A 2011 plan to reduce the federal deficit that proposes changes in the tax treatment of employer and employee contributions to 401(k) plans could have substantial negative effects on balances in those plans, according to the Employee Benefits Research Institute (EBRI).
In the proposed plan, contributions by both employers and employees to plans would no longer be deductible, but a flat-rate refundable tax credit of 18% would be introduced instead that would serve as a federal matching contribution into a retirement savings account.
Proposals that would eliminate tax deductions for current contributions to 401(k) plans were evaluated assuming a status quo in the amounts of employer and employee contributions, EBRI said.
However, additional studies showed that would not necessarily be the case. Data from an AllianceBernstein survey of employer reactions to such a proposal, as well as data from the 2012 Retirement Confidence Survey by EBRI and Matthew Greenwald & Associates, which asked plan participants how they would react to such a proposal, revealed the potential for a substantial negative impact on employee balances.
Workers currently 26 to 35 years old could see their balances decline between 6% to 22% at normal Social Security retirement age under the proposed plan, according to the study, with participants in smaller plans of less than $10 million in assets seeing an even larger reduction of 23% to 40%. Smaller plans were also more likely to be modified or even terminated by employers.
“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," Jack VanDerhei, EBRI research director and author of the report, said in a statement. "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.”
Complete study results are available in the March EBRI Notes, "Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances."