Comments Presented to the Committee on Ways & Means

United States House of Representatives Hearing on Tax Reform

June 8, 2005  

Related Links : Legislative Issues : Regulatory Issues : ASPPA asap print page

The American Society of Pension Professionals & Actuaries (ASPPA) appreciates the opportunity to submit our comments to the House Committee on Ways and Means on tax reform and the detrimental affect certain reform options could have on the employer-sponsored retirement plan system. A 50-page report—“Savings Under Tax Reform: What Is The Cost to Retirement Savings?”—discussing ASPPA’s concerns in depth can be found at www.asppa.org.

ASPPA is a national organization of almost 5,500 retirement plan professionals who provide consulting and administrative services for qualified retirement plans covering millions of American workers. ASPPA members are retirement professionals of all disciplines, including consultants, administrators, actuaries, accountants, and attorneys. Our large and broad-based membership gives it unusual insight into current practical problems with ERISA and qualified retirement plans, with a particular focus on the issues faced by small to medium-sized employers. ASPPA’s membership is diverse, but united by a common dedication to the private retirement plan system.

We understand this hearing is in anticipation of tax reform recommendations to be made by Treasury Secretary John Snow to Congress. The President’s Advisory Panel on Federal Tax Reform (Advisory Panel) has been tasked with recommending ways to improve and simplify the tax code to the Treasury Secretary by July 31, 2005. These recommendations are to focus on ways to benefit all Americans by making the tax code fairer, simpler and more pro-growth.

ASPPA applauds the Committee’s leadership in working to fashion such a fairer, simpler, and more pro-growth tax system. Like you, ASPPA believes our tax system can and should be improved. But this belief is balanced by wariness that the enthusiasm for broad reform may jeopardize some tax provisions that have played an important role in America’s economy. ASPPA looks forward to working with Congress and the Administration on strengthening America’s economy through the tax system, while at the same time recognizing that any reform to the federal tax system must continue the current policy of providing tax incentives for long-term savings through the employer-sponsored retirement plan system.

Tax Reform Could Undermine Long-term Retirement Savings

On May 27, 2005, the ASPPA Pension Education Research Foundation (PERF) released a Report titled “Savings Under Tax Reform: What Is The Cost to Retirement Savings?” that examines several possible tax reforms and their impact on retirement savings. We are attaching the Executive Summary of the Report at the end of these comments. We ask that the Report and its summary be included in this hearing’s Congressional Record.

The Report looks specifically at several suggested tax reform options, including a consumption-style tax or the reduction or elimination of the tax on capital gains and dividend payments, as a strategy to boost national saving. Many tax reform advocates favor proposals such as these. The Report concludes that while this goal might be achieved, it would be at a high cost—the loss of retirement savings plans for millions of Americans with modest means who already have difficulty putting aside adequate funds to support their senior years . Frankly, this is too high a price to pay, particularly when there are other mechanisms that could increase savings without jeopardizing the nation’s retirement system.

Any tax reform plan that reduces or eliminates the incentives for long-term savings would erode both sponsorship and participation in employer-sponsored retirement savings plans, threatening employees’ future financial security and leading to greater wealth disparities. Today’s workers could face a much bleaker retirement. Indeed, radical reform that would eliminate the current tax incentives for long-term savings could virtually destroy the existing system.

The need to preserve successful sections of the tax code is reflected in President Bush’s charge to the Advisory Panel where he stressed the need to retain incentives that promote home purchases and charitable giving. ASPPA believes a compelling case can be made to afford equal protections to provisions that encourage retirement savings. As the Social Security debate has shown, Americans are appropriately worried about economic security in retirement.

Employer-Sponsored Retirement Plan System

America is not a nation of savers. Even today about a third of workers are not saving for retirement and many who are saving have retirement accounts that are inadequate to fund a comfortable retirement. Further, demographic shifts illustrate a growing retiree problem: approximately 85 million Americans will be 65 or older in 2050 compared to 36 million in 2000.

The existing provisions of our nation’s income tax system that incentivize long-term retirement savings have encouraged a significant number of Americans of modest means to save for their retirement security. These current long-term savings incentives in the tax code have been extremely successful and deserve to be retained. The current employment-based retirement plan system is the backbone of an “ownership” society, which has made middle-income Americans significant investors in the stock market. However, more needs to be done.

