Table 2 Civilian Nonagricultural Wage and Salary Workers, Ages 16 and Over, by Salary Reduction Plan STATEMENT OF PAUL J. YAKOBOSKI STATEMENT OF PAUL J. YAKOBOSKI sponsored Social Security, chose to a defined participate. benefit Therefore, pension plan, the positive and an relationship optional tax-deferred between firm thriftsize plan and similar overall to a Sponsorship and Participation, 1988 and 1993 EMPLOYEE SENIOR BENEFIT RESEARCH RESEARCH ASSOCIATE INSTITUTE participation private-sectorrates 401 was (k) arrangement. solely a function Employees of the positive hired before relationship the endbetween of 1983firm weresiz given e andthe Spons option ored Among single workers, only 5 percent of those eligible for a deductible IRA contribution actually Total Sponsorship Participation Participation sponsorship rates. of joining the new system EMPLOYEE or remaining BENEFIT in the old Civil RESEARCH Service Retirement INSTITUTE System (CSRS) during contributed to an IRA in 1992. The likelihood of making a contribution increased with worker Workers Rate a Rateb Ratec a six-month period ending in December 1987.4 SUMMARY BEFORE THE COMMITTEE ON WAYS AND MEANS earnings. Only 1 percent of those eligibles making less than $10,000 contributed, compared with 1988 1993 1988 1993 1988 1993 1988 1993 The higher a workdr's earnings, the more likely he or she was to have a plan available at work. 27 percent of those making $50,000 or more. U.S. HOUSE OF REPRESENTATIVES (thousands) Two-thirds of workers earning $50,000 or more had an employer that sponsored a salary reduction Comparison with IRAs The original objective of establishing individual retirement accounts (IRAs) was to provide a tax- MARCH 19, 1997 T-104 plan, compared with only 8 percent of workers earning less than $5,000 (table 2). Furthermore, Salary reduction plans offer an advantage over IRAs in that the amount that can be contributed on Fifis'-six percent of roamed couples with both spouses working were eligible to make an IRA deferred°°°° retirement saving vehicle for o_o those workers who did oooo_ not have an employment-based Total 101,745 105,815 26.9% 36.8% 15.3% 23.8°/0 57.0°/0 64.6% when a tax-deductible a plan was basis available, is much higher higher. earning The workers maximum were deductible more likely IRA tocontribu participate tionthan is $2,000 lower retirement contribution plan. thatThe was fact at least is that partially today the tax vast deductible. majorityAll of such workers couples eligible with for combined a tax-deductible incomes of earners. Twenty percent of workers earning less than $5,000 contributed to a plan when one was IRA annually contribution , compared do with not contribute. $9,500 for 40 l(k), 403(b) plans, and the federal TSP, and $7,500 for 457 less than $50,000 were eligible, and I0 percent of those with combined incomes greater than I am pleased to appear before you this morning to discuss issues of individual retirement accounts Firm Size offered, plans. Furthermore, compared with the83 limits percent on the of workers salary reduction earning $50,000 plans areor indexed more. for inflation, while the $50,000 were eligible. Among eligible two earner couples, 10 percent made an IRA contribution in (1RAs) and alternative tax-qualified retirement saving plans. My name is Paul Yakoboski. I am a Less than 10 13,561 14,032 3.0 5.1 2.2 3.8 74.3 74.3 IRA maximum is not. However, nondiscrimination standards for salary reduction plans in the 10-24 1992. Among eligible two 8,164 earner couples, 8,466 the likelihood 8.0 12.1 of making a 5.7 contribution 8.4 increased 70.9 with 69.5 In senior 1992,research 89 percent associate of all single at the workers Employee were Benefit eligible Research to make Institute a deductible (EBRI), IRA a nonprofit, contribution, but _ _ __ _ _ _ _i _ __c_ Discussion 25-49 private sector may limit 6,781 the amount 6,716 that highly 14.2 compensated 20.1 employees 7.8 5can 12.7 contribute. In 55.2 some 62.9 only the nonpartisan, couples' 5 percent income. public of those policy Among eligible research couples actually organization with contributed. a combined basedincome in Washington, of less than DC. $10,000, essentially 50-99 As instances seen above, such highly participation compensated 5,563rates among 6,185 employees eligibles may 18.0are notmuch be 29.9 allowed higher to for 11.0 contribute employment-based 20.9the dollar amount salary 61.2 69.8 none contributed, while 23 percent of couples making $50,000 or more made an IRA contribution. 