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EBRI: Don't Cut Benefit Plan Tax Advantages

By SHRM Online staff  7/14/2011
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Update 7/22/2011

Deficit Proposal Could Modify 401(k) Tax Deferrals


The American Society of Pension Professionals & Actuaries (ASPPA) issued a response to the proposal by a bipartisan coalition of senators known as the "Gang of Six," which could modify the tax deferral for contributions to defined contribution retirement plans.

The senate group's proposal includes a plank to "Reform, not eliminate, tax expenditures for health, charitable giving, homeownership, and retirement, and retain support for low-income workers and families."


Brian H. Graff , ASPPA's executive director and CEO, responded in a statement that "including retirement savings tax deferrals in the same category as permanent deductions and exclusions may put American workers retirement security in jeopardy and not reduce the long-term deficit as expected because the proposal relies on inflated numbers."

Graff continued:

We are very concerned that the proposal lumps retirement savings incentives, which are tax deferrals not exclusions, into the same pot as other incentives classified as tax expenditures. In reality, traditional retirement savings tax incentives don’t eliminate income tax on retirement savings, they defer payment of income tax until workers retire and benefits are paid out. The cost of the incentives is overstated because most of the deferred taxes will be paid after the short-term window used in Washington’s budget scoring. Failure to recognize this bad budget math could decimate savings rates where Americans save most—at work.

A 2011 analysis from the not-for-profit Employee Benefit Research Institute (EBRI) found that the U.S. National Commission on Fiscal Responsibility and Reform's proposed tax changes for 401(k)-type retirement plans would cause the greatest reduction in retirement savings for the highest- and lowest-income workers.

A separate EBRI analysis found that U.S. workers would be more likely to enter insurance exchanges to purchase individual coverage over keeping employment-based health coverage if the tax treatment for health benefits through work were eliminated or cut back significantly as part of the federal debt-reduction effort.

Retirement Plan Contributions

EBRI’s research found that the commission’s recommendation to cap the annual tax preferred contributions for defined contribution retirement plans to “(the) lower of $20,000 or 20 percent of income” (known as the “20/20 cap”) starting in 2012 would most affect the highest-income workers—not surprising, because those with high incomes tend to save the most in these kinds of retirement plans. However, EBRI found that the cap would cause a big reduction in retirement savings by the lowest-income workers as well.

The analysis showed that for each age group (except for the oldest), the lowest-income group would have the second-highest average percentage reductions in 401(k) contributions if the commission's recommendation was enacted. Primarily, this is because their current or expected future contributions would exceed 20 percent of compensation when combined with employer contributions.

“Phrased another way, the 20/20 cap would, as expected, most affect the highest-income workers, but it also would cause a very big reduction in retirement accumulations for the lowest-income workers,” said Jack VanDerhei, EBRI research director.

For 2011, the combination of worker and employer 401(k) contributions is capped at the lesser of $49,000 per year or 100 percent of an employee’s compensation.

The results are from EBRI’s Retirement Security Project Model and were published in the July 2011 EBRI Notes, “Capping Tax-Preferred Retirement Contributions: Preliminary Evidence of the Impact of the National Commission on Fiscal Responsibility and Reform Recommendations.”

Health Plan Coverage 

The tax preference associated with employment-based health coverage is the largest tax expenditure in the U.S. budget, accounting for $1.1 trillion in foregone tax revenue during 2012-16. The National Commission on Fiscal Responsibility and Reform called for reducing the preferential tax treatment of employment-based health benefits as it applies to workers, first by capping them, then by freezing, phasing down and ultimately eliminating them.

An EBRI analysis found that workers would be more likely to enter insurance exchanges rather than keep employment-based health coverage if the tax treatment for health benefits through work were eliminated or cut back significantly. U.S. workers will be able to enroll in state health exchanges beginning in 2014 as a result of the Patient Protection and Affordable Care Act (PPACA), enacted in 2010.

Under the commission's proposal, most U.S. workers would face an increase in taxes, which could lead them to question the value of keeping employment-based health coverage if they had to pay taxes on a benefit that is currently not taxed, EBRI said. Lowest-income workers, in particular, would find the health exchanges more advantageous than employment-based health benefits, while high-income workers would not. And if enough workers did not prefer their employer’s health benefits, EBRI noted, the likelihood that many employers would stop offering health benefits would grow.

“Even if only a fraction workers preferred an insurance exchange over employment-based coverage, it would send a clear message to employers that millions of workers will no longer value the benefit,” said Paul Fronstin, director of EBRI’s health research and education program and author of the report.

The findings were published in the July 2011 EBRI Issue Brief, “Employment-Based Health Benefits and Taxation: Implications of Efforts to Reduce the Deficit and National Debt.”

Employment-based health coverage is the most common source of health coverage in the U.S., EBRI pointed out. In 2009, 59 percent of nonelderly individuals were covered by an employment-based health benefits plan, with 68.2 percent of workers covered, 34.6 percent of nonworking adults covered and 55.8 percent of children covered.

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