The Report states that households covered by an employer-sponsored retirement plan are more than twice as likely to achieve retirement income adequacy. As a result, one goal of tax reform should be expanding coverage under the employer-sponsored retirement plan system.

Much of today’s savings is spurred by plans offered by employers, which often offer a synergistic combination of advantages. In many cases, because of employer matching contributions, a dollar contributed by a worker grows immediately, before interest and other earnings are added. This means $1 contributed by a worker today may result in an immediate deposit—before any interest is earned—of $1.50 or more.

Putting money in an employer-sponsored plan is also much easier than saving independently. Low- to moderate-income workers are 11 times more likely to save when covered by a workplace retirement plan, in part due to the convenience of payroll deductions, the culture of savings fostered in the workplace, and the incentive of the matching contributions provided by the employer. The workplace retirement plan has been shown to be the only effective means to get these workers to save.

This is not a blanket defense of the status quo. The federal tax system is imperfect. Its retirement savings provisions could be changed for the better. But history strongly recommends continuation of priorities embedded in the existing system:

• The opportunity for individual retirement savings tied to employment should remain. Research shows that many Americans would not save at all if not offered employer-sponsored retirement plans.
• The system should maintain nondiscrimination rules to assure maximum coverage of all workers.
• The system should favor long-term savings, thereby discouraging savers from withdrawing funds prior to retirement.
• The system should acknowledge the priority of retirement savings plans by assuring that their incentives are more attractive than other savings incentives.

Small employers hesitate to offer retirement plans for several reasons, including administrative complexity and cost, and the unpredictability of their financial condition. These hurdles are offset partly by the knowledge that the small business owner cannot maximize personal retirement savings without providing a plan for workers as well. Any changes that allow small business owners to meet their retirement savings goals on an individual basis, such as through a reduction or elimination of the tax on capital gains and dividends, would inevitably threaten the future of the plans they provide their workers.

High-income earners are more likely to have retirement savings than those who earn less. The largest group of workers without access to an employer-sponsored retirement plan is comprised of those employed by small firms for a modest wage. The good news is that coverage for this segment of workers has been steadily rising. Tax reform ought not to reverse this positive trend.

Many proponents of tax reform share the goal of increasing savings. No one opposes that priority. But there is a need to focus on who is saving and how they are saving. The question is not solely how to get society to save more, but how to encourage low- to moderate income workers, who are often not saving, to save for retirement.

Tax Reform Must Accommodate Retirement Policy

From a retirement perspective, the most important and daunting goal involves convincing the low- to moderate-income workers to increase their retirement savings. The political and policy challenge lies in ensuring that any plan retains these critically important retirement savings incentives.

Some tax reforms under consideration would provide greater tax advantages to individuals investing in stocks, mutual funds and other capital investments through a reduced tax on capital gains and dividends. This would undoubtedly create a significant disadvantage to investing through the employer-sponsored retirement plan system because individual savings in capital investments generally is not “locked-up” until retirement. If retirement savings no longer enjoy a special tax advantage, low- to moderate-income workers would save less for retirement. Instead, if they save at all, it will likely be in a short-term savings plan to which they will have ready access, making it more likely than not that these savings will be spent, in whole or in part, well before retirement.

Summary

Prudent retirement policy suggests that the most efficient and effective tax retirement policy system must continue to provide long-term tax incentives to employers to establish and maintain retirement plans. As the tax reform debate accelerates, it is vital that Congress acknowledge, protect and extend the positive impact that tax policy has had on the individual retirement security of millions of Americans through long-term savings incentives.

Attachment

Savings Under Tax Reform:
What Is The Cost To Retirement Savings?

Executive Summary

More than any other issue, a reform of the federal tax system represents a significant threat to the tax incentives available for long-term savings provided through the employer-sponsored retirement plan system. Any reform to the federal tax system that would diminish these incentives would jeopardize the individual economic security currently achieved through the employer-based retirement plan system.

The President has established a tax reform commission that is exploring various ways to simplify the current tax system. Its findings are due to the Treasury Department by July 31, 2005. Among the proposals under consideration are major reforms such as consumption-style taxes or targeted approaches, such as those that eliminate the tax on capital gains and dividend income.

This research paper focuses on the crucial need for continued long-term savings incentives through the employer-sponsored retirement plan system. It illustrates the potentially devastating effect certain potential tax reform solutions could have on savings into qualified retirement plans. It concludes that any reform to the federal tax system must continue the current policy of providing tax incentives for long-term savings through the employer-sponsored retirement plan system.

