For small firms in particular, the proposed tax reform proposals put out by a presidential panel threaten employer-sponsored retirement saving plans, industry experts say.

While seemingly a long way off, these proposals can not be lightly dismissed. They contain enough attractive non-retirement features so that Congress will be receptive to reforming the tax code.

Sources close to this subject predicted President Bush would push tax reform in his State of the Union speech this winter with hearings on the subject in 2006 and there is more than a bare possibility that tax reform legislation of some kind will become law in the 110th Congress.

The President's Advisory Panel on Federal Tax Reform panel offered two options--one that would simplify the existing income tax and a second that would move the tax system closer to being a consumption, rather than income, tax.

Brian Graff, executive director of the American Society of Pension Professionals & Actuaries, leveled his sharpest criticism at a component of the second package of proposals that would eliminate the immediate deductibility of contributions to retirement accounts at work (no longer 401(k)s, but a new version dubbed "Save at Work").

Graff said the 401(k) industry ought to consider that the tax panel was advocating this change in part because it would mean more tax revenue and enable setting the corporate and income tax rates lower.  While this may be a good thing for larger corporations, many smaller firms with high owner participation, the changes may severely impact retirement plans tied to company programs.

The changes could also affect long-time employees who are critical to a small company’s success by preventing them from building a retirement nest egg through tax deferred programs. To keep these individuals, smaller firms would be forced to increase salaries and other benefits.

Edward Ferrigno, vice president of the Profit Sharing/401(k) Council of America, said, "There would be fewer people saving for retirement, especially lower and moderate income people." Within minutes after the tax reform proposals were publicly unveiled, the American Society of Pension Professionals & Actuaries put out a statement calling them "devastating to the retirement aims of millions of American workers."

In the package are proposals aimed at simplifying the income tax, employer-provided Save at Work plans would replace all existing defined contribution plans. Existing contribution limits and rules for 401(k) plans would be retained, but qualification rules would be simplified. Instead of current non-discrimination requirements, Save at Work plans would apply a single test to ensure that employee contributions are not skewed towards highly compensated employees. "Auto-pilot" type reforms would be included in the new plans.

The fear in some industry quarters is that such generous opportunities for the affluent to save by other means could doom the spread of employer plans, which can help less provident workers save for old age. "We are not saying the whole package does not make sense," said Ferrigno. "If people saved adequately on their own—but we know they don't."

Also with the potential to be adversely affected are HSAs according to Michael Cannon of the Cato Institute.  According to this leading healthcare advocate, the proposal includes three major changes affecting health care:

• It would cap the currently unlimited tax exclusion for employer-sponsored health insurance at $5,000 for those with self-only coverage and $11,500 for those with family coverage.
  
  
• Second, it would create what Tax Notes describes as “an equivalent tax break for individual policies” for those without employer-sponsored insurance.
  
  
• Third, it would roll HSAs (and other tax-preferred savings accounts) into “save for family accounts.” (Let’s call them SFFAs.) Unlike HSA contributions, SFFA contributions would be taxed.

The end result, according to Cannon, would be a severe limitation on HSAs.