Rich or Simply Frugal?

nest eggThere is always a target for bad tax policy, and these days it seems to be the rich.  Every scheme designed to raise tax revenue is usually based on taxing the rich more, taxing the poor less, and generally redistributing wealth so that society is fair.  Sadly, however, the non-wealthy but frugal and hard-working citizen often gets caught in the crossfire.  And the fallout from bad policy tends to fall on them.

Take Obama’s 2014 budget proposal that would limit the accumulation amount in a traditional or Roth retirement account based on the cost of an annuity.  For a person retiring in 2013 at age 65, the amount is about $3 million.  It is expected that this cap on tax-advantaged retirement accounts would raise about $9 billion over 10 years.

Ever since Mitt Romney ran for president and it was revealed he had tens of millions of dollars in retirement accounts, there has been concern from the administration that some savers are just saving too much.  These savers may have excessive amounts of tax-advantaged retirement funds when the time comes to retire.  So after reading countless articles about how Americans are not saving enough, now we’re saving too much?

For a person who starts saving during their mid-life crisis, invests solely in bonds and contributes minimal amounts, a $3 million cap is nothing to worry about.  Unfortunately, many people fall into this category.  But as young people are faced with the realities of an insolvent Social Security system, it is entirely conceivable that they could have millions in an account by the time they reach retirement age.  How?  Read here.

If you bothered to read the piece, you may be asking me where I got my wild assumptions.  They’re not that wild.  If an individual contributes the maximum allowable tax-deferred contribution to a 401(k) plan for 40 years (and that contribution is adjusted upward annually for inflation – which I assume to be 3 percent), and then they make additional “catch-up” contributions at age 50, and she invests in the stock market and receives a nominal rate of 12 percent (don’t laugh – the rate of return for the stock market from 1946 to 1990 was 12 percent), she could have $6 million in retirement cash in today’s dollars.  This has nothing to do with being wealthy, but it has everything to do with being a consistent saver, regardless of income.

The likelihood of any sane Congress member incorporating this limit into a budget bill is small.  But it’s always a good idea to get ahead of hair-brained schemes before they happen.

Comments (27)

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  1. Nigel says:

    How much money is to much money to save?

    • Pam says:

      According to Obama’s budget, more than would fund a $205,000 a year annuity (never mind that the cost of living varies from one city to another).

      • Nigel says:

        Interesting, do you know how they came to the conclusion that more than $205,000 a year annuity is too much? Is there a study that was done?

        • Pam says:

          Actually, the $205,000 is the annual limit that can be paid out through an ESOP (Employee Stock Ownership Plan)that is provided tax-deferred by some employers, but most people don’t have these types of plans.

  2. Miguel says:

    I find that the whole critique of saving too much is an impossible thing to prove, because there is no way to define exactly how much is enough.

    • Jeff says:

      Yes, while you are correct…there are some things that are excessive.

      • Miguel says:

        It is impossible to objectively determine what is excessive. By making that statement you assume that there is such a thing as excess. Sure, you could attach an arbitrary label on how much money is to much, but there is no way to prove that the arbitrary standard is right.

  3. Calvin says:

    The Obama Administration’s policies on taxing the rich possibly the largest paradoxical policies ever presented in congress.

  4. Wasif says:

    It’s like we are penalizing people for doing the responsible thing, I don’t think saving and being frugal is a wrong thing. But again, that just might be the Indian in me.

  5. Penn says:

    “redistributing wealth so that society is fair”

    -Making society “fair” is impossible. One man’s fair is another man’s unfair.

  6. Tim says:

    “If an individual contributes the maximum allowable tax-deferred contribution to a 401(k) plan for 40 years”

    What level of income is this based on?

    • Tim says:

      Also, very good piece. I don’t agree with a cap on retirement, it just shows quite clearly how the government is looking for other ways to get more revenue. But doing so from people’s retirement doesn’t sound logical to me. If I were to save more than 3 million dollars, I certainly wouldn’t feel it’s fair for me to get an additional tax burden after I followed the rules.

    • Pam says:

      This is not based on an income level per se. This is based on an individual of any income level contributing the maximum amount allowed each year to a 401(k) account. This year that amount is $17,500. Thus, it could be somebody earning $60,000 a year, $100,000 a year, whatever, depending on how much they are able to set aside for saving.

  7. Alex says:

    You can save as much as you want. You just won’t be able to defer taxes on the excess over $3,000,000.

    • Edward says:

      My employer adoped a 401(k) plan in the 1980 – 1982 frame, whatever the first year 401(k) was available. I contributed the max I could every year and even with relatively conservative investing ended up with more than the proposed limit (this includes both my own contributions and my employrs). I am not Mitt Romney. Point proven. I hope that since I am now already retired and the new law, if enacted, will not apply to me.

    • Denise says:

      Thanks for pointing out this important point. It was otherwise missing in this conversation… Under the proposal, you can save $300 million dollars for retirement, just not via a tax-favored account.

    • Julia says:

      Alex,

      Thank you for pointing this out! I’ve been frustrated with the responses to this proposal ever since it came out as they all seem to be ‘knee-jerk’ reactions.
      I feel the proposal itself was not well thought through, and should have been explained better.
      Administratively, it’s virtually impossible to enforce.
      Additionally, I’ve seen very few people consider if it’s particularly the government’s responsibility to subsidize unlimited tax-advantaged retirement savings? I don’t see this as a ‘rich vs poor’ debate, it’s more of a how far do we expect the government to go to facilitate retirement savings?

      • Cheyenne says:

        You’re right, Julia, it should not be a “rich vs. poor” debate, but government policymaking always seems to want to pit one class against another. And it should not be that way.

        One might also ask the question, how far do we expect the government to go in facilitating consumption, which they subsidize more heavily than they do savings. How far should they go in subsidizing mortgages, student loans, car manufacturing, everyday consumer purchases, Social Security benefits, health care?

        If we moved to a consumption tax, we would not have to argue this proposal to begin with.

        • Alex says:

          Overhauling the entire tax system is a conversation for another day. It is not really relevant when we are talking about one very specific tax-deferral loophole.

          The question here is: Is $3,000,000 in retirement savings adequate to guarantee a respectable quality of life for the two or three decades a worker will spend in retirement? Remember that median household income in the United States, as of the last census, was under $50,000.

          The purpose of sections 401(k), 403(b) and similar provisions in the tax code is to encourage workers to save, because adequate retirement savings are considered to be good public policy. Once a worker has saved $3,000,000, does public policy continue to support further tax deferrals?

          I submit that a worker who has already saved $3,000,000 is not really thinking about his or her retirement security. Instead, they are wondering if they can pass on tax-sheltered annuities to their children. That is not the stated purpose of sections 401(k), 403(b), and so forth.

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