Highlights

The Need for Long-Term Savings

• On their own accord, American workers do not save adequately for their retirement and other long-term financial needs. While 63 percent of Americans are saving to some extent for retirement, more than one-third of the working population is not.
• Demographic shifts illustrate a growing retiree population. Approximately 85 million Americans will be 65 or older in 2050 compared to 36 million in 2000.
• The growing retiree population also reflects increased longevity, with the number of people aged 85 or older expected to increase five-fold in 2050 over the 2000 population.
• Our current tax system provides the strongest incentive for taxpayers to accumulate assets for long-term savings through the employer-sponsored retirement plan system by providing for an exclusion from income for contributions made to a qualified retirement plan or IRA.
• Any reform to the tax system that does not provide incentives for long-term savings would inherently favor short-term savings choices, which provide current access to such savings.
• The policy implications of reduced long-term savings by working Americans could be substantial, particularly given the projected shortfalls in Social Security and the need for current and future retirees to supplement their Social Security benefits with personal savings.
• The current employment-based retirement plan system is the backbone of an “ownership” society, which has made middle-income Americans owners of the stock market.

Employer-Sponsored Retirement Plans

• Employer-sponsored retirement plans are heavily dependent on federal tax incentives and are clearly the most effective method for encouraging savings by low- to moderate-income workers.

According to the Employee Benefits Research Institute (EBRI), 77.9 percent of workers making from $30,000 to $50,000 and covered by an employer sponsored 401(k)-type plan actually saved in the plan, while only 7.1 percent of workers at the same level of income, but not covered by a 401(k)-type plan, saved in an individual retirement account. In other words, low- to moderate-income workers are 11 times more likely to save when covered by a workplace retirement plan.

This striking disparity is due to the convenience of payroll deductions, the culture of savings fostered in the workplace, and the incentive of the matching contributions provided by the employer.

• The likelihood of retiring with adequate savings depends upon whether an individual participated in an employer-sponsored plan. Overall, 55 percent of households covered by employer-sponsored retirement plans will have adequate savings compared to 24 percent of those without.
• Suggested approaches to tax reform, including consumption-style taxes and/or the elimination of tax on capital gains and dividend income, would tend to encourage savings outside of qualified plans since access to such savings is not restricted.
• Employers─particularly small employers─would be able to accomplish their savings objectives outside of a qualified retirement plan and would be unlikely to incur the cost and potential liability associated with establishing or maintaining a qualified plan.
• As a result, low- to moderate income workers, now not covered by a workplace plan, will save less for retirement, impairing their future economic security.

Tax Reform Must Accommodate Retirement Policy

• While some level of reform is needed given the complexity of the tax code, tax reform proposals must strive for a higher savings rates for all American workers across all income classes, not just to increase savings in the aggregate.
• Providing favorable tax treatment for individual savings outside of the employer-sponsored retirement plan system will erode both sponsorship and participation in qualified retirement savings plans, threatening financial security and leading to greater wealth disparities.
• A switch to a consumption tax system, which would only tax amounts consumed and not saved, could result in an alarming reduction in individuals’ retirement savings as employers would choose not to establish or maintain qualified plans.
• Reductions in capital gains and dividend tax rates would provide greater tax advantages to individuals investing in stocks, mutual funds and other capital investments, which would create a significant disadvantage to investing through the employer-sponsored retirement plan system.
• Prudent retirement policy suggests that the most efficient and effective tax retirement policy system must continue to provide long-term tax incentives to employers to establish and maintain retirement plans for their workers.
• It would be unacceptable to risk the retirement security of working Americans by creating a tax system that fails to recognize the need to encourage long-term retirement savings over short-term individual savings vehicles (e.g., mutual funds held outside of a plan).

The Report and its Executive Summary can be found at www.asppa.org.

As of July 2003, an estimated 36.4 million U.S. households, or almost half of all U.S. households owning mutual funds, held mutual funds in employer-sponsored retirement plans. Investment Company Institute, U.S. Household Ownership of Mutual Funds in 2003, Vol. 12, No. 4 (October 2003).

According to the Employee Benefits Research Institute (EBRI), 77.9 percent of workers making from $30,000 to $50,000 and covered by an employer sponsored 401(k)-type plan actually saved in the plan, while only 7.1 percent of workers at the same level of income, but not covered by a 401(k)-type plan, saved in an individual retirement account.