Obama Budget Proposal: Chained CPI and Cap on Retirement Accounts

Obama talks

The news media, Internet discussion boards and Twitter are full of protests about two things in President Obama’s budget proposal, leaked to the press before its official release: chained CPI for Social Security and cap on retirement accounts.

First of all, these are only proposals. The President does not make law. The proposals get fed into the sausage making political machine. By the time things come out, you probably won’t be able to recognize what went in.

Now, suppose these become law, I don’t see them as being a big deal. I like both proposals. I know some of you will vehemently disagree. First hear me out.

Chained CPI for Social Security

Chained CPI allegedly will slow down annual cost of living adjustments (COLA) ever so slightly. So what? When Social Security started in 1935, it didn’t have COLA. COLA was added only in 1975. We are not talking about eliminating COLA, just slowing it down a little bit. Because it will be gradual, people will have time to make adjustments: tap into other resources more, reduce lifestyle expenses, etc.

Private pensions typically don’t have COLA. I’m sure people would love to have a pension even without COLA. Therefore, a COLA is not a necessary component of a retirement income scheme. People on a private pension without COLA simply adjust.

If people can adjust when a pension doesn’t have a COLA, having Social Security with a slower COLA will not be the end of the world either. Wanting a higher COLA is basically wanting the younger generation to pay more to the older generation. We can debate how much of a inter-generational transfer is fair or just, but realize there’s no inherent mandate that Social Security must have a COLA fully indexed to the CPI. It went on just fine for 40 years without it.

I don’t see a problem with chained CPI. As someone in his 40s, I say be gentle, save some Social Security for me.

Cap on Retirement Accounts

Details are fuzzy to me but the gist I got is that a person’s balance in all retirement accounts will be capped at a certain number, $3 million in today’s dollars, indexed to inflation.

What if your balance goes above it? You can be required to withdraw the excess, like the Required Minimum Distribution today for those over 70-1/2. People say $3 million is too low. Well, nobody is stopping you to save more. You just have to hold the excess outside retirement accounts.

I don’t have $3 million in retirement accounts. If and when I do, is it the end of the world that I would have to hold money in regular taxable accounts? Of course not.

Tax benefits on retirement accounts are specific benefits granted by the government. They can choose who would receive them. There’s no reason the benefits must go to everyone, unlimited. In fact there are already limits today on contributions. Now we are only adding limits on the earnings.

If you have $3 million in retirement accounts, you received plenty of benefits already. Wanting it uncapped or capped at a higher number, say $20 million, is basically wanting more benefits from the government, at the cost of other taxpayers. Again, we can debate how much other taxpayers should pay you because you are a disciplined saver or good investor, but there is no inherent mandate that retirement accounts must not be capped or only capped at a higher amount.

As someone who maxed out all retirement contributions every year since working full time, I say if I ever accumulate $3 million in today’s dollars in retirement accounts, I will be satisfied and grateful for all the tax benefits I received. I will be perfectly OK with using non-retirement accounts from that point forward.

I praise President Obama for his courage to challenge the status quo. We have too many sacred cows. They must be put on the table: tax deferral in annuities and cash-value life insurance, step-up in basis at death, "stretch" IRA, lower tax on dividends and capital gains, 529 plans, … Take hard look at what purpose they serve.

If debating each item individually becomes too bogged down, as evidenced by the protests on these two relatively small items, let’s wipe the slate clean and just do it AMT style: you get one large bucket worth $X; pick whatever you want to deduct under $X. Everybody will be happy. Savers get to protect their retirement savings. Homeowners protect their mortgage interest. Parents with college-age kids will deduct higher education expenses. All we have left to debate would be how much $X is. So simple.

[Photo credit: Flickr user rob.rudloff]

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  1. JoeTaxpayer says

    I wrote about the retirement savings cap today as well. I didn’t catch the inflation promise and this struck me similar to AMT, that time and tinkering by congress would let this effectively hit far more of us than originally promised.

    (One interest point to note, they suggest that $3M will fund $200K/yr. Not so, I think we agree that even 4%, $120K is not guaranteed.)

  2. rachel says

    “I praise President Obama for his courage to challenge the status quo.”

    I’m sorry to tell you this, but Obama’s proposal has zero chance of being passed by the [conservative members] in the Republican-controlled House.

  3. Jim says

    Interesting article. However I don’t think placing a cap on retirement accounts would work out well in practice. Over the past two decades we have seen wild swings in the stock market. There have been two 50% drops, followed by over 100% increases. This would create all sorts of havoc as someone could be required to take large taxable distributions only to have the market drop shortly after. A better idea, if the goal is to limit retirement accounts, would be to reduce the contribution limits.

  4. Harry says

    Jim – I’m sure the technical aspects can be worked out. For example you can be allowed to put your forced withdrawal back in if your balance drops.

