Some high-profile observers of the retirement planning scene are taking issue with a recent Government Accountability Office (GAO) report which suggests that retirement plans like 401(k)s disproportionately benefit higher income workers.
“The facts say otherwise,” says Brian Graff, executive director and CEO of The American Society of Pension Professionals & Actuaries (ASPPA) in Washington. Graff says that based on the Internal Revenue Service’s own data, 74% of workers participating in defined-contribution (DC) plans come from households earning less than $100,000. Only 5%, he says, come from households earning more than $200,000.
The GAO study, “Private Pensions: Some Key Features Lead to an Uneven Distribution of Benefits,” found that the percentage of workers participating in employer-sponsored plans has remained at about 50% of the private sector work force for most of the past two decades. “Many employers—often those of lower income workers—continue to choose not to offer a pension or other retirement savings plan to their employees,” the study reports. “For those fortunate enough to be covered by a pension, there is a concern that much of the tax benefits flow to higher income employees, and in many instances the financial constraints on lower wage workers limit their ability to contribute to tax-qualified plans and thus, to benefit from those subsidies.”
But Graff argues that “when you measure who gets the tax benefits from these plans, the impact on moderate income workers becomes clearer.” Households making less than $50,000 pay only 8% of all income taxes, he continues, “but receive 30% of all the tax incentives associated with defined contributed plans.”
In other words, Graff says that for every dollar of income taxes paid by lower income workers, they get almost four dollars back in tax incentives. “That’s a good deal by any measure,” Graff argues, saying it shows that tax incentives are effectively and efficiently targeted at low- and moderate-income families. The reason, he says, is that these plans are subject to stringent nondiscrimination rules that are a part of the tax code and were designed by Congress to make sure these plans provide benefits fairly to everyone.
Graff cites research from the Employee Benefits Research Institute (EBRI), which found that 401(k) plans have proven to be “incredibly successful” at getting moderate-income workers to save. According to EBRI, he says, more than 70% of workers making between $30,000 and $50,000 save when covered by a workplace savings program, whereas less than 5% of those same workers save on their own when not covered by a plan. Of course, Graff concedes that more does need to be done to expand retirement plan coverage, which is why ASPPA supports proposals like the Auto-IRA proposal that would “give more workers access to these plans.”
As Congress currently reviews the nation’s tax system “toward a process of reforming it,” Graff says, “let’s make sure we get the facts straight. When the retirement security of American workers is at stake, we can’t afford to be getting things wrong.”
Dallas Salisbury of EBRI’s Conclusions
If anyone understands the benefits—and drawbacks—of 401(k) plans, it’s Dallas Salisbury, president of EBRI. He gave me a detailed explanation of the GAO report, and says that it’s important to note that the GAO was being asked to answer two questions in its study: First, can we get from a half-full glass (50% participation) to a full glass (100%)? Second, how are low- and moderate-income workers doing?
To answer those two questions, the GAO looked at who contributes how much, the proportion that would be harmed by lower limits, and the distribution of the tax preference dollars, Salisbury explains. “The last is always sure to create a perception issue, since nearly half of workers now pay no income tax, thus, they do not get ‘reduced taxes’ due to the incentive.”
The GAO notes in its study that it’s difficult to assess how many people would lose coverage if there were not favorable tax treatment. To Salisbury, this is a critical issue “if the policy question is no system or a voluntary system. It is not if the critical policy question is a voluntary system or a mandatory system.” The GAO study, he says, refers to proposals that would mandate universal participation and compare today’s 50% to what a mandatory system might achieve.
Based upon surveys performed over the years, including EBRI’s 2011 Retirement Confidence Survey, the answer, Salisbury says, “is that many plans would go away and the primary losers, as GAO points out, are low and moderate income workers.” EBRI research indicates that the tax incentives are essential to employer and individual decision making, and says that GAO argues that high-income people would save anyway, a point on which EBRI’s surveys concur.
GAO implies in its study, he says, that employers might keep plans and low- and moderate-income workers might continue to contribute. “Our surveys suggest plans would go away and low and moderate income workers would spend their money. What would have been matching contributions by employers would be kept by the employers, unless a mandate was put in place and the money had to flow to workers for retirement.”
Thus, Salisbury concludes, “the framing is key.” Compared to what individuals do on their own, he says, the current voluntary system is shown by the numbers to be very successful. Compared to what would be set aside at all income levels with a mandated system, he says, it might look “sparse.” In essence, he continues, “it is two different discussions. The advocates of a mandatory system tend to agree that the voluntary employer system is better than nothing; they just want more through a mandate.”
The GAO report, Salisbury says, would have benefited from setting up the juxtaposition more clearly by asking three other questions. First, what would a totally individually based system likely accomplish (considering how many of those without an employer plan take the time to open an IRA or save for retirement)? Second, what does the employer-based system accomplish? Third, what would a mandated system accomplish?
The GAO report, he continues, would also have benefited from an assessment of combined DC and rollover IRA amounts, since “so much of what is in rollover IRAs at all income and asset levels came out of DC plans.”
According to the Investment Company Institute (ICI), Americans held $4.5 trillion in employer-based DC retirement plans on Dec. 31, 2010, of which $3.1 trillion was held in 401(k) plans. Those figures are up from $4.3 trillion and $2.9 trillion, respectively, on Sept. 30, 2010. Mutual funds managed $2.5 trillion of assets held in 401(k), 403(b), and other DC plans at the end of 2010, up from $2.3 trillion at the end of the third quarter. Mutual funds managed 54% of DC plan assets at year-end 2010.