! Endnotes The fraction of participating workers among those where a salary reduction STATE STATEMENT MENT OF OF PAUL PAUL J. J. YA YAKOBOSKI KOBOSKI Finally, the other point of note from the data presented above is that, despite Not surprisingly, the average iRA contribution (among those without an Table I plan was sponsored E(the MPLOYEE sponsored RESEARCH BENEFIT participation RESEARCH ASSOCIATE rate) INSTITUTE also increased, rising the rapid growth in the number of defined contribution plans--primarily 1Under current law, individuals who are not active participants in a qualified employment-based retirement plan) tended to increase with the worker's Table 2 from 57 percent to EMPLOYEE 65 percent BENEFIT (table 2).RESEARCH The growth INSTITUTE in salary reduction plan Individual Retlrament Account (IRA) Participation by Workers Not Partlclpatlng In Any Employment- 401(k) arrangements--in small firms over recent years, it is at the small plan employment-based retirement plan can make fully tax-deductible annual earnings. The average contribution was $1,410 for those earning less sponsorship and participation has occurred across almost all worker and job- Based Retlrement Plan (Includes BEFORE Salary THE SENATE Reduction SUMMARY FINANCE Plans) Among COMMITTEE Clvillan Nonagrlcultural Wage and Civili level an Non where agricultural a noticeable Wage andgap Salary in Workers, plan sponsorship Aged 16 andremains. Over, by Salary The Reduction question Plan Sponsorship contributions up to a $2,000 maximum per year to an individual retirement Table 3 than $5,000 annually, compared with $2,121 for those earning $50,000 or more related characteristics, including firm size. Salary Workers, Aged 16 and Over, by Rrm Slze and Earnings, 1993 T-96 and Particil_ation, by Firm Size, 1988 and 1993 naturally arises as to what if anything FEBRUARY can be 9, done 1995 to fill this void? account (IRA). Individuals who are active participants or whose spouse is an annually. Average Annual Dollar Contributions Among Civilian Nonagricultural Wage and Salary Workers, The original objective of establishing individual retirement accounts (IRAs) active participant Age id n 16 a qualified and Over, Who empl Partlclpate oyment-based In a Salary plan Reduction and whPlan, ose adjusted The likelihood of salary reduction plan sponsorship and participation There is no easy answer to this question. SEPs and SARSEPs do exist and were was I am to pleased provideto aappear tax-deferred before retirement by youFirm thisSlze morning 1988 saving andvehicle to 1993 discuss for issues those of workers individual who Sponsored gross income (AGI) does not exceed $25,000 (single taxpayers) or $40,000 Average The original objective of establishing IRAs was to provide a tax-deferred increased with firm size (table 2). In 1993, 5 percent of those employed by a created specifically Totalto appeal to small Sponsors employers, hip but they Partici simply pation are not Participation retirement accounts (IRAs),401(k) Total plans, and Perc individual entage Contributing saving. My Contribution name is (married taxpayers filing jointly) may make a fully deductible IRA did not have an employment-based retirement plan. The fact is that today the retirement saving vehicle for those workers who did not have an Total Workers Ratea Rateb Rate c firm with fewer than 10 employees reported that their employer sponsored a utilized vast majority to any of significant workers eligible degree. for Toa the tax-deductible extent that we IRAare contribution dealing with do not Paul Yakoboski. I am a research (thousands) associate at the to Employee an IRA in 1992 Benefit Research (1993 $) contribution. Individuals who are active participants or whose spouse is an employment-based retirement plan. The fact is that today the vast majority of contribute salary reduction . plan, compared Participants with 54 percent of thoseAvemployed erage Contribution by firms businesses Institute (EBRI), that have a nonprofit, marginal nonpartisan, profits and public whose workers policy research are relatively organization young active participant in a qualified employment-based plan and whose AGI falls workers eligible for a tax-deductible IRA contribution do not contribute. 1988 1993 1988 1993 1988 1993 1988 1993 (thousands) (1993 $) with 1,000 or more employees. Note that when a plan was sponsored, the based in Washington, DC. and have relatively low earnings, there may not be great interest on either between $25,000 and $35,000 (single taxpayers) and between $40,000 and (thousands) (percentage) Total participation rate did not vary 53,636 systematically with firm 6.3% size. In all but $1,845 the side for an employment-based retirement plan. The firm cannot afford such a In $501993, ,000 among (married thetaxpayers 54 million filing civilian jointly) workers may not makeparticip a fully ating deductible in any IRA type Salary_ Reduction Plans 1988 1993 1988 1993 smallest employer category, the participation rate among workers where a EBRI has been committed, since its founding in 1978, to the