No Tax Deferral for 401(k) or Other Employer Sponsored DC plans?

There are significant consequences if the tax preferences for employer sponsored defined contribution plans are eliminated as suggested by the leaders of the President’s Deficit Commission (Simpson/Bowles), and significantly reduced as suggested by the Bipartisan Policy Center’s deficit reduction team (Rivlin/Domenici). This would drastically reduce the attractiveness of plan sponsorships by employers. This change would overturn 90 years of tax policy, drastically affect retirement saving and have unintended consequences beyond what any intend.

For example, few employers would continue to sponsor plans. As a result, few employers would push employees to save for retirement. Few employers would continue to serve as plan fiduciaries. Few employers would continue to provide financial education in their workplace. US savings overall would drop as many employees save nothing at all without a plan to save in. Many employees choosing to continue saving for retirement would direct their savings into principal-secure fixed investments like money market funds and credit union savings accounts because employer fiduciaries would no longer be there to provide a simple trustworthy path to diversified long term investing. Funds invested for the long term would be less likely to survive as the constant temptations of present need would be difficult to resist without a plan structure and incentives to hold accumulations until retirement. Financial literacy, still is not great, would fall back to pre-1990 levels.

Congress in 1921 passed legislation providing that company contributions to profit-sharing plans could be immediately taken as a deduction by the company, but employees would not have to pay tax on the contribution or related earnings until they took constructive receipt of the money. In 1981 there were 378,318 private employer sponsored DC plans with 21.6 million participants. Following the 1981 IRS ruling extending the tax deferral to employee contributions, the private employer DC system has grown rapidly and today there are nearly 700,000 plans and over 60 million participants. Add 403(b), 457 and employer sponsored IRA programs and there are now over 70 million Americans saving for retirement in the system.

The employer sponsored defined contribution system provides so much for so many and is so deeply ingrained in our workplaces and financial system that eliminating it would impact on our country far beyond the dollars and cents of a 5 year federal revenue projection.