Unpacking the 401(k) confiscation rumor

DR readers might have been alarmed to read Dan Amoss’ warning in yesterday’s edition that, “Some in Congress are floating a proposal to steal your 401(k), sell the proceeds, and invest in ‘government-guaranteed’ retirement accounts.”  Alarming especially to folks reading about it for the first time.  So let’s go into a little more depth.

This blog was among the first to warn last month about a proposal to wipe out the tax advantages of 401(k) plans.  During the last week or so, probably because of Mr. Obama’s election, this has caught fire on the Internet.  And like many things that catch fire on the Internet, people are inclined to present the issue in the most dire form imaginable.  So a plan to wipe out the tax advantages of 401(k) plans has morphed into a plan to “confiscate” 401(k) accounts — probably because Argentina’s government did something similar a few weeks ago.

Is it really a confiscation plan?  Well, yes and no.  Let’s unpack some of the nuances, because only then will we have an indication how far this ugly thing might go.

During a hearing last month, Rep. George Miller (D-California), the chairman of the House Committee on Education and Labor, suggested that “high-income” earners be no longer allowed to make tax-deferred 401(k) contributions.  Miller has since back-pedaled on this notion, and nothing has been put in the form of legislation yet.  So the spotlight has now shifted to a proposal by the star witness at the hearing, an econ professor at The New School in New York named Teresa Ghilarducci.

She’s unveiled the plan in conjunction with the left-wing Economic Policy Institute; it’s available in .pdf form on EPI’s website.  The gist of it is this:

1) Wipe out the tax-deferral feature of 401(k)s because it’s mostly the “wealthy” who enjoy that feature.

2) Force everyone to contribute 5% of their income to a “Guaranteed Retirement Account” (GRA) which invests entirely in government bonds and returns an inflation-adjusted 3% a year.  Half of this “contribution” would come from you, half from your employer.  It would be on top of whatever you “contribute” to Social Security.  In exchange for losing the tax advantages of your 401(k) contribution, the government would graciously kick in an extra $600 a year to your GRA.  As Mrs. Bakerman said on The Bob Newhart Show, “Isn’t that nice?”

As awful as all of this is, confiscating existing 401(k) balances and converting them to GRAs is not part of the plan.  Not now.  In her prepared testimony to Congress, Ghilarducci said:

Short term, I propose that since 401(k) accounts and the like are financial institutions — the bank about where 38% of the workforce can intend to save for their retirement — Congress let workers trade their 401(k) and 401(k) – type plan assets (perhaps valued at mid-August prices) for a Guaranteed Retirement Account.

Short-term, then, this is voluntary.  But long-term?  That’s the problem.  Everything about this has a slippery-slope vibe that means you can’t preclude the possibility of a forcible conversion of 401(k)s to GRAs.  And yes, if that were to happen, if everyone’s stock and bond holdings were liquidated in one fell swoop and switched into Treasuries, Dan Amoss is absolutely right — that would bring on a government-guaranteed depression.

Would our Congresscritters and the president do something that mind-bendingly stupid?  Seems far-fetched.  But there’s that Argentine thing.  So you can’t rule it out.  We’ll be watching.

The Daily Reckoning