New from EBRI: Tax Reform Proposal Could Clip 401(k) Balances

A recent proposal to change the tax preferences for employment-based 401(k) retirement plans could result in an average reduction in 401(k) account balances of between 6‒22 percent at Social Security normal retirement age for workers currently ages 26‒35, according to new research by EBRI.

 The response—a combination of plan sponsor reaction and participant response—is strongly tied to plan size, with participants in smaller plans likely to experience deeper average reductions in 401(k) balances, according to EBRI’s baseline analysis. For plans with less than $10 million in assets, participant balances at Social Security normal retirement age for workers currently ages 26‒35 could decline between 23‒40 percent, depending on the size of the plan and income of the participant.

EBRI’s report is the first to analyze the response of both private-sector 401(k) plan sponsors and participants to a proposed scenario where the current tax treatment of employer and worker pre-tax contributions would be modified such that workers would have to pay federal taxes on these amounts currently, rather than on a deferred basis (as under current law), and participants would receive an 18 percent government match on all contributions.

“Some analyses of recent proposals to change the tax preferences for employment-based 401(k) retirement programs have assumed status quo in plan design and contribution flows,” notes Jack VanDerhei, EBRI research director and author of the report. “Surveys of individual participants suggest, however, that some would decrease or even eliminate their contributions in response to these changes. Additionally, surveys of plan sponsors indicate that many would modify their plan design, or even terminate these plans.”

Full results of the study are published in the March EBRI Notes, “Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances.”  The press release is online here.

Washington Watch

By Nevin Adams

Nevin Adams, EBRI

The Senate Finance Committee is positioned to pass a highway bill, funded at least in part by changing the tax treatment on retirement accounts.

Specifically, the modified chairman’s mark of the proposed Highway Investment, Job Creation and Economic Growth bill would require that age 70-1/2 account distributions be treated, for tax purposes, as distributed within five years of the death of the account holder (unless the beneficiary is the account holder’s age, a child with special needs, or older than 70). Under current law, holders of IRAs and 401(k)-type accounts are required to begin taking taxable distributions from those accounts once they reach age 70-1/2, though if the account holder dies, the taxation of the account is spread over the life of the beneficiary. According to a Senate Finance Committee press release, this particular provision is estimated to raise $4.648 billion over 10 years (see link here).

The bill’s prospects in the Senate remain unclear, and the Wall Street Journal notes that the House version does not contain the retirement account tax change. However, the

Senate provision demonstrates how the current budgetary and economic pressures in Congress—particularly in an election year—make the tax treatment of retirement savings a major target for any number of legislative initiatives, including those that have little or nothing to do with retirement.

The Employee Benefit Research Institute (EBRI) has long provided a credible and objective source of information for both policymakers and regulators, including recent testimony provided to:

• The Senate Finance Committee on “Tax Reform Options: Promoting Retirement Security”, and “The Impact of Modifying the Exclusion of Employee Contributions for Retirement Savings Plans From Taxable Income: Results From the 2011 Retirement Confidence Survey.”

• The Senate Committee on Health, Education, Labor, and Pensions on “The Power of Pensions: Building a Strong Middle Class and a Strong Economy,” and

• The House Committee on Education and the Workforce, Subcommittee on Health, Employment, Labor, and Pensions, regarding “Retirement Security: Challenges Confronting Pension Plan Sponsors, Workers, and Retirees.”

The impact of certain tax reform proposals was evaluated in the November 2011 EBRI Issue Brief, and will be updated to include input from the 2012 Retirement Confidence Survey next month.

The Employee Benefit Research Institute is a private, nonprofit research institute based in Washington, DC, that focuses on health, savings, retirement, and economic security issues. EBRI offers a unique perspective in that we do not lobby nor take policy positions. The work of EBRI is made possible by funding from its members and sponsors, which includes a broad range of organizations involved in benefits issues. For a full list see EBRI’s Members.