From Capitol Hill to Main Street

From Capitol Hill to Main Street Presented by Thomas Rowley Director, Retirement Business Strategies Invesco 1 Important information The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment t professionals. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation. The opinions in this piece are not necessarily those of Invesco. Information in this report does not pertain to any Invesco product and is not a solicitation for any product. The tax information presented is based on current interpretation of federal income tax law. State and local income tax laws may differ from federal income tax law. 2 1

The story of area codes 206 380 425 253 509 503 971 503 707 530 510 925916 415 650 408 209 831 559 541 805 681 780 626 310 818 323 949 542 714 909 949 858 619 907 775 702 208 208 801 435 928 823 480 602 520 406 970 307 505 915 303/ 720 719 432/ 915 701 218 207 320 763 906 715 802 612 603 952 231 315 518 989 351/978 339/781 605 507 651 920 413 505 608 414 585 607 616242 810 716 845 860 401 262 515 563 224/ 547312 269517 570 862/ 631 712 630 734 308 319 219574 440 210 973 201/551 774 734 814 434/ 213/ 810/ 567/ 212 402 841 815 773 260 419/ 567 330 412/ 717 235445 809 646 576 309 765 301/ 856 917 740 660 937 240 302 516 614 785 816 217 317 703/ 718/347 410/443 913 636 314 513 304 571 202 540 618 812 502 859 606 804 434 757 620 316 417 573 270 276 423 336 919 252 815 580 865 704/ 479 870 901 931 423 828 980 910 806 405 918 731 709 864 404/ 501 662 770/ 678/ 803 205 940 678 770 843 430/ 256 817/ 214/ 430/ 706 478 903 682 469/ 903 972 229 912 325/ 601 334 254 318 251 915 936 225 228 850 386 904 830 512 337 385 979 409 504 281/ 985 352 407/ 210 713/ 321 985 832 813 727 361 863 772 941 561 754/ 239/ 954 956 941 305/ 786 808 3 Opposing philosophies and economic theories Community Society Role of government is to be responsive to social needs Government Keynesian Economics Social Security (Demand) Government Taxing and spending Medicare, should and be used to employer help manage health economy care Employer Stimulate demand: pension plan interest rate reduction government spending Government spending, gives consumers income who then spend more, fueling production. Ownership Society Maximize choice by creating efficient competitors You Hayek individual Economics account (Supply) You Laissez-faire: individually free economy owned health from plan and state health intervention saving account You Promote retirement growth: savings account lowering tax rates reducing regulation Consumers benefit from greater supply of goods and services at lower prices. 4 2

Perfect storm for reform Gathering storm clouds? 78 million baby boomers retiring 1 High US deficit and debt Cost of Social Security/ health care rising 1 Will the Demand for Assets Fall When the Baby Boomers Retire?, Congressional Budget Office, September 2009 Data shown is most recent available. 5 Perfect storm for reform US Birth Rates 1935 2004 4,500 4,000 Births (000) 3,500 3,000 2,500 Silent Generation Baby Boom Generation X Echo Boom b. 1946 b. 1965 b. 1982 1964 1982 2000 b. 1925 19451945 2,000 1935 1953 1958 1963 1968 1973 1978 1984 1989 1994 1999 2004 For illustrative purposes only. Source: www.census.gov, US Birth Rate 1935 2004; Author s overlay of generational descriptions 6 3

Deficits and debt Deficit: Government spending is greater than revenues for the fiscal year. Surplus: Government revenues are greater than spending for the fiscal year. Note: 1998-2001 saw a budget surplus, shown as negative numbers on the graph. Sources: Annual US Treasury Report on Spending and Revenue, www.fms.treas.gov; Budget of the United States of America, Historical Tables, www.gpo.gov 7 Deficits and debt Debt: National debt is a total of all (deficits minus surpluses). Over 224 years, US has borrowed more than it saved. US owes about $15 trillion as of 2012. 8 4

Cost of Social Security and health care US Federal Spending Fiscal Year 2011 ($billions) Interest 6%, $277 Other Mandatory 13%, $465 Discretionary 18%, $646 Social Security 20%, $725 Medicare and Medicaid 23%, $835 Defense Department 19%, $700 Source: Congressional Budget Office Long Term Budget Outlook 9 Who owns the debt? Intragovernmental debt includes: Securities held by US government trust funds. The trust funds are for Social Security, Medicare, and other retirement, military, insurance and transportation programs. Publicly owned debt includes securities sold to private individuals and investors, either domestic or foreign. Public owned debt (US) 36.0% Other Countries 15.0% Total Debt $14.3 trillion Social Security Trust Fund 17.0% All Others 15.5% China 8.0% Japan 6.0% UK 2.5% Source: www.treasury.gov, Report on Foreign Holdings of US Long-Term Securities, US Treasury Department, March 31, 2011 10 5