accurate statistical plan of contr employment-based , ibuti noronare the of less workers than retirement $2,000 willing to an plan, dsacrifice a only nonde6 d earnings uctible percent for IRA reported a cplan ontribution having at this point for the Salary reduction plans include 401(k) plans, 457 plans, and 403(b) plans. The plan was sponsored was about two-thirds. In the smallest firms (with fewer analysis in their careers. of economic Of course, security thisissues. generalization Through our does research not coverweall strive small to contributed to an IRA in the previous year (table 1). Therefore, over 90 Firm Size balance, as follows. The $2,000 maximum deductible deduction is reduced by $1 Total 101,745 105,815 26.9% 36.8% 15.3% 23.8% 57.0% 64.6% Revenue Act of 1978 permitted employers to establish 401(k) arrangements, than 10 employees), almost three-quarters of workers where a plan was employers, percent of those and therefore eligible to it make may be a tax-deductible possible to create IRAsome contribution vehicle chose that will not contribute for each $5toofthe inco formulation me between ofthe effective AGI limits. and responsible Individuals health who are andactive Total 15,586 25,148 $2,443 $2,681 Fewer than 10 12,505 9.0 1,792 named after the Internal Revenue Code (IRC) section authorizing them. In Firm Size sponsored chose to participate. Therefore, the positive relationship between appeal to them and that financial companies will find worthwhile to market to to do so. It is often speculated that this is due to a lack of money and a retirement participants policies. or whoseConsistent spouse is with an active our mission, participant we do in a not qualif lobby ied or advocate 10--24 6,537 8.0 1,832 Statement 1981, the Internal Revenue Service (IRS) issued the first set of proposed firm Firm size Sizeand overall participation rates was solely a function of the positive specific small employers policy solutions. and their employees. Fewer reluctance than 10 13,561 to put saving 14,032in a vehicle 3.0 where5.it 1 is beyond2.2reach (without 3.8 74.3 74.3 employment-based plan and whose AGI is at least $35,000 (single taxpayers) or 25-49 4,700 6.2 1,782 regulations covering such plans. These proposed regulations provided some relationship between firm size and sponsorship rates. Lessthan 10 303 536 3,147 1,667 10-24 8,164 8,466 8.0 12.1 5.7 8.4 70.9 69.5 significant at 50-99 least $50tax ,000 penalty) (marriedshould taxpayers 3,553 it be needed filing jointl before y) may retirement 6.6 only make age. Workers 1,729 interpretive guidelines for sec. 401 (k) and specifically sanctioned "salary 25-49 10-24 6,781 6,716 462 14.2 2 714 0.1 7.8 2,406 12.7 2,608 55.2 62.9 100--249 3,614 4.8 2,400 eligible nondeductible for a tax-deductible IRA contributions IRA contribution of up to $2,000; in small earnings firms on were themore likely reduction" plans. Through 401(k) arrangements, participants may contribute 50-99 25-49 5,563 6,185 530 18.0 29.9 850 11 2,311 .0 20.9 2,368 61.2 69.8 Among all salary reduction plan participants, the average amount contributed 250-499 2,037 2.7 1,670 than nonded eligibles uctible incolarge ntributi firms on to arecontribute; tax dBefor eferred ehowever, thunt e il distribute their participation d to the IRA rates Through enactment of the Employee Retirement Income Security Act of 1974 a portion of compensation (otherwise payable in cash) to a tax-qualified 100-249 7,497 7,775 22.8 39.0 13.3 25.0 58.4 64.2 to the50-99 plan was $2,700 613 in 1993 (well below 1,292 the maximum 2,157 tax-deductible 2,480 amount 500-999 2,090 5.4 1,763 were still under 10 percent. holder. IRAs can also be established as rollover vehicles for lump-sum (ERISA), Congress established IRAs to provide workers who did not participate 250 or employment-based more100-249 51,274 54,709 plan. 999 Typically 4,1.5 the 1,944 contribution 53.2 23 is 2,.1 4made 77 as 34.5 a pretax2,461 56.2 64.9 1,000 or more 13,361 4.8 1,992 allowed by law of $8,994 at that time). This was up slightly from $2,400 in 1988 in distr employment-based ibutions from empl retirement oyment-basedplans retirement an opportunity plans to or save otherforIRAs. retirement 250-499 250 or more d 5,471 11,973 Senated Finan 18, ce 49.9 689Committee 2,501 d 32.5 2,780 d 65.2 reduction in (or deferral of) salary that is paid into the plan by the employer (1993 $) (table 3). Except for workers in the smallest firm size category (fewer Salary reduction plans continue to grow as an important element of the on a tax-deferred basis. U.S. tax law has substantially changed the eligibility Annual 2Distributi Eamings, 250-499 ons 1993 from $ IRAs are a taxed as ord 1inar ,780y income in athe year receive 2,609 d, 500-999 d 5,485 d 47.8 d 30.5 d 63.7 on the employee's behalf. 