The $3 million retirement cap: Foot in the door?
By John D. Turner
28 Apr 2013

I keep reading that the average American is unprepared for retirement. According to this article in the Christian Science Monitor, most of us have less than $25,000 saved up for those “golden years.” This amount excludes home equity and pension benefits, so the picture isn’t quite as dire as it appears, but most Americans seem to be living paycheck to paycheck and counting on their Social Security to provide for them in their old age.

Many Americans also have IRAs, 401(k)s, 403(b)s, Roths, and other types of tax deferred or tax exempt retirement accounts. How much is in these accounts varies depending on how they are invested, how the market is doing, and how much money people have actually put into them. According to Fidelity Investments, one of the largest plan service providers, the average balance in 401(k)s they manage reached a record high of $77,300 at the end of 2012. This includes everyone, from those just starting out to those who are already retired. While this is significantly better than the $25K cited above, it is not enough to retire on.

Looking at those close to retirement, a report released recently from the Center for Retirement Research at Boston College showed that the median household retirement account balance in 2010 for workers in the 55-64 year age group was only $120,000 – better, but still not enough; certainly not for someone within 10 years of retirement. Worse yet, a third of all households in the US don’t even have a retirement account of any kind. This has led some to declare the move from defined benefit plans to defined contribution plans like 401(k)s to be “a disaster.”

So how much money do you “need” for retirement? I put need in quotes, because it depends on who you are talking to – money advisors or the President of the United States.

A recent Forbes magazine article analyzed what a 20-year old saving for his or her retirement today would need in order to have a lifestyle equivalent to $60,000 a year in today’s dollars. The answer was a retirement fund worth nearly $10 million by 2058. While $60K is more than the median family income for Americans today, including everyone from burger flippers to CEOs, it is hardly a lavish amount and unlikely to fund the sort of retirement that most people in their 20s envision. And how does the average 20-year old, just starting out, attack the daunting prospect of amassing nearly $10 million by the time they are 65?

Well, if President Obama has his way, this won’t be an issue that our hypothetical 20 years old ever need face. Mr. Obama’s 2014 budget contains a provision that would put a $3 million cap on all tax-advantaged retirement accounts. This includes traditional IRAs, Roth IRAs, and all defined contribution plans. And this isn’t a $3 million cap on each of these – the cap is on the sum of the balances on all such accounts you own; $3 million total is all you can have. If you have more, the government will relieve you of that “burden”.

Why is Mr. Obama doing this? According to him, “wealthy individuals” are using these investment vehicles to earn “substantially more than is needed to fund ‘reasonable’ levels of retirement savings.” This is simply another effort to “crack down” on such people and “redistribute the wealth” to other areas that he and others of his ilk deem more “acceptable.”

Note that the president didn’t say that these wealthy individuals somehow came about it dishonestly; he allows that they did indeed earn it. He just doesn’t believe that they should be allowed to earn quite so much. Having given the matter considerable thought, he has decided that he knows how much is “reasonable” for a person to expect to get in retirement; anything else deriving from a tax-deferred account is apparently stealing from the government.

Of course government will ultimately tax all that money anyway as ordinary income as it is disbursed. It isn’t as though the government won’t get their “fair share” eventually. The laws pretty much guarantee that the individuals with big accounts will also be in higher tax brackets.

However the president would rather have a smaller piece of a bigger pie now rather than wait to get a larger share of a larger pie at some time in the future. This way he can look like a hero to most, smiting those evil rich folks while at the same time doing his part to refill the government’s coffers that he has been so instrumental in emptying.

Because really, most Americans won’t care too much; for most of us, with an average of only $77K (or maybe $120K if we are older) in our retirement accounts, $3 million seems like a bridge so far that we can hardly relate to it anyway. So what if he imposes a $3 million cap? It doesn’t affect me!

Or does it? Ever seen the government pass a law, particularly a tax law that doesn’t change? Just take a look at the history of the standard deduction, which has varied all over the place during the history of the income tax. Or the child tax credit. Or the homeowner interest deduction. Or even the tax brackets. They go up and down. Sometimes they are indexed for inflation, sometimes not. And even if they are indexed for inflation, the government frequently changes the index to suit their needs.

The CPI is the government’s method of calculating and reporting inflation. The government would like to substitute a new index, called the “chained CPI” which is supposed to be a more “accurate” representation of inflation. Since the CPI is the index the government uses to adjust all sorts of government programs, including Social Security, military retirement, and federal retirement cost of living increases (COLAs), income tax brackets, the amount you can contribute each year to IRAs and defined contribution plans, and others, changes to this number affect all Americans.