100-249 7,497 7,775 22.8 39.0 13.3 25.0 58.4 64.2 reduction cited above, plans andthan in extreme for IRAs. cases Why? they may not be allowed to contribute anything to the plan as a Fifty-six EBRI has percent been committed, of married couples since itswith founding both spouses in 1978,working to the accurate were eligible statistical to make analysis a deductible of -- _vo_-- - _0_-- _ _E _ Z 250 or more 51,274 54,709 41.5 53.2 23.4 34.5 56.2 64.9 result. Since IRAs are not emplo1_nent-based, they are not subject to such nondiscrimination IRA Married economic contribution, couples security with but issues. only one earner 10 Through percent arc our more of research these likely actually than we strive those contributed. to with contribute two earners to the to formulation be eligible for of a 250-499 d 5,471 d 49.9 d 32.5 d 65.2 standards. Participation in a salary reduction plan is generally more convenient since it is offered through the effective and responsible health and retirement policies. Consistent with our mission, we do not deductible IRA contribution. Seventy-two percent of single earner couples were eligible to make 500-999 d 5,485 d 47.8 d 30.5 d 63 ..7 Statement _ = workplace and involves automatic contributions from a worker's paycheck before he or she even lobby or advocate specific policy solutions. Seventy-two an IRA contribution percent of that single was ea atrleast ner couples partially were tax eligible deductible. to make Thisa included deductible 100 IRA percent contribution, of those 1,000 or more d 43,753 d 54.3 d 35.3 d 65.0 sees Employers the money. will often Plan provide sponsorsmatching will alsocontributions market the plan on to a certain their employees percentageand of typically the earnings educate that a but earning only less 9 percent than $35,000, chose to do 22 percent so. of those earning $35,000 to $49,999 and 16 percent of those _o them as to the Importance for their retirement income security of participating in the plan. With worker chooses to contribute (e.g., an employer may match 50 percent of the first 6 percent of pay earning IRA Usage $50,000 or more. Among eligible single earner couples, 9 percent made an IRA Annual Earnings, 1993 ($) O IRAs, that participants on the other inhand, the plan an choose individual to contribute) must make . aSuch conscious matching decision contributions to seek out are such optional on the Less contribution than $5,000 in 1992. Six 7,595 percent 7 of ,275 those making Before 3.8 less thethan 8.1$10,000 1.1 made a contribution, 1.6 28.0 19.9 Alternatives Through enactment to IRAs exist of thethat Employee allow workers Retirement to save Income money Security for retirement Act of 1974 on the (ERISA), same tax- Congress information on his or her own (unless it is offered through work). Moreover, it has been speculated part of the employer, and thus do not constitute an inherent advantage for these plans over IRAs. $5,000-$9,999 10,119 10,419 8.8 13.1 2.6 4.4 29.7 33.6 compared with 22 percent of those making $50,000 or more. deferred established basis IRAs enjoyed to provide by fully workers deductible whoIRA did not contributions. participate in These employment-based plans, referred retirement to here as plans that They some may,workers however, who serve are as eligible a strong for incentive a tax-deducible to participate, IRA contribution as will be may discussed not belater aware . of their $10,000-$14,999 12,463 15,015 15.3 22.7 5.6 10.0 36.6 43.9 salary an opportumty reduction plans, to saveare foremployer-sponsored retirement on a tax-deferred tax-qualified basis.plans US.offered tax law athas an employer's substantially House Committee on Ways and Means $15,000-$19,999 13,658 14,238 22.2 35.7 10.3 19.5 46.2 54.6 eligibility. While changed IRAs thewere eligibility created and todeduction allow individuals rules forwithout IRAs since an employment-based then. The Economic retirement Recovery plan Tax to Act discretion, and therefore are not available to all workers. Differences between IRAs and salary $20,000-$24,999 10,956 12,408 30.2 43.9 15.5 26.7 51.2 60.8 A second advantage of salary reduction plans over IRAs is that the plan sponsor serves as a save of 1981 for retirement (ERTA) extended on a tax-deferred the availability basis, of theIRAs fact is tothat all workers, the vast including majority of those those with eligible pension to reduction plans include: $25,000-$29,999 9,841 9,737 35.4 46.5 20.0 31.1 56.7 66.8 fiduciary filter for the thousands of investment options available today. Salary reduction plans Another important reason is the availability of employer matching contributions with salary coverage. The Tax Reform Act of 1986 (TRA '86) retained tax-deductible IRAs for those who did make tax-deductible contributions to an IRA choose not to do so. It is often speculated that this is • the amount that can be contributed on a tax-deductible basis is typically much higher than with $30,000-$49,999 20,993 19,858 43.9 57.1 27.8 41.3 63.2 72.4 offer participants a limited menu of investment options from which to choose. The plan sponsor reduction plans. Among workers whose employer sponsored a salary reduction plan in 1993, 51.3 due notan to participate a IRA, lack of in money, an cmployment-based but even among higher retirement earning planworkers, (and if married, those who whose are eligible spouse did for a not $50,000 or more 7,876 8,566 55.4 67.6 40.9 56.3 73.7 83.2 has a fiduciary