4 In many cases, an employer provides a "matching" than 10 employees), the average amount contributed did not vary greatly with employment-based retirement income system. The percentage of civilian and deduction rules for IRAs since then. The Economic Recovery Tax Act of except 500-999 for the portion of the a total IRA distribut 1,671 ion that is aattributable to 2,615 1,000 or more d 43,753 d 54.3 d 35.3 d 65.0 Less than $5,000 7,007 2.1 1,410 contribution that is some portion of the amount contributed by the employee, firm size. It ranged from a low of $2,400 for participants in firms with 25-49 nonagricultural wage and salary workers with an employer who sponsors a 1981 extended 1,000 or more the availability a of IRAs to 15,438 all workers, including a those with 2,816 n$ o5, nd 00 e0-. du -$9,999 ctible contributions, 8which ,943 are excludable from 3.3 gross income. 1,962 generally up to a specified maximum. The employee pays no federal income employees to a high of $2,800 for participants in firms with 1,000 or more salary reduction plan increased from 27 percent in 1988 to 37 percent in 1993 pension $10,000-$14,999 coverage. The Tax Reform 10,385 Act of 1986 (TRA '86) 3.2 retained tax- 1,485 Taxable distributions prior to age 59 1/2 are subject to a 10 percent penalty tax, tax on the contributions or on the investment earnings that accumulate until employees. The average contribution among those participants with an Source:EmployeeBenefitResearchInstitutetabulationsof the May 1988 andApril 1993 Current PopulationSurvey (table $15,000-2 -$ ). 19,999 Over the same time 7period, ,478 the fraction of all 4.6workers _ participating 1,481 deductible IRAs for those not covered by an employment-based retirement unless they are taken as part of a series of equal payments made for the life Hearing on employeebenefitsupplements. withdrawal. Some plans also permit employee after-tax contributions; the employer with fewer than 10 employees was $1,700 in 1993, down dramatically $20,000-$24,999 4,572 7.4 1,503 Source: EmployeeBenefitResearch Institutetabulationsof the May 1988 and April 1993 Current plan in such but plans restricted rose from the tax 15deduction percent to among 24 percent. those The with fraction a retirement of participating plan to (or life expectancy) of such employee and his or her beneficiary, or the IRA earnings from $3,100 on these (1993contributions $) in 1988. are also not taxed until withdrawal. aThe fractionof workerswhose employersponsorsa salary reductionplan for any of the employeesat the worker's $25 Population ,000-$29,999 Surveyemployee benef3, it1 suppl 79 ements. 8.1 1,601 individuals workers owner dies among o with r bec those incomes omes where disable below ad.salary specified reduction levels. plan In addition, was sponsored TRA '86 also added two b._.hlace of employment. aData notavailable. $30,000-$49,999 4,392 13.1 2,078 increased, new categories risingoffrom IRA contributions: 57 percent to 65 nondeductible percent (table contributions, 2). The growth which in salary e fractionof allworkersparticipatingin a salaryreductionplan. 3The Discussion Revenue Act of 1978 established a new tax-favored retirement plan Public-sector $50,000 or more employers can Individual establish 1,463 Retirement similar plans Accounts under 24.1 IRC sec. 457; 2,121 reduction plan sponsorship and participation has occurred across almost all accumulate tax free until distributed, and partially deductible contributions, CThefractionof workers participatingina salaryreductionplan amongthosewhoseemployer sponsorsa plan for any aimed primarily at small employers--the simplified employee pension (SEP). charitable organizations qualified under IRC sec. 501 (c)(3) (for example, a tax- As seen above, participation rates among eligibles is much higher for worker and job-related characteristics, including firm size. which are deductible up to a maximum amount less than the $2,000 maximum of the employeesat the worker's place of employment. SEPs are arrangements under which an individual retirement account (IRA) is exempt hospital, church, school, or other such organization or foundation), dDatanot available. employment-based salary reduction plans than for IRAs. A relevant question otherwise allowable. 1 Sourc establishe e: Employee d forBen each efit Religible esearch Institute employtabulations ee. These of tharrangements e April 1993 Current are Population sometimes Survey and public school systems and public colleges and universities can establish for policy purposes in considering how best to increase retirement savings is The likelihood of salary reduction plan sponsorship was greater among larger employee benefit supplement. called SEP-IRAs. The Tax Reform Act of 1986 by (TRA '86) added a salary reduction tax-deferred why? annuity plans under sec. 403(b). The 1983 Social Security firms. However, when a plan was sponsored, the participation rate did not According to EBRI tabulations of the April 1993 Current Population Survey feature under which employees in small firms (25 or fewer employees) may Amendments required that a new civil service retirement system be vary with firm size. employee benefits supplement (CPS-ebs), in 1993, among the 54 million elect to have a portion of their pretax salary contributed to a SEP. Such established to cover federal Paul employees Yakoboski, hired