There has been a lot of talk in Washington about deficit reduction, tax expenditures and tax reform. One of the largest identified tax expenditures is the exclusion for employer provided retirement plans, both defined contribution and defined benefit. I was at a seminar recently where the reported number for 2011 was $112 billion for fiscal year 2011. Among the alternatives offered to raise revenue is to reduce the amount that can be contributed to a defined contribution plan from the current $50,000 or 100% of compensation to $20,000 or 20% of compensation, in either case, whichever is less.
What is missed in this debate about tax expenditures, deficit reduction and retirement plans is the fact that — except for Roth contributions — retirement plan contributions are a tax deferral, rather than a tax exclusion. Ultimately, the taxes deferred are paid by the participants who receive the benefits. Those interested in the considerations that can go into quantifying the difference between a tax deferral and a tax exclusion may be interested in a brief published by the Center for Retirement Research at Boston College entitled “What’s the Tax Advantage of 401(k)s?” That analysis shows that the tax cost for 401(k) plans is $50-70 billion per year. It makes for interesting reading and raises important policy considerations for those of us working with retirement plans.