  5. Investor Junkie says

    Hi Harry,

    I think this is a terrible idea on many levels. All of the PR articles cite Romney’s “excessive” sized IRA account. When in fact the target is so low for what they are suggesting that it’s not for “fat cats” that will not get hurt. In addition, it’s not just IRA accounts they want to target, but the total of all retirement accounts (401(k)s included).

    While I agree we should just go with a flat tax and get rid of all deductions, this isn’t exactly a good idea since a 3-4% withdrawal rate certainly will NOT put you in the “rich” category.

    I’ve also discussed it on my blog a well and mention other issues I have with it.


  6. TJ says

    Harry, I don’t disagree with you, but I think that the government (including state and local) should have to give up the COLA on THEIR pensions if this is to pass. If not, it’s just yet another perk for those who were fortunate enough to get hired by a public employer.

  7. Harry says

    TJ – Absolutely. I would even question why public sector employees must have a pension when private employers don’t have any problems with attracting workers without a pension.

  8. Steve says

    I don’t see how any SS/pension can work without COLA increases. According to http://www.ssa.gov/oact/STATS/table4c6.html a retiring 67 year old can expect to live 16 or 18 more years. During that time, the purchasing power of their SS payment would significantly, about 1/3rd. And that’s just the average – for the 50% that live longer, it would get steadily worse.

    I do also wonder if the chained CPI is having their cake and eating it too. By which I mean, steak becomes cheaper than chicken, so the hypothetical consumer switches to steak; but then chicken lowers in price, so they switch back. But depending on specifically how they define “lowers in price” (if it’s relative, or absolute, i.e. nominal dollars per pound or better, per calorie) it could have a ratcheting effect.

  9. rachel says

    To Harry at # 7:

    As I understand it (and I could be wrong) public sector employees are not eligible for Social Security for the pay they’ve gotten working government jobs. If that’s true then their SS is going to be little to nothing. Nobody in their right minds is going to sign up for that kind of penury.

  10. Harry says

    Well bring everyone into Social Security then. Not all public sector employees are outside Social Security. Some are already contributing to Social Security. There’s no reason to leave people out. There are also worries about underfunded public pension plans at the state and local level. Merging into Social Security will solve that problem. Turn over the money to Social Security and give people credit under Social Security.

  11. Peter says

    Just get rid of all the various different tax advantaged retirement accounts and stick with one.

    For example, an IRA with a contribution limit of $10,000 a year, adjusted yearly for inflation. Combine the benefits of the traditional and roth. This would benefit lower and middle income families the most. No need to have any maximum cap and would be very simple.

  12. Peter says

    “Details are fuzzy to me but the gist I got is that a person’s balance in all retirement accounts will be capped at a certain number, $3 million in today’s dollars, indexed to inflation.”

    Actually, this is how it would work (from the President’s budget proposal):

    “The Budget would limit an individual’s total balance across tax-preferred accounts to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or about $3 million for someone retiring in 2013.”

  13. JoeTaxpayer says

    The mechanism is not a forced withdrawal of excess, only the inability to deposit.
    So, the very plan that cites the Romney-sized $100M IRA as its origin, won’t have any impact on that IRA, but will cap the rest of us to $3M.

  14. Harry says

    Yes, Peter, we have a clearer picture now after the official release. You are not forced to withdraw once you reach the cap; you just can’t add more. Actually there’s a less talked-about much bigger whale in the budget proposals than this $3 million cap thing. I will have a new post about it on Monday.

  15. Bob says

    “rachel on April 9, 2013
    I’m sorry to tell you this, but Obama’s proposal has zero chance of being passed by the [conservative members] in the Republican-controlled House.”

    Harry, while I do not think you need to make moderating as suffocating as on the Bogleheads, I think you should filter out asinine posts like this. Else, it makes me think you support such idiocy.

    BTW, the real [extreme politicians] are the Democrats who say they support Medicare and Social Security but fight tooth and nail not to change them when it is clear that they will bankrupt the country if we don’t.

  16. Harry says

    Bob – I let people comment whether they agree with me or not. Not suppressing the comments does not mean I agree with the opinion, which everybody is entitled to their own. I agree naming specific politicians with derogative terms is perhaps a little excessive and unnecessary. The opinion that the proposals have zero chance of passing can be expressed without those. I’m going to edit them out but leave the opinion alone.

  17. Peter says

    Interesting, so under this proposal you can still have an infinite amount in tax advantaged accounts?

    Looking forward to the post on Monday.

  18. Harry says

    Yes. If you seed your Roth IRA with early startup shares valued at $0.01 per share, when your startup is acquired for $10 per share, you will have a lot of money in your Roth IRA, all tax free. Too bad you can’t add to it any more but you don’t care about the piddling $17,500 at that point.

  19. David says

    It’s a foot in the door at this point. It’s probably not going to affect most Americans, but (if it passes) it does reestablish an old precedent for capping account balances. When you live by government favors, you die by government favors. I just hope it doesn’t come back to bite Americans in the wallet.

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