The Obama administration’s FY 2014 budget proposal included a cap on tax-deferred retirement savings that would limit the amounts accumulated in specified retirement accounts to that necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan under current law.
The maximum annuity permitted for a tax-qualified defined benefit plan is currently an annual benefit of $205,000 payable in the form of a joint and 100 percent survivor benefit commencing at age 62. This would translate to a maximum permitted accumulation for an individual age 62 of approximately $3.4 mil-lion at today’s interest rates.
The budget proposal is targeted at a wide range of retirement plan vehicles, including individual retirement accounts (IRAs); Sec. 401(a) plans (tax-advantaged retirement plans, including 401(k)s); Sec. 403(b) tax-sheltered annuity plans; and funded Sec. 457(b) arrangements maintained by governmental entities—and, of considerable surprise to many who had been following similar proposals in the past, this proposal specifically includes defined benefit plan accruals, as well. If enacted by Congress, the Obama administration’s proposal would be effective with respect to contributions and accruals for taxable years beginning on or after Jan. 1, 2014.
EBRI’s analysis finds that although a very small percentage of current 401(k) participants with IRA accounts have combined balances sufficient to be affected by the proposed limit immediately, over time—and depending on the applicable discount rates, whether a defined benefit pension is involved, and the size of the 401(k) plan—the impact could be much greater.
Simulation results for 401(k) participants assuming no defined benefit accruals and no job turnover show that more than 1 in 10 current 401(k) participants are likely to hit the proposed cap sometime prior to age 65, even at the current historically low discount rate of 4 percent. When the simulation is rerun with higher discount rate assumptions closer to historical averages, the percentage of 401(k) participants likely to be affected by these proposed limits increases substantially.
For 401(k) participants assumed to have a 2 percent, three-year, final-average defined benefit plan with a subsidized early retirement at 62, nearly a third are assumed to be affected by the proposed limit, at an 8 percent discount rate.
Additional analysis is performed for small plans (those with less than 100 participants) to assess the potential impact of eventual plan terminations if and when the owners and/or key decision makers of the firms reach the cap threshold. Depending on plan size, this may involve as few as 18 percent of the firms (at a 4 percent discount rate) or as many as 75 percent of the firms (at an 8 percent discount rate).