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Financial Planning > Tax Planning > Tax Reform

Employer-Sponsored 401(k) Plans Would Drop ‘Significantly’ if Tax Treatment Curtailed: Study

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A new report by the American Benefits Institute and Mathew Greenwald & Associates has found that curtailing the current tax treatment of contributions that workers and their employers make to 401(k) plans will “significantly reduce” employers’ willingness to sponsor plans. The survey comes after 11 senators signed onto a resolution calling for the protection of retirement benefits in the tax code in any deal to avoid the fiscal cliff.

The survey of more than 500 companies, which was conducted by Greenwald & Associates in partnership with the American Benefits Institute, which is the educational and research arm of the American Benefits Council, found that “virtually all employers polled (91%) believe the exclusion of 401(k) contributions from current income taxation is important to their workers’ decision to contribute to the plan and seven in ten employers (72%) think their workers contribute more than they otherwise would as a result of the exclusion,” noted James Klein, president of ABC.

“Without a robust private employer-sponsored retirement system, Americans will be less well prepared for retirement, and pressure on public programs like Social Security will grow. That is a lose-lose situation for both retirees and the government and is completely contrary of the goals of deficit reduction,” Klein said.

Even if retirement tax incentives are spared in fiscal cliff talks, Klein noted during a conference call with reporters on Tuesday that “these ideas will likely be part of the larger comprehensive tax reform and deficit reduction” efforts next year.

“As part of a deal to avoid the ‘fiscal cliff’, or in the context of broader deficit reduction next year, the current tax-deferred treatment of 401(k) contributions could be changed to generate short-term federal revenue,” Klein said. “This survey demonstrates that it would be short-sighted and ill-advised for Congress and the President to do so. Retirement plan contributions are not ‘tax breaks’ or ‘loopholes.’ Retirees pay income tax on the benefits they receive.”

The survey also solicited employer reactions to specific tax proposals:

  • the “20-20” proposal, in which total contributions would be limited to the lesser of $20,000 or 20% of compensation;
  • the refundable tax credit proposal, in which total contributions would no longer be excluded from income tax, but employees would receive a tax credit equal to some percentage of their yearly contributions;
  • the 28% proposal, whereby the tax exclusion of plan contributions for workers in the 35% tax bracket would be limited to 28%–effectively imposing a 7% tax on employee and employer contributions.

Employer opinion strongly suggests that such measures would be extremely counterproductive. “Between one-third and one-half of employers think these proposals would cause them to drop or consider dropping their 401(k) plan. Quite remarkably, the likelihood an employer would drop or consider dropping its plan, or eliminate or reduce features like matching contributions or auto-escalation of contributions actually increases among larger employers. Among smaller companies not yet sponsoring plans, as many as 48% would be less likely to start one in the next two years,” Klein said.

The survey also found that employers believe that their employees would save less under these proposals. “Between 4% and 60% of employers feel these proposals would reduce the value of a retirement savings plan for employees and think their employees would be likely to decrease or eliminate their plan contributions if such proposals were enacted,” Klein said.


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