Researc after h Asso December ciate 31, 1983. The Probably the single most important reason is the availability of employer civilian workers not participating in any type of employment-based arrangements are sometimes referred to as SARSEPs. An employer may offer Federal Employees Retirement System (FERS), which Congress adopted in 1986 matching contributions with salary reduction plans. Among workers whose Among all salary reduction Emp plan loyeeparticipants, Benefit Resethe archaverage Institute amount contributed retirement plan, only 6 percent reported having contributed to an IRA in the both an employer-funded SEP and a salary reduction SEP as long as the total and which went into effect in January 1987, combines Social Security, a to employer the plan sponsored was $2,700a in salary 1993reduction (well below planthe in maximum 1993, 51.3 tax percent deductible reported amount that previous amount contributed year (table 1). per Therefore, employee does over not 90 percent exceed certain of those limits. eligible to make a defined benefit pension, and an optional tax-deferred thrift plan similar to a their employer provided matching contributions to the plan. The actual allowed by law of $8,994 at that time). tax-deductible IRA contribution chose not to do so. It is often speculated that private-sector 4TRA '86 placed401(k) a $7,000 arrangement. limit on pretax Employees employee hired contributions before the end to private- of 1983 percentage was likely higher, as 30.2 percent did not know if their employer this is due to a lack of money on the part of lower income workers, but these Washington, D,C. sector 401(k) plans. This limit was indexed to the consumer price index were given the option of joining the new system or remaining in the old Civil matched contributions. Among those responding that their employer did As seen above, participation rates among eligibles is much higher for results hold across different income levels. Only 2 percent of those eligible for beginning in 1988. The 1995 limit is $9,240. Service provide Retirement a matching System contribution, (CSRS) during the average a six-month reported period match ending rate was in 65 employment-based salary reduction plans than for IRAs. A relevant question a tax-deductible contribution in the lowest earning bracket (under $5,000 December 1987.5 5The thrift plan is available to workers covered by either the Federal percent (i.e., for every $1 the employee contributed, the employer contributed for policy purposes in considering how best to increase retirement savings is annually) contributed to an IRA. While the contribution rate among eligible Employees 65 cents). Retirement Such employer System matching (FERS) contributions or the Civil Service are notRetirement available with System IRAs. why? Probably the single most important 9 February reason 1995 is the availability of higher earners is greater, the vast majority still do not participate. Three- (CSRS) Such plans, , but different while providing rules appl for y many to theworkers two groups. who may FERS not employees otherwise are have employer matching contributions with salary reduction plans. Also, such quarters of those with earnings of $50,000 or more and not participating in an had automaticall an employment-based y covered underretirement the thrift plan, plan, do andinvolve the government explicit decision contributes While workers reporting an employer match available were more likely to plans tend to be marketed to employees by the sponsoring employer. employment-based plan did not contribute to an IRA (table 1). An additional the equivalent of 1 percent of pay for each employee whether or not the making participateon the in the part plan of individuals than those that reporting will directly no match impact , the their difference retirement was not reason hypothesized for low participation rates among those eligible is that individual income security. contributes. These Emplo decisions yees start may with makewhether further or contributions not to participate of up in to 10 as great as might be expected, according to EBRI tabulations of the April 1993 Finally, another point of note is that, despite the rapid growth in the number individuals, especially lower income individuals, are reluctant to put their percent the plan. of If base workers salarydo(up decide to theto same participate, maximum they asmust 401(k) thenplans). decide The how much CPS-ebs. The participation rate among those reporting an employer match was of defined contribution plans--primarily 401(k) arrangements--in small firms saving in a vehicle where it is beyond their reach (without significant tax The views expressed in this statement are solely those of the author and should not be attributed to the government to contribute will to the thenplan match, and dollar usually for how dollar, that the money first is 3 to percent be allocated of emplo among yee 77.8 percent, compared with a rate of 71.8 percent among those reporting no over recent years, it is at the small plan level where a noticeable