ways that would improve access to retirement savings:

Expand the plan-startup credit. Currently, employers with fewer than 100 employees can receive a tax credit of up to $500 to offset as much as 50 percent of the cost of starting up a new retirement plan. The RESA would increase the maximum credit to $5,000 for employers where at least 20 non-highly compensated employees are eligible to participate. (To be precise, the limit is $250 per non-highly compensated employee up to that maximum.) Such a change would incentivize employers to expand savings options to lower- and middle-earning employees.

Create a new tax credit to incentivize automatic enrollment. Studies have shown that retirement-plan participation increases substantially when plans automatically enroll their employees. To promote the adoption of automatic enrollment, the RESA would create a tax credit of $500 per year for up to three years for: 1) new plans that adopt auto enrollment (which would be on top of any other plan-startup credits for which they are eligible), and 2) existing plans that adopt automatic enrollment. (Under automatic enrollment, individual employees remain free to opt out at any time.)

Allow graduate and post-doctorate students who receive fellowship income to contribute to IRAs. IRA (Individual Retirement Arrangement) contributions are only allowed for individuals who have earnings—compensation from employment or self-employment—in the same calendar year. Under current law, however, income earned by graduate and post-doctorate students for fellowships does not count. This restriction denies some younger Americans an opportunity to save for retirement just as they are forming savings habits that can persist through the rest of their lives. A provision in the RESA, modeled off a bipartisan bill sponsored by Sens. Elizabeth Warren (D-MA) and Mike Lee (R-UT), would lift the restriction and enable these individuals to make contributions to tax-advantaged retirement accounts.

Limit the “Stretch-IRA” estate-planning tactic. Savings in tax-deferred retirement accounts are subject to minimum-distribution requirements when individuals reach older ages in order to promote the accounts’ intended use for income in retirement rather than an open-ended tax shelter. But if an individual dies and leaves a 401(k) plan or IRA to a non-spousal heir, such as a child or grandchild, the heir – who is still subject to required minimum distribution (RMD) rules – can satisfy the requirements by taking very small annual distributions that are intended to make the account last throughout their life expectancy, shielding the bulk of the inherited retirement savings from income taxes for decades. This approach especially benefits the youngest beneficiaries of inherited IRAs, hence its common use as part of the estate plans of wealthy families.

The RESA would change the RMD rules on inherited, aggregate retirement savings so that any amounts in excess of $450,000 (indexed for inflation) must be withdrawn—and would be subject to any applicable income taxes—within five years. The legislation would allow an exception from these new rules for surviving spouses, beneficiaries of similar age, beneficiaries with disabilities (meeting the definition used by the Social Security Disability Insurance program) or who are chronically ill (meaning that they would likely qualify for benefits under private-sector long-term care insurance), and minor children (though child beneficiaries would be required to draw down inherited balances in excess of the $450,000 threshold in the five years following the year in which they reach adulthood).

The savings from this provision, which is estimated to increase tax revenue by more than $3 billion over 10 years, would be used to offset the cost of other provisions within the RESA, such as the expanded plan-startup tax credit and a provision to promote access to workplace retirement savings plans by allowing pooled-employer plans.

Promoting greater access to workplace retirement savings through the tax code can be a key step towards improving retirement security in the United States.

Many of these tax incentive provisions are identical to recommendations from BPC’s recent Commission on Retirement Security and Personal Savings. Promoting greater access to workplace retirement savings through the tax code can be a key step towards improving retirement security in the United States. The fact that this legislation does so in a fiscally responsible way is admirable.