Changing to the new chained CPI is being advertised by the government as a method of “saving” trillions of dollars in the future – savings that are coming out of all of our back pockets as the government finds a way to let it to pay out less than it promised on a whole host of benefits while at the same time telling us that what it is really doing is “saving money;” who doesn’t want the government to be more frugal? Isn’t that what the “tea party” protests have all been about?

Simply put, the chained CPI has the effect of reducing the reported inflation rate. It does so by assuming your behavior will change as a result of inflation; as things get too expensive the chained CPI supposes you will choose cheaper alternatives. And the government will enforce this behavior with less money in your pocket when it comes to the annual COLA.

The cost of living really doesn’t go down, of course – just the amount that the government pays you in COLAs instead of what you would have received previously. The government “saves”, and you lose. Additionally everything else that depends on the government’s measure of inflation, such as the income tax brackets, move each year by less than they ordinarily would. Over time this adds up to a substantial erosion of your purchasing power and ability to keep your head above water in those “golden years” when you are on a fixed income.

The chained CPI assumes that as inflation erodes your standard of living, you will switch from eating caviar to eating dog food, and the COLAs tied to the reduced CPU will enforce those economic decisions.

So the “fair” amount now is $3million. But what happens if a year or so from now, the government needs more “revenue” and decides that the $3 million is “too generous” and changes it to $2 million? Or – pick a number? The big problem with letting the government into the game of determining how much you can earn and how much is “fair” for you to keep is that once the camel’s nose is under the tent, how do you keep the camel out? If the government is allowed to determine how much you “need” then what is to keep them from resetting the goal posts any time they like?

What is to keep them from expanding the definition? As it stands right now, President Obama is unaffected by this proposed change to the law, because he receives a pension from the government for his service as President. This pension, indexed for inflation, will be worth at least $5 million over his projected lifetime, but is not subject to the cap because pensions are not tax advantaged accounts. What if somewhere down the line the government looks at this law and says “why shouldn’t this apply to pensions as well?” If $3 million over your lifetime is a “fair” cap on defined contribution plans, why not on defined benefit plans (pensions) as well? Particularly on pensions paid by federal tax dollars - exempting elected officials, of course.

Pension plans are going the way of the dodo these days in private industry. The main place you find them now is in governments at the federal, state, and local level. Most private plans are defined contribution plans. If such plans for most Americans are capped at a max of $3 million, why shouldn’t all retirement systems be capped the same? Wouldn’t that be “fair?” Such a cap would mean, for example, that the maximum amount of money that you would be able to receive from the federal government in the form of a retirement could not exceed $3 million total.

That seems like a lot of money. Who would need more? For that matter, what sort of gold-plated pension system would let someone draw $3 million from the public treasury in retirement pay? Let’s run through an example and find out.

Take a hypothetical 23-year old that graduated from college in 1993 with a BS degree, pinned on her butter bars as a second lieutenant in the US Air Force and is retiring this year having completed 20 years of active duty. All my examples are going to be based on 2013 pay scales. As such they will be low because they won’t take into account cost of living increases for current workers and retirees over the next 20 years. Actual dollar amounts will be higher.

This year she is 43 years old and a Lt Col in the Air Force. She decides to retire from active duty and lands a civil service job working for the Air Force as a GS-13 step 1. As an active duty retiree, she now receives retired pay equal to 50% of her high-3 base pay. For simplicity we will just use her final pay instead. Under the current pay tables this would be half of $9,529, or $4764 per month. This works out to $57,178 per year for serving her country and putting up with the usual crap that goes along with being in the military. Thank you for your service!

At age 43, she has a bright future ahead. She can be expected to live at least another 35 years, maybe more. And assuming her retired pay never changes, she has 52 years before she has to worry about hitting the $3 million cap at which time she would be 95 years old. There is a good chance she won’t make it to 95 so she doesn’t have to worry about hitting the cap. Life is good.

But what happens when she reaches social security age? At age 62 she can start drawing social security for all those years she paid into it. Contrary to what many might think, military personnel do pay social security tax. So do FERS civil service employees. In fact, social security is considered the 3rd “leg” of the civil service retirement system, which consists of the pension, TSP (defined contribution plan), and Social Security.