Where are we going? What we know What s on the 2013 agenda Taxes Social Security Health care Retirement 11 What we know Fiscal Cliff is behind us. Have we solved the issue? Affordable Care Act is law. Taxes take affect 2013, law kicks in 2014. Dodd-Frank financial reforms are law. Rules and regulations will be worked out and implemented. Cabinet members are planning to leave. Defense Secretary Leon Panetta Treasury Secretary Tim Geithner Secretary of State Hillary Rodham Clinton 12 6

Tax reform 13 Fiscal Cliff Overview 2011 Bowles-Simpson Plan: Balance tax increases ($2.6T) and spending cuts ($2.9T). Debt grows slower than economy, so debt shrinks. Much of proposed cuts were caps on future spending. 2012 needed both: $1.4T in entitlement programs cuts $2.5T in revenue (tax) increases *Note: Second Boehner offer did not specify mandatory/discretionary spending cut split. Source: www.washingtonpost.com/blogs/wonkblog/wp/2013/01/02/the-fiscal-cliff-negotiations-in-one-chart/ 14 7

American Taxpayer Relief Act of 2012 Complex compromise passed in the middle of the night to avoid the "fiscal cliff." Kicks the can : delays sequester for two months. 2013 battles coming: Debt ceiling and budget resolution Spending: entitlement program reforms Social Security and Medicare biggest part of deficit. 15 American Taxpayer Relief Act of 2012 New definition of wealthiest Americans Obama campaigned to raise tax rates on incomes above $250,000. Rates rise to 39.6% for income over $400,000 (single), $450,000 (joint). Tax rates stay same on incomes below. Capital gains and qualified dividend income. Maximum tax rate of 20% in the new 39.6% bracket. Retains 15% tax rates for all other taxpayers. 16 8

American Taxpayer Relief Act of 2012 Limits deductions: Phases out certain itemized deductions and exemptions for incomes above $300,000 (joint), $250,000 (single). May increase taxes for those below new 39.6% rate. Estate, gift and generation-skipping transfer tax: Tax exemption is $5 million(indexed). Maximum estate tax rate increased to 40% for deaths after 12/31/12. Unused gift and estate tax exemption can be passed to surviving spouse. Paychecks may shrink: Social Security taxes go up 2%; payroll tax holiday ends. New 0.9% Medicare tax on wages over $250,000 (joint) and $200,000 (single) filers. New 3.8% surtax on net investment income of certain individuals, estates and trusts. 17 Social Security reform 18 9

Social Security reform Began to use interest earned in 2011 Principal drain begins 2023 Trust fund exhausted by 2036 Community Society Protect existing system and benefits Oppose individual accounts FICA taxes currently stop at $113,700 (2013) in income Increase FICA taxes up to $250,000 in income Ownership Society Road Map for America Proposal Under age 55 allowed to put percent of payroll tax to personal accounts Gradual increase in retirement age Slow benefit growth by recalculation of cost-of-living allowance (COLA) 19 Health care reform 20 10

Social Security versus Medicare Two-earner couple earning $89,000 and retiring in 2011: Social Security: Paid $614,000 in social security taxes, expect to receive $555,000 in benefits Medicare: Paid $114,000 in Medicare taxes, expect to receive $355,000 in benefits Medicare Trust Fund Began to use interest earned in 2008 Principal drain began in 2011 Trust fund exhausted by 2024 Need 21% increase in taxes or 17% reduction in benefits or some combination Source: Urban Institute estimates 21 Patient Protection and Affordable Care Act PPACA (aka Obamacare) PPACA covers uninsured, premiums not based on gender; bans pre-existing condition denials and catastrophic caps. PPACA funding starts 2013. 3.8% on lesser of income above $200,000 (single); $250,000 (joint) or net investment income 0.9% additional Medicare tax Taxes on pharmaceuticals, high-cost diagnostic equipment 10% federal sales tax on indoor tanning services 2014 Insurance Program or penalties begin. States form insurance exchanges to compare and buy policies Individual id mandate begins Employer mandate for employers with 50+ employees Insurer tax: based on market share; rate rises 2014-2018 22 11

