The cap on tax-deferred retirement savings proposed in President Barack Obama’s 2014 budget, which limits accumulated savings in a retirement plan (including defined benefit accruals) to between $2.3 million and $3.4 million, will affect very few people immediately, but will have a bigger impact on plan balances over time, according to an issue brief published recently by the Employee Benefit Research Institute in August.
The proposed cap would affect tax-advantaged plans like IRAs, 401(k), 403(b) and 457(b) plans, and defined benefit plans. It would prohibit participants who reach the cap from making tax-deferred contributions until the balance falls below that level again, but earnings from market gains would be unaffected.
Obama’s budget ties the cap to the maximum annuity amount a participant can receive from a tax-qualified defined benefit plan, currently $205,000 per year, according to EBRI. The brief noted that those annual benefits, if they begin at age 62, would translate to a maximum permitted accumulation of approximately $3.4 million at today’s interest rates. If enacted, the cap would take affect for tax years 2014 and beyond.
However, that $3.4 million cap was determined by assuming the discount rate, which is the rate actuaries use to estimate how much future cash flows will be worth in today’s dollars, remains at 4%. EBRI noted that if the discount rate goes up, the present value of those benefits, and thus the level at which savings would be capped, could be reduced dramatically. If the discount rate increases to 6%, the cap would fall from $3.4 million to $2.7 million. At 8%, the cap would fall to $2.3 million.
EBRI said such a scenario isn’t out of the question. According to the brief, a reversion to historical norms “might be expected once the Federal Reserve eases its current monetary policies designed to keep interest rates low.”
EBRI ran several simulations to determine how the cap would affect different plans. The simulations assumed equity returns of 5.9% and bond returns of 3.3%. ERBI also assumed that even if participants were ineligible to make a contribution in a certain year because they reached the cap, they would continue to make contributions at the same rate in any year they were able to.
In the first simulation, EBRI assumed 401(k) participants with no defined benefit accruals. At a 4% discount rate, between 10% and 20% of participants would suffer reduced balances as a result of the cap; 10% would lose 1.7% of their balance and 5% would suffer a drop of at least 5.5%.