duty to choose the options offered in a prudent manner. In essence, the sponsor has percent reported that their employer provided matching contributions to the plan. The actual deductible participate IRA in such still a do plan), not, in but gcneral, restricted participate. the tax deduction It is alsoamong often speculated those withthat a retirement individuals plan are to • salary reduction contributions may be limited by nondiscrimination standards, while IRAs are percentage already done was thelikely first higher round of because screening 30.2for percent the participant. did not know if their employer matched reluctant individuals to tie with upincomes their savings belowin specified a vehiclelevels. where In it is addition, beyond TRA their reach, '86 added without two new significant categories tax of not subject to such standards, Hearing on _;_0_. contributions. Among those responding that their employer did provide a matching contribution, penalties, IRA contributions: should theynondeductible need the money contributions, before retirement. which 2 accumulate tax free until distributed, and Sourcc: EBRI tabulations of the May 1988 and April 1993 Current Population Survey employee benefit supplements. • the plan sponsor serves as a fiduciary, filter for the thousands of investment options that are Sec. 401(k) and 403(b) plans can allow loans to participants. Whether a plan has a loan feature is the average reported match rate was 65 percent (i.e., for every $1 the employee contributed, the partially deductible contributions, which are deductible up to a maximum amount less than the aThe fraction available of workers today, whose employer sponsors a salary reduction plan for any of the employees at the worker's place of ,.-. _" employer at the discretion contributed of the65 plan cents). sponsor. SuchTb.e employer federalmatching TSP does contributions have a loan are feature. not available See. 457with plans are Salary_ $2,000Reduction maximumPlans otherwise allowable. The Small Business Job Protection Act of 1996 increased _ _ = employment. • some salary reduction plans allow loans to participants, while IRAs are prohibited from b Savings and Investment Provisions in the IRAs. not allowed to offer loans. IRAs do not have loan features. However, IRA money can be Alternatives to IRAs exist that allow workers to save money for retirement on the same tax- the amount that may be contributed on a deductible basis on behalf of a nonworking spouse (if the The fraction offering of all loan workers features, participating in a salary reduction plan. c withdrawn at any time Administration's for any purpose (it Fiscal is generally Year subject 1998 Budget to a 10 percent Proposal penalty tax if deferred working basis spouse enjoyed is eligible by fully for adeductible deductibleIRA contribution) contributions. from These $250 to plans, $2,000.1 referred to here as The • fraction IRA money of workers canp be artiwithdrawn cipating in at a salary any time reduction for any plan purpose, among but those it whose is typically employer subject sponsors to a a I0 plan for any of the Studies withdrawn have before foundage evidence 59 ½, that in addition the availability to income oftaxation). an employer Salary match reduction does have plans an effect may allow on salary reduction plans, are offered through work at an employer's discretion, and therefore are not employees at the worker's place of employment. percent penalty tax (in addition to income taxation) if withdrawn before age 59 ½, and withdrawals in instances of "hardship," but they are not required to do so. If a plan does not allow d participation. For example, a 1995 Hewitt Associates' study of 401(k) plans found an average available to all workers. However, when they areby available to workers, they do have some The overwhelming majority of those workers cligible to make a tax-deductible contribution to an Data not available. • if a salary reduction plan does not allow loans or withdrawals, a worker cannot access the participation loans or hardship rate of withdrawals, 76 percent in a worker plans with would an not employer be ablematch to access as opposed the funds to in anhis average or herof account 59 advantages relative to IRAs as a retirement wealth accumulation tool. These are discussed shortly. IRA currently choose not to do so. This is true among single workers and among married couples _-_ _._ _" funds in his account under any circumstances until the time he leaves that employer. under any circumstances until the time he or she leaves that employer. percent in plans with no employer match. 