Retirement reform 23 2015 Projection US Working Population (ages 18-75) 5 Millions of people 4 3 2 Roth Pre-Tax Defined Contribution Defined Benefit 1 Echo Boom b. 1982 2000 Generation X b. 1965 1982 Baby Boom b. 1946 1964 Silent Gen. b. 1925 1945 18 23 28 33 38 43 48 53 58 63 68 73 Age For illustrative purposes only. Source: www.census.gov, annual projections by age, Table 9: Resident Population by Sex and Age: 2010 to 2050; author s overlay of generational descriptions 24 12

Defined Contribution (DC) plans Three trends: Retirement readiness: Increasing probability of keeping living standard in retirement Transparency of fees and services: Giving more information to measure value Retirement Income: Turning retirement savings into lifetime retirement income 25 Retirement reform: legislative themes Middle Class Task Force: Retirement Readiness Move 401(k) from savings plan to retirement plan Social Security + (DC/IRA) = 75% of retirement t income Pension Protection Act of 2006: Automatic enrollment and escalation Qualified default investment alternative (QDIA): Target-date funds (TDFs) 2013 continued focus on transparency, reliability themes 26 13

Retirement reform: transparency A three-step process; information disclosure to: 1. The Department of Labor (DOL)/IRS Form 5500 return 2. Plan sponsors 408(b)(2), plan sponsor disclosure effective July 1, 2012 Description of services and compensation (both direct and indirect) of plan service providers 3. Participants 404(a) participant disclosure rules effective Aug. 30, 2012 Source: 2009 Form 5500 instructions 27 Retirement reform: retirement income Treasury Department provides lifetime income guidance: Issues: Participants need to save for retirement and create lifetime incomes Concerns: Institution backing lifetime income, inflation, fees and legal issues (including fiduciary safe harbors for selection of products) Guidance: Provides road map from distribution to annuity Eases restrictions to offering longevity annuities Clarifies spousal consent rules Encourages partial annuities Sources: Proposed regulation 1.417(e)-1; proposed regulation 1.409(a)(9)-5; revenue ruling 2012-4; revenue ruling 2012-3 28 14

2013 tax reform developments? Capitol Hill wants to raise revenue; sees three tax targets: Employer-provided health care Retirement plan and IRA exemptions Mortgage interest t exemptions Proposed retirement plan revenue enhancers: Limiting pretax deferrals; $17,500 for 401(k)s in 2013 Capping compensation limit for pretax contributions Eliminating catch-up contributions Setting an overall cap on itemized deductions Removing the employer tax deduction Greater emphasis on Roth? 29 2013 potential regulatory developments Fiduciary definition: 2010: DOL proposed new fiduciary rules, extending to IRAs. 2011: Congress rejected, claiming it was too broad. 2013: New DOL fiduciary i definition iti will be issued. Lifetime income and monthly statements: DOL wants to focus participants on lifetime income needs. Proposed Lifetime Income Disclosure Act: Statements should add projected retirement income, based on account balance. Fee disclosure: DOL may increase audits to ensure fee disclosure compliance. TDFs: Finalized QDIA is due. 30 15

Legislative landscape for 2013 May see proposed legislation on: Automatic enrollment IRAs. Firms with 10+ employees with no retirement plan. IRA contributions deducted from paychecks and directly deposited. Broadening multiple employer plans (MEPs). MEPs are single plans for unrelated employers. To encourage retirement savings; broadened eligibility and administrative consolidation for plan sponsors to participate in MEPs. Universal, Secure & Adaptable (USA) Retirement Fund proposed dby Sen. Tom Harkin (D-IA). 31 Legislative landscape for 2013 Two parts of Harkin s proposal: First: USA Retirement Funds = Private pensions Universal access, privately run, professionally managed Add-on to DC plan, not replacing an existing pension Overseen by trustee board run by employees, retirees and employer representatives Features: Automatic enrollment, payroll deduction, portability Lifetime income benefit based on contributions and earnings Employers to make modest contributions Low-wage workers get refundable credits Second part: strengthening Social Security. Phasing out payroll tax wage cap over 10 years Adjusting Social Security calculations Changing the COLA 32 16

Summary Deficit Taxes Social Programs Community Society Baby Boomers Retiring Ownership Society Soemtmies, atlhuogh cnofusnig, yuo can atculaly uesdnatnrd the udnerlynig stroy wtihuot ervertyhnig sepeleld out ecxatly crroect. I ecnuoarge you to saty fcosued on the mseassge: The future is unknown. For illustrative purposes only. 33 Thank You The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation. The opinions in this piece are not necessarily those of Invesco. Information in this report does not pertain to any Invesco product and is not a solicitation for any product. The tax information presented is based on current interpretation of federal income tax law. State and local income tax laws may differ from federal income tax law. All data provided by Invesco unless otherwise noted. 14811 34 Invesco Distributors, Inc. 17

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