Five years after Congress opened the individual retirement account to all workers, the Senate Finance Committee is trying to shut the door. Some 18 million to 20 million Americans stand to lose tax deductions for their IRAs as the result of yesterday's vote to limit tax-deferred contributions to the approximately 6.5 million people who have no other retirement plan.
Workers who are covered by a company pension plan would no longer be eligible to deduct $2,000 a year ($4,000 for a married couple) from their taxes for an IRA. They could, however, continue to contribute to an IRA with after-tax dollars, and delay paying taxes on the income earned by the account.
"This proposal threatens to destroy virtually all the progress made by Americans in providing for their own retirement," said David Silver, president of the Investment Co. Institute, the trade association for mutual funds. Mark Clark of the U.S. League of Savings Institutions echoed that sentiment, saying, "This is the only incentive to save." The two groups stand to lose billions of dollars worth of business if the committee plan becomes law, but neither would say how much.
Amendments to restore the IRA deduction are expected when the plan reaches the Senate floor in June.
Dallas Salisbury, president of the Employee Benefit Research Institute, argued that it is "really not that big a deal because the lower marginal tax rate 15 or 27 percent, under the proposal combined with the increase in the penalty for premature withdrawal 15 percent , would make it uneconomical to use an IRA even if it were available."
The proposed bill also prohibits workers from having both an IRA and a 401(k) plan. Set up by employers, 401(k) plans permit workers to put part of their income into a special retirement account and defer taxes on it -- just like an IRA.
The Finance committee plan would reduce the maximum annual tax deferred contribution to a 401(k) plan to $7,000 from the present $30,000 or 25 percent of income. The House has a similar cap, but it would allow limited IRA contributions, reducing an individual's IRA deduction by $1 for every dollar put into a 401(k) plan.
A 1983 EBRI study showed that 53 percent of IRA contributors are primarily interested in the tax break, as opposed to saving for retirement. The 11th-hour rush to make IRA contributions before April 15 tends to confirm that. It is considered likely that many people will no longer contribute to IRA accounts if the deduction is lost.
The precise number of IRA contributors is not known. EBRI, basing its calculations on Internal Revenue Service data on returns, puts the figure at 24.4 milion people. The Investment Co. Institute, using telephone surveys by itself and Market Facts Inc., places the number at 28 million households, or up to 40 million individuals.
Total IRA assets now amount to about $250 billion, according to ICI. Mutual funds hold about 16 percent of the IRA funds. Between 7 and 8 percent of all deposits in savings and loan associations institutions are IRA and Keogh retirement plan funds.
Some of the people who now make tax-deferred contributions to IRAs could switch to 401(k) plans, if the finance committee plan becomes law. EBRI estimates that about 20 million people are eligible to participate in 401(k) plans, although only half do so at present. About 80 percent of large companies have 401(k) plans, but just 30 percent of small ones do.
It is likely that the cutback in IRAs would affect women more than men because about 40 percent of IRA contributors are women, but only a third of the 401(k) contributors are female, according to EBRI.
Legislators prefer the 401(k) to the IRA because of provisions that prohibit higher-paid employes from contributing a much larger share of their wages. The IRA, on the other hand, offers a larger tax break to individuals in higher brackets, because the deduction amounts to almost 50 percent in the top tax bracket, but much less for lower-income families. Another reason for tightening IRA eligibility was that some people were borrowing from their 401(k) plans to fund their IRAs and getting two deductions.
There are two other "tremendously significant provisions" of the Senate Finance Committe's package, according to Karen Ferguson, director of the Pension Rights Center.
One would decrease from 10 to five the number of years in service required for workers to "vest" or be eligible to claim benefits from a pension plan. About half of all workers are now covered by a company pension plan. Sen. John Heinz (R-Pa.) has estimated that vesting changes will raise that percentage to 81 percent from the 63 percent that would otherwise be expected by the year 2011.
The second would stop the practice of reducing or wiping out pension benefits by integrating them with Social Security payments.