6 Similarly, a 1996 Buck Consultants study of 401(k) (both one earner and two earner couples). And it is true across income groups, although those with Paul J. Yakoboski, Ph.D. plans found an average participation rate of 67 percent in plans with no employer match, compared Salary reduction plans include 401(k) plans, 457 plans, 403(b) plans, and the federal Thrift higher incomes are more likcly to contribute when eligible (table 1). Senior Research Associate Salary reduction plans continue to grow as an important element of the employment-based with Partwipation participation rates near 80 percent in plans with some form of employer matching Savings Plan (TSP). The Revenue Act of 1978 permitted employers to establish 401(k) Employee Benefit Research Institute retirement contribution, income v system. The percentage of civilian nonagricultural wage and salary workers Salary reduction plans continue to grow as an important clement of the employment-based arrangements, named after the Internal Revcnue Code (IRC) section authorizing them. In 1981, According to EBRI tabulations of the April 1993 Current Population Survey employee benefits with an employer who sponsors a salary, reduction plan increased from 27 percent in 1988 to 37 retirement income system. According to EBRI tabulations of the April 1993 CPS-ebs, the the Internal Revenue Service (IRS) issued the first set of proposed regulations covering such plans. supplement (CPS-ebs), in 1992, 89 percent of all single workers were eligible to make an IRA percent in 1993. The fraction of participating workers among those offered a plan also increased, percentage Finally, theof other civilian notable nonagricultural point from the wage dataand presented salary workers above iswith that, an despite employer the rapid who sponsors growth over a These proposed regulations pro_ided some interpretive guidelines for sec. 40 l(k) and specifically contribution that was at least pm-tially tax deductible. All such workers earning less than $35,000 rising from 57 percent to 65 percent. The grow_&in salary reduction plan sponsorship and recent years in the number of salary, reduction arrangements in small firms, it is at the small plan salary reduction plan (the sponsorship rate) increased from 27 percent (27 million workers) in Washington, DC sanctioned "salary reduction" plans. Through 401 (k) arrangements, participants may contribute a (86 percent of single workers) were eligible. In addition, 22 percent of single workers earning _--_ _ __ __-- _ -- ._ _ participat/on has occurred across almost all worker and job-related characteristics, including firm level that _anoticeable gap in plan sponsorship remains. The question naturally arises as to what, if 1988 to 3;t percent (39 million workers) in 1993 (table 2). Over the same time period, the fraction portion ot_compensation (other_vise payable in cash) to a tax-qualified employment-based plan. between $*35,000 and $49,999 and 20 percent of those earning $50,000 or more were eligible for a size. anything, can be done to fill this void? SIMPLE IRAs and SIMPLE 401(k)s were created by the of deductible all workers IRA participating contribution.in such plans (the participation rate) rose from 15 percent _'_ (16 million Typically, the contribution is made as a pretax reduction in (or deferral of) salary that is paid into Small Business Job Protection Act of 1996 for this very reason. Time will tell how successful they workers) to 24 percent (25 million workers). The fraction of participating workers among those the plan by the employer on behalf of the employee) In many cases, an employer provides a As wall seen be. above, participation rates among eligibles is much higher for employment-based salary where a salary reduction plan was sponsored (the sponsored participation rate) also increased, "matching" contribution that is some portion of the amount contributed by the employee, generally 19 March 1997 reduction plans than for IRAs. Why'? Likely reasons include: rising l Under from current 57 percent law, individuals to 65 percent who . are Thenot grov_th active inparticipants salary reduction (and,plan if married, sponsorship whoseand spouse is up to a specified maximum. The employee pays no federal income tax on the contributions or on • participation in a sala_ reduction plan is generally more convenient since it is offered through participation not an active has participant) occurred in across a qualified almostemployment-based all worker and job-related retirement characteristics, plan can make including fully tax- firm the investment earnings that accunmlate until withdrawal. Some plans also permit employee after- sizethe . workplace, and involves automatic contributions deducted from a worker's paycheck; deductible contributions up to a $2,000 maximum per year to an individual retirement account tax contributions; the earnings on these contributions are also not taxed until withdrawal, • plan sponsors typically market the plan to their employees and educate them as to the (IRA). Individuals who are active participants or whose spouse is an active participant in a The qualified importance likelihood employment-based of forsalary their retirement reduction plan and plan income whose sponsorship security adjusted of and participating gross participation incomein (AGI) increased the plan; does with not