Growth in Individual Retirement Account contributions could be cut by between $7 billion and $8 billion next year if the House Ways and Means Committee's version of tax reform becomes law, according to pension consultants.
Savings institutions and mutual funds, which hold a significant number of IRA dollars, are lobbying to change the bill while planning campaigns to maintain their share of the market.
The situation arises because the committee's bill would require anyone with a tax-deferred savings plan run by his employer -- known as a 401(k) plan -- to deduct from his IRA any contributions to his 401(k).
The effect would be to make most employes better off putting their money into a 401(k) than an IRA. New limits would result in increased revenue of $4.9 billion over five years.
These so-called "K plans" are employer-sponsored programs under which employes can set aside a portion of their pay in an investment account, deferring taxes on it until retirement. In addition, employers may make matching contributions, which are also tax-deferred.
Under current law, total contributions by both employe and employer are limited to $30,000, or 25 percent of compensation, whichever is less. The committee would restrict the total amount employer and employe can put in to $25,000. This includes a ceiling of $7,000 on employe contributions.
Because of the linkage with IRAs, the employe faces the choice of being able to put a maximum of $2,000 into an individual IRA (or $2,250 total for both spouses' IRAs if one doesn't work) or up to $7,000 for a 401(k). He or she could not contribute $2,000 to an IRA and $5,000 to 401(k). Similarly, the K plan participant, who now has the choice of contributing $2,000 or $1,125 or $250 to the IRA of a nonworking spouse, will be limited to a $250 contribution.
The employe can fund an IRA if the K plan contribution is less than $2,000, but the total of the two cannot exceed $2,000. For example, an individual who put $1,500 in a K plan would be permitted an IRA deduction of $500.
Pension consultants said one of the reasons for this approach is to prevent people from borrowing from a 401(k) plan to fund an IRA and getting triple tax advantages from the two retirement plans and the interest deduction. Massachusetts Mutual Life Insurance Co. estimates that 63 percent of companies with K plans permit employes to borrow from their K plans and thus have the use of the money without having to pay withdrawal taxes. In addition, 89 percent of those surveyed permit hardship withdrawals before age 59 1/2 for reasons such as college education, medical catastrophe or home purchase.
The bill would prohibit deduction of interest on loans from K plans. It also would lower the maximum loan amount by substituting a complex formula for the current ceiling of $50,000. And it would require interest and principal on all loans -- except for those for first-time home buyers -- to be paid on a regular schedule over five years.
The bill also slaps a 15 percent penalty on premature withdrawals, in addition to regular income taxes. Premature IRA withdrawals also would incur a 15 percent penalty, up from 10 percent.
If a worker is able to save the maximum allowed, it would make more sense to put the entire amount -- up to $7,000 -- into a 401(k) because between 84 and 90 percent of companies match their workers' contributions, according to the Employee Benefit Research Institute. The most common match is 50 cents for every employe dollar up to 6 percent of wages.
If all 3.6 million persons who currently fund both IRA and 401(k) plans were to switch entirely to K plans, IRA contributions for the year would be $7 billion less than would be expected if the law were not changed, said EBRI's president, Dallas Salisbury. He estimated annual IRA contributions this year at $32 billion. The $7,000 cap on the amount an individual can sock away in a 401(k) plan also wouldresult in a $300 million drop in expected contributions, which Salisbury expects to reach $13 billion this year.
Wes Howard, editor of I.R.A. Reporter in Cleveland, estimated that new IRA contributions could be cut back by $8 billion, or 20 percent from expected levels, if all those who are eligible switch. Last year total IRA assets grew 23 percent to $39.5 billion by his calculation.
Howard said any mass switch would most affect those financial institutions that do not market 401(k) plans, such as small banks, savings and loans and credit unions. Mark Clark, senior vice president for public affairs of the U.S. League of Savings Institutions, called the link to IRAs a "regrettable" distincentive to savings, but expressed confidence that savings institutions, which have 27.2 percent of IRA investments, would be able to maintain their share of the market.
Stock brokerages also would be hit, because self-directed accounts -- the fastest growing type of IRA -- are rare under 401(k) plans.