gap in plan penalty) should they need it before retirement age. 2 contributions the match. Employe various e The Benefit investment true and Research difference 50 percent Institute options , iniof tsparticipation offered officers the next , trustees by2 the ,percent, rates sponsors plan.between , with or They other nomay those staff. match also The with Employee be have yond a match toBen 5 efit sponsorship remains. The question naturally arises as to what if anything can Research Institute is a nonprofit, nonpartisan, public policy research organization. be percent. decide done how to CSRS fill employer this participants voidmatching ? may contributions contribute up are to 5 topercent be allocated. of their Decisions salaries to do available and those without a match available may have been understated by Workers eligible for a tax-deductible IRA contribution in small firms were the these thrift tabulations plan but to arethenot extent entitled that tothose government who did contributions. not know whether a match not end there. When plan participants change jobs, they receive lump-sum more likely than eligibles in large firms to contribute; however, their distributions of their vested account balances and must decide whether to roll was available were more likely, in actuality, not to have had a match than to 6Workers are immediately vested (that is, entitled to receive nonforfeitable participation rates were still under 10 percent. The IRA participation rate the money over and preserve it on a tax-deferred basis or spend it and in the and have nonrevocable had a match. benefit Other payments studies have from found the plan) evidencein their that the ownavailability of among workers without a retirement plan in very small firms (with fewer process incur federal income and, if under age $9 1/2, penalty taxes. contributions an employer match and any does investment have a more gainssignificant on those contributions. effect on participation. Workers For are than 10 employees) was 9 percent. This dropped to 5 percent for those in firms example, a 1993 Hewitt Associates' study of 401(k) plans found an average also immediately vested in employer contributions counted for ADP (actual with 1,000 or more employees. This may be at least partially explained by the The participation following rate discussion of 77 percent refers to inthese plans arrangements with an employer generically match as as salary opposed to deferral percentage) testing and earnings on those contributions; otherwise, availability of simplified employee pensions with a salary reduction option onl reduction y after plans. having A worked worker'sfor benefit the sponsoring from suchemplo plans yer consists for a minimum of employee an average of 59 percent in plans with no employer match. 7 (SARSEPs) at firms with fewer than 25 employees) contributions, any employer matching contributions, forfeitures of nonvested number of years do they become vested in any employer matching contributions and investment gains on those contributions. benefits by former participants, plus any investment gains and less any In addition, participation in a salary reduction plan is generally more Among those without an employment-based plan who did contribute to an IRA, investment losses. 6 convenient since it is offered through the workplace and involves automatic 7See Hewitt Associates, 401 (k) Plan Hot Topics, 1993 (Lincolnshire, IL: Hewitt the average contribution was $1,845 in 1992 (or slightly under the deductible contributions from a worker's paycheck before he or she even sees it. Plan Associates, 1993). limit of $2,000 for single filers). While those in smaller firms were more Salary reduction plans continue to grow as an important element of the sponsors will also market the plan to their employees and typically educate likely to contribute to an IRA, they also tended to make smaller contributions employment-based them as to the importance retirementfor income their retirement system. According income security to EBRI of tabulations relative to contributors from large firms. The average contribution rate of participating in the plan. With IRAs, on the other hand, an individual must of the April 1993 CPS-ebs, the percentage of civilian nonagricultural wage and participants in firms with fewer than lO employees was $1,792, compared with make a conscious decision to seek out such information on his or her own. salary workers with an employer who sponsors a salary reduction plan (the $1,992 for those in firms of 1,000 or more employees. sponsorship rate) increased from 27 percent (27 million workers) in 1988 to 37 Furthermore, it has been speculated that some workers who are eligible for a percent tax-deducible (39 million IRA contribution workers) in may 1993 not (table be aware 2). Over of their the same eligibility. time period, the fraction of all workers participating in such plans (the participation rate) rose from 15 percent (16 million workers) to 24 percent (25 million workers). Suite 600 4 2 2121 K Street, NW Washington, DC 20037-1896 202-659-0670