exceed firm size $25,000 Public-sector employers can establish deferred compensation plans under IRC sec. 457; charitable (single taxpayers) or $40,000 (married taxpayers filing jointly) may make a fully deductible IRA (table 2). in 1993, 5 percent of those employed by a firm with fewer than 10 employees reported • employer matching contributions are available in many salary reduction plans; and orgamzations qualified under IRC sec. 501(c)(3) (for example, a tax-exempt hospital, church, contribution. Individuals who are active participants or whose spouse is an active participant in a that their employer sponsored a salary reduction plan, as compared with 54 percent oft_hose • it is possible that some workers who are eligible for a tax-deducible IRA contribution may not school, or other Such organization or foundation) and public school systems and public colleges employed qualified employment-based by firms with 1,000 plan or more and whose employees. AGI falls When between a plan$was 25,000 sponsored, and $35,000 the participation (single and be universities aware of their can establish eligibility_, tax-deferred or they may annuity not beplans awareunder of theIRC inherent sec. 403(b). tax advantages The 1983 offered Social by The views expressed in this statement are solely those of the author and should not be attributed to the an IRA. taxpayers) and between $40,000 and $50,000 (married taxpayers filing jointly) may make a fully rate did not vary systematically with firm size. In all but the smallest employer category, the Security Amendments required that a new civil service retirement system be established to cover Employee Benefit Research Institute, its officers, trustees, sponsors, or other staff. The Employee Benefit deductible IRA contribution of less than $2,000 and a nondeductible IRA contribution for the participation Research Institute rate is among a nonprofit, workers nonpartisan, where a plan publicwas policy sponsored research was organization. about two-thirds. In the federal employees hired after December 31, 1983. The Federal Employees Retirement System smallest balance, firms as follows. (fewer than The $2,000 10 employees), maximum almost deductible three-quarters contribution of workers is reduced where by $1 a plan for each was $5 of (FERS), which Congress adopted in 1986 and which went into effect in January 1987, combines income between the AGI limits. Individuals who are active participants or whose spouse is an 4 The thrift plan is available to workers covered by either FERS or CSRS, but different rules apply 2Distributions active participant frominIRAs a qualified are taxed employment-based as ordinary income planin and thewhose year received, AGI is at except least $35,000 for the portion (single to taxpayers) the two groups. or at least FERS $50,000 employees (married aretaxpayers automatically filing covered jointly) under may only the thrift makeplan, nondeductible and the IRA of the total IRA distribution that is attributable to nondeductible contributions, which are government contributionscontributes of up to $2,000; the equivalent earnings ofon 1 percent the nondeductible of pay for contribution each employee arewhether tax deferred or not until the excludable from gross income. Taxable distributions prior to age 59 1/2 are subject to a 10 distributed to the IRA holder. The Small Business Job Protection Act of 1996 increased the amount indi-vadualcontributes. Employees may make further contributions of up to 10 percent of base percent penalty tax, unless they are taken as part of a series of equal payments made for the life (or salary (up to the same dollar maximum as 40 l(k) plans). The government will then match, dollar life thatexpectancy) may be contributed of the IRA on owner a deductible and his basis or her onbeneficiary, behalf of a nonworking or the IRA owner spousedies (if the or becomes working 6 See Hewitt Associates, Trends & Experience in 401(k) Plans, 1995 (Lincolnshire, IL: Hewitt disabled. spouse is eligible for a deductible contribution) from $250 to $2,000. Thus a single earner couple, for dollar, the first 3 percent of employee contributions and 50 percent of the next 2 percent, with Associates, 1995). if eligible for a fully deductible IRA contribution, may contribute $4,000. IRAs can also be no match beyond 5 percent. CSRS participants may contribute up to 5 percent of their salaries to 3The Tax Reform Act of 1986 placed a $7,000 limit on pretax employee contributions to private- 7 See Buck Consultants, 401(k) Plans." Employer Practices & Policies, September 1996 (New established as rollover vehicles for lump-sum distributions from employment-based retirement the thriR plan but are not entitled to government contributions. sector 401(k) plans. This limit was indexed to the consumer price index beginning in 1988. The York, NY: Buck Consultants, Inc., 1996). plans or other IRAs. 1997 limit is $9,500. 5 See IRC see. 414(q) for definition of highly compensated employee.