Don't Lower Caps on Employee Retirement Savings
By Stephen McCaffrey, PSCA Board Chairman
As published in Pensions & Investments on February 1, 2017.
For many Americans, saving in a tax-qualified defined contribution plan such as a 401(k) or 403(b) is the best opportunity to create a financial nest egg for use in retirement.
Each year, the IRS establishes the amount employees are permitted to save in these plans. In 2017, the maximum limit participants can contribute to their 401(k) and 403(b) plans is $18,000. Additionally, American workers age 50 and older are permitted to save an additional $6,000 (referred to as “catch-up” contributions).
As the new administration and Congress set their sights on reworking the tax code, the Plan Sponsor Council of America encourages policymakers to support existing annual contribution limits and disavow efforts to limit contributions to tax-qualified defined contribution plans.
Why does it matter?
For nearly four decades, employers have shifted their employee retirement plans to defined contribution plans from defined benefit plans. Caught in this trend, employees increasingly, if not exclusively, must rely on their employer-sponsored defined contribution plans to save for a comfortable retirement.
Believing the IRS-established tax-advantaged savings limits are fair and reasonable, most employers have structured their defined contribution plans to enable and encourage employees to save adequately for a comfortable retirement.
Some employers fear federal policymakers, and now possibly those at the state level, might seek to reduce these limits.
According to recent research produced by the Employee Benefit Research Institute, reduced savings limits could create significant reductions in maximum savings rates for millions of workers and would likely hurt younger workers the most. These same workers will fund entitlement obligations like Social Security without the guarantee the programs will be there when they retire.
Countering the critics
Employers sponsoring tax-qualified retirement savings plans believe proposals to reduce such limits are short-sighted and harmful, especially as traditional pension plans are phased out. Specifically, plan sponsors believe the current limits:
- reward younger savers for tightening consumption now for a more comfortable and stable retirement later;* allow two-income families to save more if only one spouse has access to a tax-qualified defined contribution plan;
- help workers maximize savings opportunities during good times, when future earnings are unpredictable;
- increase employees' ability to defer more later in life (not to be confused with the catch-up provision); and
- reduce employees' dependence on entitlement programs in retirement.
In an effort to help employees create and maintain a sound retirement savings strategy, an increasing number of employers sponsoring 401(k) or 403(b) plans are designing their contribution strategies (i.e., the employer match) to provide an incentive for employees to save upward of 15% to 20% of their eligible compensation for retirement.
The reality of the current tax paradigm is that it is good for both individual savings and government coffers. While counterintuitive, tax deferrals into 401(k) and 403(b) plans in the current tax year increase tax revenue in future tax years; put another way, tax deferrals reduce short-term revenue, but increase revenue in the year the income is recognized because of the investment growth multiplier.If federal and state policymakers are confident in their own promises of future economic growth and prosperity, maintaining current deferral limits is the smarter approach for everyone.
Higher limits encourage savingsGenerally, employers sponsoring tax-qualified retirement plans care about the future well-being of their employees. They recognize an employee's ability to comfortably and confidently retire is affected by many factors.
- Retirement can equate to uncertainty. While studies suggest the average employee retires three years earlier than anticipated, many older workers are reluctant to retire out of fear they will outlive their retirement nest egg.
- According to a 2017 study by EBRI, the average couple with median prescription drug expenses will need approximately $265,000 to have a 90% chance of being able to cover health-care expenses in retirement.
- Eligibility for entitlements is not a guarantee. Employees are increasingly concerned about the future of Social Security and Medicare, and younger employees have serious concerns about the adequacy of these government benefits.
Most employers sponsoring 401(k) and 403(b) plans have firmly entrenched the existing limits in their plan design, contribution strategy, employee education programs and their communication efforts. Moreover, recognizing the challenges all Americans face in saving adequately for retirement, many employers contemplate such limits in their total rewards strategies and benefits philosophies.
Maintaining a strong private retirement system is vital to our nation's financial security. As the voice of plan sponsors, the PSCA opposes any attempt by policymakers to reduce the existing 401(k) and 403(b) plan contribution limits, and asks all policymakers to reaffirm their commitment to leave them alone.