Data & ResearchJuly 11, 2011

Capping Tax Preferred 401(k) Contributions Helps No One, Says EBRI

The Employee Benefit Research Institute (EBRI) found that the proposed tax reform regarding 401(k)-type retirement plans from the National Commission on Fiscal Responsibility and Reform would hurt both the highest- and lowest-income workers.

Reported by PLANADVISER staff

EBRI’s research finds the Commission’s recommendation to cap the annual tax preferred contributions to either $20,000 or 20% of income (whichever is lower) for 401(k)-type plans – referred to as the “20/20” cap – would most affect the highest-income workers—not surprising, since those with high income tend to save the most in these kinds of retirement plans. However, EBRI also found the cap would cause a big reduction in retirement savings by the lowest-income workers as well.

The analysis finds that for each age group (except for the oldest), the lowest-income group has the second-highest average percentage reductions in 401(k) contributions. Primarily, this is because their current or expected future contributions would exceed 20% of compensation when combined with employer contributions.

“Phrased another way, the 20/20 cap would, as expected, most affect the highest-income workers, but it also would cause a very big reduction in retirement accumulations for the lowest-income workers,” said Jack VanDerhei, EBRI research director.

Currently, the combination of both worker and employer 401(k) contributions is the lesser of a dollar limit of at least $49,000 per year, or 100% of an employee’s compensation.

The results are from EBRI’s Retirement Security Project Model and are published in the July 2011 EBRI Notes, “Capping Tax-Preferred Retirement Contributions: Preliminary Evidence of the Impact of the National Commission on Fiscal Responsibility and Reform Recommendations,” available online at http://www.ebri.org. The analysis breaks down results by age group and by relative income group.