Capping Tax-Preferred Retirement Contributions: Preliminary Evidence of the Impact of the National Commission on Fiscal Responsibility and Reform Recommendations
Employee Benefit Research Institute (EBRI)
July 1, 2011
EBRI Notes, Vol. 32, No. 7, July 2011
In December 2010, the National Commission on Fiscal Responsibility and Reform released their long-awaited document on federal debt reduction, “The Moment of Truth.” Although their guiding principles and values (pages 13-14) specifically mention the need to keep America sound over the long run by implementing “policies today to ensure that future generations have retirement security, affordable health care, and financial freedom,” the document puts forth a tax reform plan that would modify retirement plans by capping annual “tax-preferred contributions to [the] lower of $20,000 or 20% of income” (page 31). This is often referred to as the “20/20 cap.” Even if one were to ignore the potential interaction of the proposed limitations with the present values of accruals under defined benefit plans and/or the existing tax preferences available to some individual retirement account (IRA) contributions, this alternative formulation of capping tax-preferred contributions would substantially reduce the current limits available under qualified defined contribution (401(k)-type) plans. Currently, the combination of employee and employer contributions is the lesser of a dollar limit of at least $49,000 per year and a percentage limit of 100 percent of an employee’s compensation. This paper provides preliminary evidence of the impact of these “20/20 caps” on projected retirement accumulations under a set of assumptions explained in detail. New results from EBRI’s Retirement Security Projection Model™ (RSPM) show that the highest-income quartile within each age cohort would see the largest average percentage reduction in projected balances at retirement. However, for each age cohort other than the oldest one, the lowest-income quartile would see the second-highest average percentage reductions. Phrased another way, the proposed cap would, as expected, most affect the highest-income workers; but it also would cause a very big reduction in projected retirement accumulations for the lowest-income workers. While the results presented in this paper provide a first approximation of the potential impact of these constraints on workers, as well as the distribution of the impact by income, they do not tell the entire story. A follow-up study will also explore the likely impact of these constraints on retirement plan sponsor behavior and estimate the extent to which fewer employers would be willing to offer qualified defined contribution plans (especially among plans offered by small employers).
The PDF for the above title, published in the July 2011 issue of EBRI Notes, also contains the fulltext of another July 2011 EBRI Notes article abstracted on SSRN: “The Impact of the Recession on Employment-Based Health Benefits: The Case of Union Membership.”
Number of Pages in PDF File: 16
Keywords: 401(k) plans, Defined contribution plans, Employment-based benefits, Income replacement rate, Pension plan assets, Pension plan contributions, Retirement income, Retirement plans, Savings, Tax reform
JEL Classification: D31, D91, E62, J26, J33Accepted Paper Series
Date posted: July 21, 2011
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