We are going to project that she will start taking Social Security at 63. Using the 2013 figures as well, she would likely receive around $1850 per month based on her contributions over the years. This adds up to $22,200/year in social security benefits in addition to the $57,178 per year in military retirement benefits for a total federal pension of $79,378 per year beginning at age 63. This means from the time she retired until age 63 she would have received a total of $1,143,576 in military pension. At the point she begins drawing social security at age 63, she will now reach the total $3 million cap now just a little over 23 years later at age 86. Remember, we are not including any COLAs in any of the calculations; actual numbers would be higher, resulting in actually reaching the cap sooner.

Hmmm. This is actually a bit less than her projected life expectancy at this point. This presents a problem. It is possible she could run out of retirement pension before she dies. Perhaps she had best start setting money aside in some other investment vehicle just in case.

Now let’s look at her civil service job. Under FERS retirement law, you cannot receive credit for any military service in your FERS retirement computation if you are receiving military retired pay under an active duty retirement unless you waive your military retirement pay. For this example we are going to assume the retirement pay is not waived. This means the civil service retirement would be based solely on time served in civil service after the military retirement. Let's further assume she works for 20 years and retires from civil service at age 63. Since she is now over age 62 and has 20 or more years of creditable service, she can retire with a civil service pension. How much would she get and how does this affect her under the cap?

According to the rules, since she is over 62 years of age, she will receive 1.1% of her high-3 average salary over the 20 year period times the number of years of creditable service. Using the 2013 pay charts and making the same assumptions we did with the military retirement, and further assuming that she would retire as a GS-13 step 10, and that she retired under the "rest of the US" pay table, which yields the lowest pay rate, this would give her an annual pension of $23,400 beginning in this case, when she retires at age 63. ($106,369 * 0.011 * 20)

So, to sum up: at age 63, she has received a total of $1,143,576 in military pension from the federal treasury. She will also be receiving additional $22,200/year in social security. Going forward, she will be receiving $102,780 per year in total benefits from all three retirement programs. She is now going to hit the $3 million cap in a bit under 18 years from age 63, or around age 81.

Remember, this assumes no cost of living increases or pay raises, in the case of the civil service system, in ANY of these programs from what is being paid now, in 2013. And it also doesn't take into consideration that she may be a disabled vet. Beginning in 2014, disabled vets with 50% or more VA disability will receive concurrent disability payments from the VA; this means that their VA benefits will no longer be offset against their military retirement check, in which case she would have yet another independent income stream from the federal government.

And what happens if the government’s fiduciary “needs” outweigh your retirement “needs” (as determined by that self-same government), and it is decided that a $2 million pension cap is “fair”? Or less?

Now granted, most military retirees are not Lt Cols. Most are probably MSgts on average, with correspondingly lower retirement checks ($2164/month vice $4764/month) and would probably come in at a lower grade in civil service as well. Of course, we didn’t take pay increases, promotions, or COLAs into effect either.

So what do you think? Do you think the government, if it establishes the cap called for in the president’s budget, will be satisfied with that? Do you think they will move the dollar amount of the cap? Do you think they might broaden the cap to include pensions, particularly federal government pensions? What about other benefits, like Medicare, Medicaid, Tricare for Life, or FEHB? Is it possible benefits received in those could be capped as well?

I know it is cliché to talk about a “slippery slope” argument these days. But when dealing with the government it seems that everything is a slippery slope. About the only thing you can trust with government is that for the most part, elected officials will act in their own self-interest, and that if you give the government a chance to mess you over it will. It may seem cynical, but that has been my experience after 33 years of being associated with it both as a citizen and an employee.

From the perspective of a citizen, this cap is a bad idea and you should let your congress critter know that. It’s bad because it sets a precedent and allows the government into yet another area where it has no business; determining how much a person can save and how much a person “needs” when they retire. It’s bad because once initiated, it can spread without bound to other government programs providing retirement benefits. It’s bad because it is constitutionally unsound; nowhere in the constitution is the government given this power. And finally, it is bad because it flies in the face of the capitalist ideal this country was founded on and smacks more of what one would find in a Socialist, or dare I say it, Communist society instead.

When implementing a new, radically different plan, government usually starts small and works from there. The income tax camel got its nose under the tent in 1913 with a top rate of only 7%, affecting less than 1% of the population. You can see from this chart what it has done over time.

The government revenue camel is sniffing around the tent again only this time it is your retirement at stake. Learn from history. Keep the nose out or else before long the entire camel comes visiting and Hoovers your nest egg leaving you with nothing but an empty shell, on government assistance, and living vicariously through the lavish vacations of your elected officials instead of the ones you had planned for yourself in that somewhat less than golden twilight of your life.